Daily Stock Market Commentary – 5/19/2008

Friday’s action fit the definition of The Hanging Man: a Bearish Reversal Japanese Candlestick Signal that implies that the previous uptrend should reverse to the downside. It occurs within an established uptrend, such as the one from the March low. It has a small real body (white or black) at or near the high (and, therefore, it has little or no upper shadow). Although the color of the real body is not critical, black is more bearish than a white, and we saw a black real body on Friday. Also, it has a long lower shadow, like legs dangling down from the real body. The hanging man’s small real body implies the previous uptrend is losing momentum. The next period’s action (on Monday) would confirm the bearish implications of the hanging man if there is a downward window (gap) or a long black candle. It seems possible that Friday’s session, which included options expiration, might have ended the rally, as options expirations sometimes have in the past.

I have been assuming that the March-May rally was nothing more than a counter-trend rally and Secondary Reaction Continuation Pattern within the context of a Primary Bearish Trend. That may yet prove accurate. The sum total weight of the evidence for the stock market in general appears mixed, so a cautious approach still seems prudent.

Spotlight on event stocks: Here is a stock screen I designed to pick out potential “event” stocks, both Bullish and Bearish. Sometimes, stocks with large changes in price and volume are revealed to be deal stocks, sooner or later, or are the subject of some other extraordinary events, positive or negative.

Energy (XLE) Neutral, Market Weight. On 5/16/08, both the XLE price close and the XLE/SPY Relative Strength Ratio rose to new all-time highs, again confirming a major uptrend.

Materials (XLB) Neutral, Market Weight. On 5/16/08, XLB price rose to another new all-time high. On 4/16/08, both the XLB price and the XLB/SPY Relative Strength Ratio rose to new all-time highs, confirming the major uptrend.

Industrial (XLI) Neutral, Market Weight. Since 3/31/08, the XLI/SPY Relative Strength Ratio has underperformed moderately.

Technology (XLK) Neutral, Market Weight. On 5/15/08, the XLK/SPY Relative Strength Ratio rose to a new 4-month high, confirming again an improving intermediate-term trend.

Consumer Staples (XLP) Neutral, Market Weight. Since 3/28/08, the XLP/SPY Relative Strength Ratio has underperformed moderately.

Utilities (XLU) Neutral, Market Weight. Since 10/17/02, the XLU/SPY Relative Strength Ratio has outperformed substantially. Since 1/24/08, the XLU/SPY Relative Strength Ratio is flat, meaning that Utilities have performed in line with the S&P 500.

Consumer Discretionary (XLY) Bearish, Underweight. Since 1/5/05, the XLY/SPY Relative Strength Ratio has underperformed substantially. On 1/11/08, the XLY/SPY Relative Strength Ratio fell to a new 6-year low, confirming a major downtrend.

Health Care (XLV) Bearish, Underweight. Since 10/9/02, the XLV/SPY Relative Strength Ratio has underperformed substantially. On 5/15/08, the XLV/SPY Relative Strength Ratio fell to another new 6-year low, again confirming the existing Primary Bearish trend.

Financial (XLF) Bearish, Underweight. Since 3/23/04, the XLF/SPY Relative Strength Ratio has underperformed substantially. On 3/17/08, both absolute price and the XLF/SPY Relative Strength Ratio fell to their lowest levels in nearly 5-years, again confirming a major Bearish trend.

Foreign stock indexes are outperforming. EFA outperformed since 2/8/08 and, longer term, since the major bottom on 3/12/03. EFA is the ETF representing the EAFE, the international developed country stock markets, ex the U.S. and Canada.

NASDAQ Composite price outperformed since 3/3/08. Therefore, one might argue that the 2-month Relative Strength trend has been improving. But longer term, the relative trends in larger time frames appear to be contradicting. The NASDAQ underperformed since 11/7/07 and, on 3/3/08, Relative Strength fell to a new 9-month low, confirming downtrends in larger time frames.

Growth Stock/Value Stock Relative Strength Ratio has been in an uptrend for the intermediate term, since 2/1/08. Long term, the Growth/Value ratio (IWF/IWD) has been in an uptrend since 8/8/06.

The Small Cap/Large Cap Relative Strength Ratio has been rising since 3/10/08. But the Relative Strength Ratio is still in a downtrend since the peak on 4/19/06, so the main long-term trend is Relatively Bearish for Small Caps.

