Tag Archives: technical analysis

Passing The Stress Test

DJIA

DJIA

SPX

SPX

Nasdaq Composite

Nasdaq Composite

XLF

XLF

 The real stress test has already happened, but these results won’t be publicly recognized. For the last few weeks, the major indices have tested upside resistance multiple times tempting the bears to get back into the game. The remaining uncertainty in the market is significantly less than at the beginning of the year, and the Government’s Stress Test and auto industry turmoil account for a large percentage of the overall market volatility. The results of the Stress Test have been delayed three days, to May 7th. The delay stems from disagreement between the banks and the regulators, and while only delaying the inevitable, is perceived as a positive. There is only one reason the banks would disagree with regulators over the results, because the regulators made a mistake, miscalculated or estimated incorrectly. If the regulators were to overestimate, the banks would never raise attention to it. The disagreement has positive market implications, particularly because most, if not all, negative news has been priced in. This week’s volume was below average, but this is to be expected. Smart money is either already long, or they are awaiting the results of the Stress Test so they can jump into the “healthy” banks. The bears had plenty of opportunities to take this market lower, but failed to succeed, even in the light of a worse than expected GDP.

The first chart is the Dow Jones Industrial Average over the last 20 years, monthly. The Fibonacci retracements suggest important resistance at 8240. Closing above 8240 resistance at the end of May would imply the market has its sights set on the next level, 9650. At the end of May, when the markets have closed above the 8240 level, the uptrend march will  continue. I can see the DJIA testing 10,000 during the summer, but do not expect this to last. Expect the DJIA to retrace all the way back to the 8240 level after touching 10,000. This retracement would be extremely healthy, and would establish a base, or support, on top of current resistance. Establishing support on top of previous resistance has bullish implications, and is exactly what each of the major indices is currently doing.

The second chart is of the S&P 500 over the last 10 years, monthly. The Fibonacci retracements again suggest we are approaching important resistance levels, 880. Closing above 880 for May implies 1014 is next. Again, after touching this level, I expect a retracement to 880. The third chart is of the Nasdaq Composite over the last year, daily. No surprises here, the Nasdaq is also nearing important resistance at 1760. Closing above 1760 for the end of a day would imply 1900. However, I expect the Nasdaq to fill the gap at 1950 before retracing. Depending on the relative strength of the market at this time, I do not necessarily expect the Nasdaq to retrace as significantly as the DJIA or SPX. The fourth chart is the XLF Financial SPDR over the last year, daily. Fibonacci retracements are deliberately not drawn here. Over the last month, the XLF has gapped higher and begun to consolidate. This consolidation is similar to what the indices are doing, except the XLF’s next move is contingent on the results of the Stress Test.

As I mentioned already, these results will eliminate a lot of the uncertainty surrounding the financial sector, and will likely be the necessary catalyst to lift this market higher. It is not a coincidence that the markets appear to be searching for a catalyst, especially since reasons for the market to trade lower have not caused any significant decline. Much of the negative news regarding the banks and any forced capital increases has already been priced in. Citigroup and Bank of America, 2 of the 19 banks preparing to receive results of the Stress Test next week, have been shorted heavily. Rumors turned fact concerning additional capital has hit both Citigroup and Bank of America hard, but most analyst do not expect significantly negative remarks from the Government. Citigroup has already announced the conversion of preferred shares to common at the conversion price of $3.25. The short interest in Citigroup is about 23%, and any relatively good news will cause a huge squeeze. I expect to see Citigroup double before expiration of the June option contracts. The open interest for the June $5 calls is over 1.7 million. The derivative markets are quiet indicators of what’s to come.

