Thursday, August 02, 2007

Yoyo Market

Another late-day buying spree clinched a positive close, but Thursday remained a tepid day for stocks overall.

If the action had a familiar yoyo twang, it's partly because the NASDAQ changed directions nine times again for moves of 10 points or more. In the past 13 hours of trading, the Composite has now seesawed 18 times in moves greater than 0.4%. This is why the market feels so choppy, and shows the difference of opinion currently gripping Wall Street.

Once again, leading stocks mirrored this indecision. Stocks on the IBD100 under accumulation or distribution were evenly matched at 14 each (on Tuesday, it was 25 each). The most troubling part was that while the IBD100 climbed 0.7% -- less than the NASDAQ -- 72 of 100 stocks saw volume lower than the day before. Institutions aren't buying the fundamental leadership, and this isn't what you want to see in a market trying to put in a bottom.

The chart below shows that NASDAQ volume faded 14% as price climbed 0.9%. This is as good a time as any to mention that true, v-shaped bottoms are rare. Maybe not tomorrow or the next day, but the odds favor a buying hiatus eventually, with prices falling back near the low. Then, if the bulls are right, institutions will pile in and a follow-through day will be born. If this doesn't happen, it's likely that structured credit has produced several more bodies...or worse.

Most ST technical indicators point to more gains ahead, but the path to those gains could be very unpredictable. Season your exposure to taste.

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Since earnings and economic data have generally been good, the market's obvious vulnerability stems from an unknown amount of fetid credit risk, amplified through the yen-based carry trade. Credit malignancies show up unannounced. However, you can keep tabs on the carry trade risk by comparing XJY with SPX.

This first chart below shows that in the years before the carry trade craze hit, XJY (red) and SPX (blue) moved in rough parallel. Important features were different, but the overall direction between them was similar.

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However in 2005, the yen and the SPX began moving in inversion, and the carry trade hit stride. A weak yen partially helped fuel the SPX's rise, and an excess was born.

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This third chart below is the current 6-month version. As you can see, the recent troubles for US stocks began in June. It's no coincidence that as the yen rallied 4.3% in five weeks, the SPX shed 5% -- a fairly tight relationship.

If you want an edge regarding US stock market direction, track XJY.

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One of the bigger problems with this pullback has been market breadth. Even though the NASDAQ dip has been light, breadth has plummeted. This has likely been due to the fact that large-cap strength has held the Composite in place, while the vast majority of stocks have tumbled.

It's hard for the market to move higher with poor breadth, so below are two different ways to keep tabs on this key metric.

NASI breadth is the most famous, but it lags horribly and rarely has anything good to say about breadth (just kidding). Note that it shows a much deeper drop now than during the February pullback. It's also showing zero signs of life.

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Meanwhile, the EMA-smoothed NAAD offers much more timely signals, and reflects a significant bounce back in the past two weeks. I keep an eye on both, and they sit at the top of my list of live charts of the market internals..
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Very intelligent, seasoned professionals insist that the credit contagion threat is an urban legend. Meanwhile, equally intelligent, seasoned professionals view the credit threat as a once-in-a-generation risk to the financial markets. While these are serious issues, from a dramatic perspective, you can't write this stuff any better.

Since there's no way to know for certain who's right, parse the market for clues. Right now, equities are very jumpy, and the ST advantage is still with the bears. However, those EOD rallies are a change of pace. Be ready to seize the moment, but count to 10 a few times before pulling the trigger.

The jobs data will no doubt contribute to Friday's action. See you then.



1 comment:

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