Saturday, June 23, 2007

Looking Ahead

A thousand words on the Blackstone IPO are pictured at left. No further comment.


The pendulum swung the other way on Friday, as the bulls proved no better at follow-through than the bears. Not only was the 60-minute divergence test a dud, the NASDAQ slid 1% on a whopping 35% surge in volume.

In truth, over 1 billion NASDAQ shares traded at Friday's close as part of the Russell rebalance (Global, 1000, 2000, 3000 and Microcap). The rebalance had little effect on Friday's session other than the settlement spike, and Investor's Business Daily isn't even counting it as a distribution day.

The exclusion is fair because NASDAQ trade was tracking 15% lower -- about 1.7 billion shares -- when the closing spike hit. The 1% loss and volume surge were real, but the selling intensity in this back-and-forth market continues to be conspicuously absent.

As the indexes look poised for disaster, leading stocks continue to show few signs of stress. For weeks, the IBD100 has outran the market on up days, and tracked in-line on down days. While the NASDAQ fell 1.4% this week, the IBD100 added 0.1% and is up 19.3% YTD. This bullish divergence will eventually change, but so far, there's no sign of it. In fact, it continued on Friday.

The IBD100 fell 0.9% -- less than the NASDAQ, SPX or Dow -- and 10 stocks even hit record highs. Breadth was terrible market-wide, but the IBD100 did OK. Just one Dow stock closed higher on Friday, and only 1-in-10 advanced on the SPX. However, on the IBD100, 1-in-5 moved up. The biggest problem was that distribution spread to 26 IBD100 stocks. While this is higher than normal, the average decline for those stocks was just 2%.


What does all of this mean for stocks going forward?

Everyone wants simple answers, but unlike May 2006, it's a mixed picture. Near-term, the market is clearly weak. However, key strengths are in place that could limit downside risk. Longer-term looks even better, as there are no signs that the global expansion is waning.

Below are 10 observations to help frame the mixed outlook, and help determine what the uncertainty means for your investment approach and time horizon.

1. The market is still split, but the tables have reversed. The NASDAQ now leads the market with a 7.2% gain YTD. This ties the Dow, but it's ahead of the SPX's 5.9% gain. The NASDAQ chart below is weak on many technical levels. However, it's still above key support, including the 50-day and 2530. From a TA perspective, it remains in an uptrend.

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2. By contrast, the SPX has acute malignancies and is on the verge of rolling over. While the double-top on the daily has captured everyone's imagination, the weekly SPX shows the double-top playing second fiddle to a bearish expanding wedge. The 40-week is about 4% below. If the SPX spends more than a few weeks consolidating below the red line, it's a whole new ballgame for the US stock market.

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3. A key reason the SPX is failing is that the Financials float in a perfect storm of hedge fund woes, higher rates, housing uncertainties and (now) zealous politicians. It's difficult for the market to make headway without the Financials, although it's worth noting that the XLF is still above its 40-week. Expect a fight at support, with 34 as the point of no return.

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4. Option investors have gradually shifted their bias to puts. This is unfortunate for the TOF Ratio, which on Friday printed a second, negative EMA crossover. While this crossover was weak and undramatic, it technically triggers a Sell. This rarely ends well for stocks.

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5. Speaking of options, the VIX continues to suggest that choppy markets may be around for a while longer. Friday marked the 13th consecutive day that the VIX had an intraday range of greater than 7%. This VIX hyperactivity began with the infamous bond selloff. The fact that it's still going strong even though bonds have stabilized is an indication that hedge fund concerns still weigh heavily on the minds of option investors.

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6. The mainstream press is quick to turn oil into a stock villain on a daily basis, but the market says that -- at best -- it's a wild card. Evidence exists that the market has "gotten used" to higher oil (other global markets sure have). On the chart below, oil surges in 2005 and 2006 pushed the NASDAQ lower. However, by Oct 2006, this inverse effect had faded. Now, crude is back to Aug 2005 levels of $70, while the NASDAQ is 19% higher, and the Transports are 33% higher. There's a limit of course, but $70+ crude may not be the stock guillotine it once was.

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7. Treasury yields are another bogeyman of dubious repute. Utilities, REIT's, Banks and other rate-sensitive groups are reeling from the shock of a 65-bp move in long yields in just 5 weeks. This clearly couldn't have come at a worse time for the struggling housing market. But the rest of the market -- and the world -- hasn't lost perspective that rates are still very accommodative. For the record, 10-year Treasury yields usually live above the Fed funds rate (green line), so expect yields to keep moving higher.

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8. If the US stock market was really poised at the gates of Armageddon, Cyclicals would look very different than the chart does below.

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9. Technology stocks are another key cyclical group showing steady strength. The Tech Index slipped half as much as the NASDAQ did this week, and has weathered the recent volatility very well. For more info on the outlook for tech stocks, see Time for Tech?.

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10. Finally, on Thursday the guys at Bespoke noted that NYSE Short Interest hit another record high in June. Short interest rose 6% in the past four weeks, and has now swelled an eye-popping 30%! over just the past four months. The shorts obviously have big plans for the SPX.

For more information, 24/7 Wall St. highlights short interest moves on individual sectors and names. It's interesting stuff, and even includes short selling info on Warren Buffet's holdings (+44% jumps in both BUD and WFC). The short sellers are counting on weak Q2 earnings. If they come in OK, expect a fresh squeeze to ensue.

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courtesy of Bespoke

The short-term risks for stocks are elevated, and those risks can be catastrophic if you're in the wrong sectors. Meanwhile, the fundamental leadership has been sending a steady message in 2007 that the market isn't on the brink of The Big One.

Maybe not Monday, or next week, or even in the weeks after that, but the market itself is suggesting that stocks are eventually headed higher.

Until Monday, have a great weekend.




Bill Luby said...

Excellent work, dk, particularly vis-a-vis the cyclicals and the tech. I'll be watching the cyclicals more closely in the coming week(s).

Since you're so good at explaining the complex machinations of the stock market, are you going to explain the ending of the movie as well?



dk said...

Thanks, Bill. black stone + enigma = that photo. It's like he made that movie just for Friday's IPO!

If you're curious, one of the best explanations of the film can be found at Kubrick 2001. It's a slowly-paced (sometimes cheesy) Flash presentation, but patience and (wincing) is rewarded. It concisely articulates the themes and meaning of the film, including the famous "IPO" scene from this post. Step into the light - lol.

Aaron from Baltimore said...

Hi this is aaron from and i was wondering if you would want to write on my site. You would be a great addition and we would love to have you, dk.