Markets do not like uncertainty, and when the banking and auto industry issues have been resolved, expect a continuation of this bull market rally. The three largest contributors to the recent market decline was housing, banking and the auto industry. The housing issues were resolved some time ago when the Government took control of Freddie Mac and Fannie Mae. However, it took until a few weeks ago to empirically support a housing bottom. The recovery of the banking crisis began with the failure of Bear Stearns, showed signs of improvement with the consolidations of Merrill Lynch into Bank of America and Wachovia into Wells Fargo, government intervention with AIG, and the collapse of Lehman Brothers. Thursday’s Stress Test results will conclude the banking industry’s roller coaster ride, and mark the beginning of the financial recovery. The finalization of  the Chrysler/Fiat deal and the restructuring of General Motors will consummate this entire financial crisis. Although it is clear that the auto industry was not initially involved in this crisis, the threat of systemic risk implied by the collapse of the industry exacerbated fear and volatility in the markets. As each of these issues are put further and further in the past, less overall market uncertainty and volatility will exist. This directly implies steady growth, in my opinion, similar to the growth seen in the 90’s. Low volatility and steady growth are characteristic of secular bull markets.

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Sell in May and Go Away?

Friday the major indices ended their impressive six consecutive up week streak[1]. During the streak, the SPX averaged 4.15% return per week with the first week boasting a 10.71% increase. Regardless of what the media or the bears are saying, this rally has substance. A rally of this magnitude should not have lasted as long if the underlying fundamentals were not changing. The real question is whether or not American citizens will pay for this rally in the future. The answer is yes, and they will pay for it in the form of double digit inflation. For the future of this country, let’s hope unemployment begins to decrease before inflation begins to increase.
 
The major indices declined Monday and Tuesday on fears that the Swine Flu would turn into world-wide pandemic. As of Wednesday night, there have been 93 confirmed cases in the United States and one death. The one death in the United States was a 22 month baby in Texas, but the baby was not an American citizen. The baby was a Mexican citizen and was visiting Texas to receive medical attention. Although it is suspected that as many as 160 people have died in Mexico only 8 deaths have been confirmed. Swine Flu is suspected of sickening more than 2,500 people in Mexico, but only 99 cases have been confirmed by the CDC[2]. While this could escalate into a world-wide pandemic if the virus is able to spread to enough people, it is likely to be less serious than the attention it is receiving. Only people from Mexico have died, a fact that scientists cannot explain thus far. It is likely that Swine Flu will pass faster than Bird Flu or SARS[3]. Some of the confirmed cases in the United States did not know they had the virus, which may suggest the virus can be controlled with proper precautions.
 
Last Thursday, jobless claims[4] decreased by less than expected, implying an economic recovery. Although the existing home sales[5] were worse than expected, new home sales[6] exceeded expectations. This mixed housing data supports the notion that the housing market is bottoming. On Tuesday, consumer confidence posted[7] the largest one-month jump in four years. This data sparked an early morning rally, but low volume and Swine Flu concerns caused a late afternoon fade. GDP[8] contracted more than expected for the first quarter of 2009. This news, along with the Federal Reserve meeting, acted as the catalyst for Wednesday’s 2%+ rally.
 
The results of the Stress Test will be announced Monday, May 4th. There have been many rumors surrounding the release of these results, specifically in regards to some of the banks needing additional capital. Citigroup will likely announce the conversion of preferred shares for common shares at the conversion price of $3.25 on Monday following the release of the Stress Test results. The conversion will be an attempt to improve their tangible common equity, one of the main metrics of the Stress Test.
 
Market Fallacy expects the major indices to trade significantly higher over the next seven trading days. Current targets[9] for the SPX and DJIA are 950 and 9000 respectively. Following this explosion to the upside, an ensuing retracement is highly probable. The major indices have established new support above the previous resistant levels, an extremely bullish sign. The markets are preparing for a significant move in either direction, with a slightly higher probability for a move higher. It is not impossible for a retracement over the next two weeks, but unlikely. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets. http://www.marketfallacy.wordpress.com
 
