Daily Stock Market Commentary – 5/27/2008

Stock index price action on Monday 5/19/08 fit the definition of a Shooting Star: a Bearish Reversal Japanese Candlestick Signal that implies that the previous uptrend should reverse to the downside. Indeed, stocks fell sharply over the next 4 trading days. On Wednesday 5/21/08, momentum indicators turned Bearish: RSI (14) and Stochastic (14) broke down to their lowest level in more than a month, and MACD Histogram turned negative. The popular S&P DEP RECEIPTS (AMEX: SPY) broke down below an uptrend line rising from its 3/17/08 low. That uptrend line was the lower boundary line of a Bearish Rising Wedge pattern. That breakdown implies a test of the March low.

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. The sum total weight of the evidence for the stock market in general appeared to be taking on more of a Bearish bias last week. 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.

Materials (XLB) Neutral, Market Weight. On 5/16/08, XLB price rose to another new all-time high. On 5/20/08, XLB/SPY Relative Strength Ratio 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.

Utilities (XLU) Neutral, Market Weight. The XLU/SPY Relative Strength Ratio rose to a new 4-month high on 5/22/08. Since 10/17/02, the XLU/SPY Relative Strength Ratio has outperformed substantially. Since 5/15/08, the XLU/SPY Relative Strength Ratio has been rising again. So, Utilities have outperformed the S&P 500 both long term and short term.

Consumer Staples (XLP) Neutral, Market Weight. Since 3/28/08, the XLP/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 an improving intermediate-term trend.

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

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.

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.

Financial (XLF) Bearish, Underweight. On 5/21/08, the XLF/SPY Relative Strength Ratio fell to its lowest level in more than 7 years. 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 Relative Strength Ratio rose to a new 5-month high on 5/23/08. 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. Longer term, the relative trends in larger time frames are not encouraging. The NASDAQ underperformed from 11/7/07 to 3/3/08, when the Relative Strength Ratio fell to a new 9-month low, thereby confirming downtrends in larger time frames.

Growth Stock/Value Stock Relative Strength Ratio rose to a new 3-year high. 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 outperformed since 3/10/08. The Relative Strength Ratio is still in a downtrend since the peak on 4/19/06, however, so the main long-term trend has NOT confirmed the improved intermediate-term trend for Small Caps.

Crude Oil July futures rose again. Trends are still Bullish 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 contract rose again. On 5/16/08, Gold broke out to a new 3-week high and broke a downtrend line from the 3/17/08 top, thereby turning Bullish. 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 underperformed Gold since 10/31/07. Longer-term, GDX significantly underperformed Gold since 10/31/07. Therefore, GDX trends are Bearish relative to Gold itself.

U.S. Treasury Bond prices bounced upward after holding above the lower end of a 2-week trading range. The minor Ripple Trend has been and remains 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 fell to its lowest close in a month, thereby confirming a Bearish minor Ripple Trend. 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 months, 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 47.3% Bulls versus 30.8% Bears as of 5/21/08, according to the weekly Investors Intelligence survey of newsletter advisors. The Bull/Bear ratio held at 1.54, the same as 1.54 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 19.55, is rising, following a 2 month downtrend. Fear had been decreasing but now is starting to rise again. Previously, VIX had been falling since its peak of 32.64 on 3/17/08 to a low of 16.30 on 5/15/08. 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 23.36, is rising, following a 2 month downtrend. Fear had been decreasing but now is starting to rise again. Previously, 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 0.71, which indicates normal 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 1.40, which indicates fairly normal 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. On 5/19/08, the Transports tested their all-time high and failed to make a new high. Meanwhile, the Industrials languished far below their highs. Following such failure to advance, a downside test should follow. The Dow Theory