Saturday, June 16, 2007

The Bull Lives On

Despite six weeks of effort and a lethal arsenal, sellers were unable to deliver the kill shot this week. As a result, the major indexes escaped into the sunset on Friday.

Well, actually the NASDAQ bolted to a six-year high on a 26% surge in volume!

While it's tempting to give Friday's big volume a Quad Witch asterisk, remember that real money was used to trade those shares. Option expiration or not -- and even during OE selloffs -- all volume counts.

Frustrated sellers are "blaming" a familiar list of nefarious causes for this week's rally. Tainted inflation data, PPT intervention, global liquidity, the "sheeple" effect and even Bradley turn dates are each taking their turn on the dais of shame. However, the real reason for this week's surge is far more interesting:

The selling dried up.

When things are bad, there is never a shortage of stock for sale. However, for the past 9 weeks, each time that shares flooded the market, buyers stepped in to scoop up the inventory. In fact, NASDAQ 2530-ish (chart below) has been tested 10 times since April. Each time support held, culminating in the dramatic Triple Support test on June 8. Five sessions later, the Composite tagged a new, 6-year high.

This isn't the market action of amateurs. Investors have had ample opportunity to weigh in, and something's clearly going on here. Based on the market's behavior since July 2006, that "something" is probably simple and familiar: the upcoming earnings season will be solid yet again.

The stock market is a selfish, one-trick pony. Treasury yields, gasoline, housing, China, the dollar -- you name it, it only matters if it does one thing: impacts earnings. As long as corporate earnings are OK, stocks will eventually keep going up. Heaven help us when earnings finally disappoint.

At the daily level, the chart below shows that nine weeks of brutal consolidation have left the major indexes with significant technical damage. The most glaring is MACD. On the NASDAQ, eight direction changes since April(!) have caused this momentum indicator to diverge from price. For MACD to heal, a break above the dotted downtrend line is a critical first step.

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The weekly chart smoothes out the volatility and shows a much clearer picture of just how bullish the market really is. Notice that momentum has continued to climb, while the 10-week line was tested in 4 of the past 5 weeks. This past week saw a record high on a bullish engulfing candle. Throw in stochastics and this is a very nice-looking chart with room to run.

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Even in the financial markets, humans need a steady parade of disposable villains to help process fears of the unknown. 2007 has seen the housing crisis, inverted yield curve, Chinese stocks, higher oil, Q1 earnings and sell-in-May each take their turn in the barrel. The result of these threats is an 8.8% gain in the NASDAQ.

Now, rising Treasury yields are the Vader de jour. The chart below shows that all yields have done over the past five weeks is return to where the Fed left them a year ago. The market was shocked by the abrupt change, but that surprise won't last. Rates remain historically low, and the FOMC continues to have little reason to change policy in either direction.

Considering Friday's new NASDAQ high -- and the wick below -- investors have already begun the process of shopping for a new villain.

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A classic candidate for New Villain is energy. Oil finally broke above 12-week resistance with no hurricanes in sight, and energy stocks are under accumulation.

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The VIX appears to have given another Buy signal this week. Even though the bond debacle saw the SPX slip just 3.4%, options volatility completely lost its mind and the VIX popped 36%. Time to try decaf?

There's an interesting volley going on between Adam at Daily Options Report and Bill at VIX and More about the near-term future of the VIX. Adam feels a return trip to the single digits is in store; Bill lays out a great argument of how this is unlikely. Though Adam's take is historically more favorable for stocks, recent VIX performance tips the debate in Bill's favor. Both of these guys are very good, but regardless of who is correct, the Sharapova/Ivanovic pics make the debate worth following. :)

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Finally, contrarian bullishness is alive and well, as the 6-year NASDAQ high appears to have succeeded in making investors even more bearish. Despite impressive internals, soaring market leadership and record highs, the AAII Bull Ratio ticked lower. Also, across the web, head-n-shoulders chatter has now morphed effortlessly into "abandoned baby" warnings! This rally continues to offer very little pleasure for the average investor.

Dr. Brett has published a two-part series called, Trade Like a Scientist. It's a learned, critical version of "follow the ball" (sort of), and in a market like this, it's a worthwhile read.

It's a beautiful weekend in Los Angeles and we've been enjoying the sun today. Pool party tonight!

Hope you're having a great weekend.




I.L. said...

"time to try decaf?": excellent. Thanks for my laugh du jour.
I.L. (musingsofatrader)

dk said...

Thanks, I.L. Glad to oblige. Part of that California laid-back thang - lol.