[1] SPX, synonymous with S&P 500, closed down 0.39% for the week beginning April 20
[2] Center for Disease Control and Prevention
[3] Severe acute Respiratory Syndrome
[4] Jobless claims consensus 651,000 vs. 646,750 actual
[5] Existing home sales consensus 4.72 million vs. 4.57 million actual
[6] New home sales consensus 330,000 vs. 356,000 actual
[7] Consumer confidence consensus 30.0 vs. 39.2 actual
[8] GDP consensus -5.0% vs. -6.1% actual
[9] S&P 500 target 950 and Dow Jones Industrial Average target 9000

Support and Resistance Levels for the SPX

SPX

SPX

 Yesterday’s decline was very misleading to a lot people. The market dropped hard and every sector felt the fallout. Because no sector was left unscathed, the effects were magnified. This distortion caused some people to load up on short positions in certain sectors, particularly the financials. However, today’s rally was led by the same financials. Right now the financial sector is the strongest and most influenced by manipulation (term many bears use to describe the government regulation). Please do not fight this trend, the government has made it clear they will do everything in their power, including implementing legislation to benefit the banks. The name of the game is the banks win. On April 24, banks may receive preliminary results from the stress tests and the Federal Reserve is expected to release the methodology for the assessment. Final results are expected May 4.

Today the Treasury Secretary, Timothy Geithner, implied that the stress test results will indicate that most of the 19 biggest U.S. banks will have enough capital. The banks that require further funds are expected to get a mix of converted government preference shares and private money. It is no coincidence that the following this announcement the markets rallied, and were led by the financials. The three largest banks (Citigroup, JP Morgan Chase, Bank of America), by market capitalization, receiving bailout money all advanced at least 9%.

From a technical standpoint, if the SPX can close above the 877 resistance level, the next technical target is 1,008. Closing above 880 and forming a base will be bullish as it will create a new floor about 50 points higher than the previous (830 range). If the markets can consolidate around this level without any significant retracement or without retesting previous levels, we will see SPX 1000 in the near future. Near future here does not mean next week or even next month, but rather implies the SPX will see 1000 before it sees 800. The SPX is still trading within the uptrending channel, and with each passing day, the top of the channel is increasing.

Citigroup (C)

Citigroup (C)

 In a shorter time frame Citigroup is making a bullish flag pattern. According to the technicals, no breakout to confirm this pattern has occurred. In this chart, today’s candle was almost a bullish engulfing candle pattern. I understand that “almost” is worthless, but the price action reveals bullish momentum. Citigroup also bounced off of its 50 day moving average this morning, which is also bullish. If Citigroup closes above the $4.00 resistance level for consecutive days, a breakout to $5.00 would be immanent. I can see Citi reaching the upside resistance of $7.00 around the time the SPX is approaching 1000. I continue to see huge upside potential in the financial sector. I expect today’s trend of the financials leading the market higher. It should be noted that this is not as bad as some (Art Cashin) make it out to be. For many experienced traders, the consensus is that the sector that led into the recession will not lead out. While I will agree with this statement, it is important not to lose sight of the fact that the financial crisis was a direct result of the housing bubble bursting. The financials are perceived as the sector that led the markets lower, but this is only because they are larger and received more media coverage. The financials can and will lead us out of this economic downturn. They will not be the only sector as I expect tech and small caps to excel as well.

Bullish on Oil

U.S. Oil Fund ETF (USO)

U.S. Oeil Fund ETF (USO)

The U.S. Oil Fund ETF attempts to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. I was unable to find a chart that I could annotate and post of the commodity itself, so this will act as a proxy. Addressing the downside risk first, the longer term triangle bearish pattern suggests the possibility of a 50% retracement in the spot price of crude. The realization of this scenario would price crude around $25 a barrel. Technical analysis confirms that my previous downside target of crude under $30 is in fact possible. However, when I made this prediction, crude had not bottomed and the economy was not improving. Commodity prices are more supply and demand sensitive than equities in regards to the physical assets. The pricing of equities is done on a supply and demand basis, but here I’m referring to the availability or use of the physical commodity. This downside price target was plausible, and even likely if the economy would have stagnated in March. The economic improvements have greatly reduced this possibility, but to respect technical analysis, we should not completely eliminate the chance of this downside price target being realized.

