Wednesday, May 23, 2007

The Greenspan Put

Marketwatch posted a representative headline on Wednesday:

Stocks end lower after Greenspan's China comment. Let's listen in...

"...and they have this really cool flag with these five yellow stars..."

Regarded by many as financial America's crazy Uncle Al, Greenspan got blamed for yet another market event on Wednesday. The only problem is that the actual selling pressure started almost an hour after his comments hit the wire.

The mainstream press needs a "reason" for things, but observant investors know that Wednesday's reversal likely has its roots elsewhere. Distribution days, a wobbly TOF Ratio, negative MACD divergence and almost a million consecutive up days all point to a market in search of a rest.

As some lace up their grave-dancing shoes, it's worth noting that the sellers have their work cut out for them. While there's record short interest, massive option hedging, and a ProShares feeding frenzy, the IBD100 still isn't attracting any sellers. The IBD100 slipped the same as the NDX on Wednesday, but its breadth was better and it had 16 record highs. Most surprising of all, just 15 stocks printed distribution days. Within the fundamental leadership, the selling isn't off to a very good start. Of course, that can change very quickly.

Market internals were actually quite strong before the market reversed. Afterward, they were negative of course, but hardly lopsided. On a reversal day, New Highs still swamped New Lows, 483-81.

The market has given plenty of warnings to adjust risk to taste. Wednesday was the 4th distribution day in three weeks, MACD has diverged, stochastics are overbought, and that's a nasty-looking red candle. However, volume picked up just 4% after tracking much stronger earlier in the day. When the selling started, volume backed off.

Considering the Composite failed at exactly 2600, technical selling accounts for some of Wednesday's move. What happens next is impossible to know, but the chart below is certainly a wobbly piece of business.

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The bond market is finally throwing in the towel. Despite a housing and auto recession, the conditions for a rate cut simply aren't there. Both the FOMC and the stock market have consistently indicated this since summer 2006, but until recently, bond investors were unconvinced.

Greenspan wasn't alone on Wednesday, as rising rates were also blamed for the selloff. Maybe so, but the chart below shows that rising rates -- like the inevitable destiny of the Chinese stock market -- are a surprise to no one (the Banks certainly weren't surprised). Unless unemployment rises, rates will continue to meander towards 5.25%, and some of that bond money will eventually flow into the stock market.

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There's no way to know how much selling lays ahead. Technically, the market has been flashing a variety of warning signs, and if you aren't in your comfort zone by now, you could be in for a bumpy ride. Tomorrow and Friday see manufacturing and housing data, which sometimes moves the market and sometimes not.

Keep an eye on the fundamental leadership and the volume, and your odds of success are greatly increased. Watching the TOF Ratio doesn't hurt either.

I'm traveling tomorrow through June 3(?). See you from the road.



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