Daily Stock Market Commentary – 5/25/2007

For the fourth consecutive session, the Standard & Poor’s 500 cash index (1,507.51) probed above its all-time high close of 1,527.46 set on 3/24/2000. I previously listed that number as Potential Resistance, below. It is a natural spot for the stock market to pause or reverse trend. Each day, when traders saw that the market could not hold above that level, they dumped long positions. On Thursday, the S&P 500 broke its 10-week uptrend line.

The SPDR S&P 500 ETF (AMEX: SPY), which fairly represents actual trading in the capitalization weighted general stock market, broke down decisively below the uptrend line rising from the low of 3/14/07. The SPY gave us ample warning by forming Multiple Spinning Tops this week. The implication of Spinning Tops is that whatever trend existed previously has lost momentum and is vulnerable to correction or reversal. The relatively long upper shadow and small lower shadow accentuate the failure of the rally to overcome resistance.

The Advance-Decline balance was very Bearish on both the NYSE and NASDAQ. The Cumulative Daily Advance-Decline Line for the NYSE broke down to a new three-week low from a Triple Top formation. Over the past two weeks, breadth has diverged negatively from price, thereby giving warning of trouble ahead. The Cumulative Daily Advance-Decline Line for the NASDAQ has been in a downtrend for the past six weeks.

Trading volume rose both on the NYSE and NASDAQ, indicating more intense selling pressure and confirming the Bearish trend for the short term.

Various momentum oscillators have turned down after clearly losing upside momentum for weeks. They have been overbought and diverging Bearishly from price, thereby giving warning that the time for a consolidation or correction might be approaching. For example, daily MACD applied to the SPY topped out on 4/27/07 and has diverged negatively since then by falling as price made higher highs. MACD crossed under its trailing Signal Line on 5/10/07, and now both MACD and its Signal Line are heading down, indicating that price momentum is heading down. MACD is at its lowest level in five weeks. Also, the MACD Histogram is negative and falling, indicating acceleration to the downside.

Sentiment indicators have been showing extreme and increasing Bullish complacency.

Mergers and acquisitions, leveraged buyouts, and corporate stock buybacks are major Bullish drivers of the Bull market for stocks. I designed the following screen to pick out potential “event” stocks. 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.

The relative ratio of foreign stock markets to the S&P 500 fell slightly. On 5/21/07, this ratio fell to a new nine-week low, thereby confirming again an ongoing downside correction. In the bigger picture, foreign stocks outperformed U.S. stocks since the Bull Market started in 2002. That is a powerful major trend, but all major trends have corrections.

The ratio of the NASDAQ Composite relative to the S&P 500 fell sharply, continuing its downtrend. On 5/17/07, it fell to a new seven-month low, the lowest since October 2006, for a Bearish confirmation for the longer term. The NASDAQ has greatly underperformed the S&P 500 for more than seven years, since 3/10/00. The secular trend is Bearish.

The ratio of Growth stocks relative to Value stocks turned back down again. The previous gain off the low of 5/16/07 had been only a modest fraction of the previous big loss from the peak on 4/27/07, suggesting a weak counter-trend rally. On 5/16/07, the ratio fell to its lowest level in three months, and that was a Bearish trend confirmation for Growth. Growth has substantially underperformed Value since year 2000, so the secular trend is Bearish.

The ratio of Small Cap stocks relative to Large Caps fell again. It is down substantially from its peak on 4/16/07. On 5/17/07, it fell to a new nine-month low, which was another in a series of Bearish trend confirmations for Small Caps. Longer term, Small Caps have underperformed for more than a year, since 4/19/06, so the major trend also is Bearish for Small Caps relative to Large Caps.

The U.S. OIL FUND ETF (AMEX: USO), which reflects the market price of crude oil futures, broke down to the lowest prices in a week. The downtrend was confirmed by rising volume. The Energy Select Sector SPDR ETF (XLE) also broke sharply lower to the lowest prices in a week on rising volume. XLE outperformed GLD again. The stocks of the oil companies have been much stronger than oil as a commodity, and that looks like an important trend.

StreetTRACKS Gold Trust ETF (NYSE: GLD), which reflects the market price of gold futures, fell sharply, breaking April and May lows, thereby confirming a significant downside correction. I had written that the mildly rising price action of previous recent days resembled a common minor countertrend correction pattern, a Bearish Flag. The iShares Silver Trust (AMEX: SLV) broke down to its lowest level in a week. Since Monday, SLV underperformed GLD moderately. Since February, SLV underperformed GLD substantially. The Gold Miners Index (XAU) broke below previous four-day lows and underperformed GLD. XAU fell to a new two-month low on 5/17/07, confirming an intermediate term downtrend. XAU has significantly underperformed GLD since 4/16/07.

The ratio of the price of bond TIPS to 10-year U.S. Treasury Notes eased slightly lower. It is still in a rising trend since 4/16/07, indicating rising inflation expectations.

iShares Lehman 20+ Year U.S. Treasury Bond ETF (AMEX: TLT) made new lows during the trading session but reversed to close slightly higher on the day. The larger trends still look Bearish, however.

The U.S. dollar rose to close at a new six-week closing high, a sign of strength. From 4/25/07 through 5/1/07, the dollar established and tested technical support at 81.10, which was just a little above its 25-month price low at 80.48 set on 12/31/2004. Long-term trends are far from encouraging, however. The U.S. dollar has been in a major Bearish trend for nearly six years, since it peaked out at 121.29 on 7/5/2001. Beyond that, the dollar has been weakening since WWII, so the secular trend is also Bearish.

Liquidity driven merger and acquisitions news has been helping to keep the old Bull alive. Both U.S. and foreign corporations hold excess cash after several years of rising profits, and so M&A speculation as well as leveraged buyouts and corporate stock buybacks have provided substantial Bullish stimulus to stock prices. In 2007, mergers and acquisitions are running about 60% ahead of 2006’s record pace, driven by rising stock prices and private-equity funds that raised more than $250 billion for takeovers since the start of 2006. Takeovers are on track to surpass 2006’s all-time high of $3.49 trillion, according to data compiled by Bloomberg.

Conservative earnings estimates also have been useful in keeping the old Bull alive. First quarter 2007 corporate earnings reflected a significant growth slowdown. Nevertheless, earnings were ahead of expectations, which had been lowered to very conservative levels in advance of actual reporting. Managements and Wall Street have learned that investors hate disappointments, so they simply don’t give them any–unless absolutely necessary.

Stocks generally are fully valued to over priced by long-term historical standards. But that alone does not mean that stocks cannot continue to trend higher.