Benefit of the Doubt Goes to the Bulls

SPX – 1136.94

DJIA – 10,625

“Greek civilization peaked about 2500 years ago and hasn’t been very important for the past two millennia. Today, when we think of Greece, we think of cruising theMediterranean. I can’t think of one significant product I own that is Greek. If Greece disappeared, I doubt it would make a difference to my economic life. Indeed, I doubt it would make much difference to the economic lives of almost anyone outside of Greece. Yes, there are banks in Europe that own some Greek debt but the recent Eurozone bailout package probably means those bonds won’t default for another year or two at a minimum.”

-James Meyer, CFA, Tower Bridge Advisors, May 17, 2009

Time did not overbalance for the S&P 500 (SPX), indicating the weakness from the April 26 high (1219.80) is a correction and higher prices likely lie ahead in coming weeks. Still, price overbalanced after a three or four section advance, often a clue that it’s late in the cycle and the next intermediate advance could be the last. Most recently, this phenomenon occurred in 2007 when price overbalanced after the high in July and the SPX rallied to a new all-time high in October unconfirmed by the Advance/Decline line and marking the bull market’s end.

Today’s cyclical bull market gets the benefit of the doubt until proven otherwise. I suspect the May 6 low (1069.65) marked the correction’s low and yesterday’s test was successful. With volume worse than breadth, there was enough weakness to force out a lot of the trend followers, zap investor sentiment and set up short sellers for more pain. Nevertheless, it’s a cut and chop sort of market, probably late in the cycle, a circumstance that causes me to trim position sizes, while attempting to buy as close to the low as possible.

The Market Trend Indicator (MTI) is in NEUTRAL territory. Both the SPX and DJIA are below their respective 18% weekly exponential average, 1155.48 for the SPX this week and 10,737 for the DJIA. The New York Advance/Decline line is 932 net advances above its 18% average.

Peak net volume readings are (80.6) for the NYSE and (74.0) for NASDAQ. I mentioned a (71.1) figure last week for the Russell 2000 (RUT) but that should have been the S&P SmallCap 600. I don’t have volume data for the Russell 2000 but it must have been on my mind because I was short that index. I covered much of my short position yesterday and lowered the stop buy point on what’s left to just above last Thursday’s high to insure a profit on the trade. I know, I cut profits, basing my actions on technical evidence and bias, educated or not, but Mr. Market’s in a tricky, devilish mood.

Peak net volume readings on last week’s bounce were +53.3 for the NYSE and +53.2 for NASDAQ. Yesterday’s net volume readings on the test were (55.0) for the NYSE reconfirming downtrend while NASDAQ showed more strength with a (38.0) reading. for NASDAQ. Net volume readings above the test figure on both indices would confirm an MTI uptrend reading. Intermediate-term net volume readings also overbalanced to signal downtrend, (28.0) versus a +26.9 hurdle rate for the NYSE and (26.9) versus a +22.8 peak reading on its prior intermediate-term advance for NASDAQ. Peak reading for the cyclical bull market, +31.0 and +40.2respectively for the NYSE and NASDAQ were not overbalanced, so the reading is applicable to the intermediate-term trend and not the primary trend. I use daily net volume signals to trade moves lasting weeks to late while intermediate-term signals often come too late to trade, as I suspect was the case last week. However, a rally to new highs, if unconfirmed by weekly net volume, would constitute a warning.

I think the Nasdaq 100 (NDX) and small cap indices fell more and bounced back more than the SPX and I think are likely outperform the SPX on the next rally. Dollar strength, fears of a double dip in Europe and its impact on a slowdown in China appear to be behind the weakness in oil, copper and other commodities. Gold bucked the trend, up against every currency, including the dollar. While the dollar most likely backs off if I’m right about the stock market, I wouldn’t be surprised to eventually see it rally above it 2009 high.

I don’t expect Basic Materials to maintain leadership beyond the initial bounce. As for gold, I think its advance has the potential to accelerate if the dollar backs off. Gold and Gold Mining climbed back into the top ten group relative strength list. Last weekend’s Financial Times reported that frantic over the eurozone bailout, Germans lead gold rush frenzy.

I plan to re-establish a short position in long-term bonds, with an initial stop against via inverse exchange traded funds (ETFs) such as TBF (ProShares Short Barclays 20-yr+ Treasuries), SHV (iShares Short Barclays Treasuries) and for more leverage, TBT (ProShares UltraShort Lehman 20-yr. Treasury). I’ll start with stops against the May 6 high with plans to tighten them as soon as possible.

FORTUNE magazine interviewed Oaktree Capital’s Howard Marks. He explained, “John Kenneth Galbraith said there are two kind of forecasters: the ones who don’t know and the one who don’t know they don’t know. I put myself in the former category. We don’t have an economic forecast. But we’re not counting on a high degree of prosperity in the years that lie immediately ahead.”  I seem to share Marks’ worries which follow.

“No. 1, that the economy is highly reliant on the government stimulus program. What happens when they’re withdrawn?

No. 2, the economy is reliant on artificially low interest rates. What happens when they rise to normal levels?

No. 3, there are still a lot of problems to be worked out in commercial real estate, and a lot of banks still hold a lot of commercial mortgages.

No. 4, the main source of energy in the economy over the prior 20-yers has been the consumer, who did his part by spending more money than he made. Where does growth come in the next five                       years if the consumer doesn’t go back to doing so?”

Just when you thought we were free from global warming, last month was the warmest worldwide April on record since records were started in 1880. At least U.S. and credit card delinquencies and charge-offs continued to decline for the same month. From the big number file, the Bank for International Settlements (BIS) reported the gross value of derivative trades declined 33% in 2009 to $21.6 trillion from $32.4 trillion and down 15% from $25.4 trillion at mid-year.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 27            (Thursday)

June 2              (Wednesday)

Jun 11             (Friday)

June 14            (Monday)

June 25            (Friday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Conclusion:

Time did not overbalance, an indication higher prices lie ahead in coming weeks. A SPX close above 1155.48 and DJIA close above 10.737 would signal uptrend and confirm another quick shake is past. I expect small cap stocks and the NDX to lead the SPX on the next intermediate advance and recommend ETFs tied to those indices. My recommended stop point for remaining shorts is just above the SPX’s May 13 high (1173.57).

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.