The upside potential, on the other hand, looks very promising. Technically, the shorter term pennant bullish pattern suggests the possibility of a 10% increase in the spot price of crude. The realization of this scenario would price crude around $60 a barrel. This short term price target seems very probably as we head into the summer driving season and approach the start of hurricane season. Another pattern found on this chart is the cup with a handle pattern. This pattern is known as a bullish continuation pattern. The cup is not as clear in this chart because it appears a little more “V” shaped than the actual spot price of crude does. The handle is the consolidation that has occurred after crude reached upside resistance around $55 a barrel. The handle typically represents the final consolidation/ pullback before the breakout. The smaller the retracement is, the more bullish the formation and significant the breakout. Based on this pattern, the longer term upside potential is an approximate 40% increase in the spot price of crude oil. This translates to about $75 a barrel, which has been my end of the year price target on crude for about a month now. The volume on the breakout should increase substantially as crude trades above the handle’s resistance. A dramatic increase in volume will be the final confirmation the breakout is underway.
This Bloomberg article supports my assessment on crude.

Dow 10K

SPX

SPX

 I know the title says Dow 10K and this is a picture of the SPX, synonymous with the S&P 500, but they track each other close enough to make the point. In addition, the price weighted nature of the Dow, versus the market capitalization weighted nature of the SPX causes some problems in forecasting. Nevertheless, the market bias is higher.

Chart Interpretation:
I have use Fibonacci retracements to show target levels as well as trend lines that suggest a head and shoulder reversal patter, also known as a Kilroy Bottom. According to the retracement levels, closing above 849.32 on the SPX is bullish and suggests the index will trade higher, more specifically to its next resistance level: 962.25. In my newsletters on www.marketfallacy.com, I called the possibility of a bottom on March 10th just shortly after the intraday lows of 667 on the SPX occurred on March 6th. This link is to the March 10th newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-10-09_2009-03-11.html. In the same newsletter I also suggested it was very likely the SPX would trade at or near 815 and the DJIAat or near 7900. In the weekend edition on March 15th, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-15-09_2009-03-15.html, I called the bottom. With the SPX closing at 806.12 on March 24th, I increased my target  on the SPX to 875, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-24-09_%7C_Dont_Fight_the_Fed_2009-03-24.html. On the 2nd of April, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-2-09_%7C_Cramer_Calls_Bottom_2009-04-02.html, I increased my targets once again. On the 2nd, the SPX closed at 834.38 and the DJIA7978.08. Please do not misunderstand me, I by no means am patting myself on the back for these calls, I simply wanted to post reference points to support why I changed my targets.

In addition, the purpose of bringing up the forecast is to explain what I was seeing when I made these predictions. In another article I’ll explain how I predicted that the DJIA would trade in the 6000’s all the way back in August of 2008 (DJIAwas trading in the mid 11000’s). In early March, I saw the current Kilroy Bottom forming. After drawing a neckline at almost 875, I realized if the trend holds, the SPXwould have to trade above 1000. I know the chart shows a neckline at around 950, but the interpretation of the charts are subjective. On a side note, I believe that if you are truly gifted at the stock market, you should be able to take the same information, the same charts, and tell one person why they should buy, then walk into the next room and tell another person why they should sell. The difference is probability or likelihood that the current trends or information will be realized.