Crude Oil June futures rose to a new all-time high, confirming uptrends in all time frames. U.S. OIL FUND ETF (AMEX: USO) is not a pure play on Crude Oil, although it generally moves in the same direction.

The Energy stock sector has underperformed Crude Oil since 12/10/07.

Gold June futures turned Bullish. Gold broke out to a new 3-week high and broke a downtrend line from the 3/17/08 top. Longer term, the 7-year trend is still Bullish.

Silver is still lagging Gold. Silver sharply underperformed Gold since 3/5/08. In addition, iShares Silver Trust (AMEX: SLV) has been relatively weak compared to Gold longer term, since 12/7/06. Finally, for the past 28 years, since 1/2/80, Silver has underperformed Gold.

The Gold Miners ETF (GDX) / Gold Bullion Relative Strength Ratio fell to another new low on 4/29/08. Longer-term, GDX significantly underperformed Gold since 10/31/07. Therefore, GDX trends are Bearish relative to Gold itself.

U.S. Treasury Bond prices are flat. The minor Ripple Trend is neutral/sideways. Bonds have traced out Secondary Reaction, intermediate-term downside correction phase since the price peak on 3/20/08. Bond prices benefit from fears of financial crisis, and they correct to the downside when financial crisis takes a back seat to some other news of the day.

The U.S. dollar broke down below 2-week lows. The minor Ripple Trend is down. The major Primary Tide Trend of the dollar remains down.

The Art of Contrary Thinking: Traders need to be extremely nimble to keep up with rapid changes in the mass mood of late. The business and financial news has flipped from fear to hope and back again many times in recent weeks, creating an extremely choppy trading environment. Investors’ moods and stock volatility have jumped up and down abruptly with the latest “reports”. When mass psychology shifts so dramatically and unpredictably from hope to fear, without warning, risk control becomes more important than aggressive profit seeking. Stay flexible.

Sentiment/Contrary Opinion: There were 46.0% Bulls versus 29.9% Bears as of 5/14/08, according to the weekly Investors Intelligence survey of newsletter advisors. The Bull/Bear ratio rose to 1.54, up from 1.37 the previous week. The ratio’s 38-year range is 0.28 to 17.51, and the median is 1.47.

VIX “Fear Index”, now at 16.47, is in a downtrend, meaning that Fear is decreasing. VIX has been falling since its peak of 32.64 on 3/17/08. The all-time high was 45.74 on 10/8/98. The all-time low was 9.89 on 1/24/07. VIX is a market estimate of expected constant 30-day volatility, calculated by weighting S&P 500 Index CBOE option bid/ask quotes spanning a wide range of strike prices for the two nearest expiration dates.

VXN “Fear Index”, now at 20.00 and falling, is in a downtrend, meaning that Fear is decreasing. VXN has been falling since its peak of 35.63 on 1/22/08. The all-time high was 114.23 on 10/8/98. The all-time low was 12.61 on 7/29/05. VXN measures NASDAQ Volatility using a method comparable to that used for VIX.

CBOE Put/Call Ratio is 0.59, which indicates relatively neutral sentiment. Its 4-year simple moving average and median are 0.62, and its 4-year range is 0.35 to 1.28.

ISEE Call/Put Ratio is 1.42, which indicates relatively neutral sentiment. The ratio’s 4-year simple moving average is 1.50, 4-year median is 1.47, and 4-year range is 0.51 to 3.04.

Fundamentals: The 2003-2007 Bull Market was fed by abundant global liquidly, M&A, leveraged buyouts, corporate stock buybacks, and the net balance of positive earnings surprises. The unfolding fallout from the subprime credit market crisis has derailed that engine. Economic statistics and corporate earnings have been weakening.

A Secondary Reaction was signaled on 4/18/28, when the Dow-Jones Industrials and Transports both closed at 3-month highs. But the Primary Tide Major Trend still may be Bearish. The Dow Theory confirmed a Primary Bear Market on 11/21/07 when both the Dow-Jones Industrial Average and the Dow-Jones Transportation Average closed below their respective closing price lows of August, 2007.

To discover the next Resistance, traders probably will be watching how the market acts at the following levels for the Standard & Poor’s 500 cash index (1,425.35):