Most bears are calling for a significant retracement. Some bulls are even secretly hoping for a slight pullback in fear that the markets cannot sustain the current up-trend. Let me first begin by saying, I was one of the more bearish traders in the Fall of 2008. Until recently, I thought I was watching the collapse of the greatest empire ever, the United States. However, the last month has given me much hope. America is the land of opportunity, and the current market environment is a huge opportunity. Because of these opportunities Americans have always overcome adversity, whether it’s the bombing of Pearl Harbor, September 11, 2001 World Trade terrorist attack, natural disasters such as fires in California or Hurricanes hitting the coasts of Texas and Louisiana, Americans have always shown perseverance. Unfortunately, in order for there to be good opportunities there have to be bad ones. During the past 8 months talking to different investors, I have continually reminded them that if the want the coin they have to be willing to have both sides, heads and tails. This translates to: If you want economic boom, you have to have economic recession. It’s completely natural, and in fact a very good thing. Through economic recessions, the economy gets rid of the companies that should not be, in order to prepare itself for the ensuing expansion.

I made this reference to the show that I have not always been as bullish as I am currently for two reasons. The first reason is hopefully to establish some credibility and the second, very similar to the first, is so that I could show that I change as the facts change. Until recently, there has been a lot of uncertainty in the market. Generally, markets do not like uncertainty, and as a result volatility increased. During the increased period of volatility, negative news compounded this uncertainty and exacerbated it. This resulted in psychology driving the markets rather than facts. Fear and lack of trust produced the bankruptcy at Lehman Brothers. Yes they were probably insolvent as well, but once there is a run on a bank, it almost always goes under. The bears that are left are hoping for results of the stress test or a bankruptcy announcement from General Motors to reverse this market. I seriously see these events as very positive. It’s about expectations. We all know that GM is struggling, it won’t surprise anyone if  they file for bankruptcy. I think the market might actually rally on this information as there will be less uncertainty. Additionally, results of the stress test will reveal which banks can survive andwhich will fail. Again, uncertainty will exit the markets because the bad banks will fail while the good banks have the backing of the United States Government. I know that this post is under the technical analysis tab, I’m getting to its technical relevance. But first I need to say one more thing about the banks. Some people have suggested that banks raising additional capital is bearish. While I’d agree that this without a doubt means the need more capital, obviously because they wouldn’t raise capital if they didn’t need it, but do not agree that it is bearish. The fact that Goldman Sachs was able to raise $5 billion this week without the backing of the government is huge. It means that once again people are trusting the banks to do what they do.

Now for the technical relevance of all this fundamental information. I think the markets will continue higher to approximately SPX 1000 before any significant retracement occurs. At that time I am going to reduce the size of all my long positions, but I am not going to short the market. My reference earlier to changing when the facts change will be reiterated here. Unfortunately, economists such as Nouriel Roubini are going to all the credibility they have established over the last year quickly. Nouriel Roubini, also known as Dr. Doom, is a professor of economic at Stern school of business at New York University. He predicted the real estate bubble in September of 2006, and the ensuing sub-prime crisis in September 2008. Many people viewed him as very pessimistic, just as they did to me when I told people the DJIA was headed to the mid 6000’s. Nevertheless, he received much credibility and respect for his predictions. Sadly, he thinks the economy has not bottomed, and is on the verge of losing all the credibility he gained in the last two years.

Having said this, as the SPX approaches 1000, I expect a significant retracement in the range of 20-25%. This would move the SPX back down to around 800, still approximately 20% off the March 6th lows. Remember if the SPX does get to 1000, it will have rallied approximately 50% off the bottom with virtually no down movement. Markets do not move in straight lines, although this might suggest otherwise. According to Elliot Wave Theory (EWT), we have ended the down-wave and are now in an up-wave. This change in trend is due to the violation of rule one of the three consistent rules of EWT: 1) wave 4 cannot enter wave 1’s territory 2) wave 3 is never the shortest impulse wave 3) wave 2 never exceeds the start of wave 1.

If the markets continue to follow technical analysis, a continuation of the up-trend to approximately SPX 1000 followed by a 20-25% retracement are supported by the forming of the Kilroy Bottom, Fibonacci retracements, EWT and even fundamental analysis. All of the technical analysis just covered have very similar targets, with a small margin for error. Regardless, it has been very accurate and profitable for me since suggesting the possibility of a bottom in early March.