Daily Stock Market Commentary – 5/30/2007

Stock market momentum failing. Volume weak. Bonds breaking down. But M&A active.

On Tuesday, major U.S. stock price indexes started on the upside in response to M&A news, but it was all over by 10 a.m.

The two-day rally attempt (Friday and Tuesday) recovered a typical fraction of Thursday’s steep loss. The combined high-low ranges of both Friday and Tuesday were contained entirely within Thursday’s range, suggesting consolidation of losses. The short-term trend implication is that price likely will exit the two-day range in the direction that continues the previous trend, which in this case is down.

Trading volume rose modestly but remained at very low levels, probably indicating uncertainty after last week’s technical trend line break.

The Advance-Decline balance was moderately Bullish on the NYSE and a bit less Bullish on the NASDAQ.

The Standard & Poor’s 500 cash index (1,518.11) appears to have stalled out near its all-time high close of 1,527.46 set on 3/24/2000. The area around an old high makes for a natural zone for a market to pause or reverse trend.

Last week, 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 and remains below it. The SPY gave us ample warning by forming Multiple Spinning Tops last 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 shadows and small lower shadows accentuate the failure of the rally to overcome resistance.

Various momentum oscillators turned up slightly on Tuesday. But they have been losing upside momentum since late April-early May, have been overbought, and have been 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. 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 and falling.

In the news, M&A reports and speculation captured attention in early trading. The Royal Bank of Scotland-led group launched an offer for ABN Amro. Tishman Speyer and Lehman Brothers were reported to be close to a deal to acquire Archstone-Smith—which was previously highlighted on this page for extraordinary positive price and trading volume change. BMW was reported to be interested in buying Ford Motor Co’s Volvo unit. Avaya–which was previously highlighted on this page for extraordinary positive price and trading volume change–was reported to be a buyout target by private equity firms. URS agreed to buy engineering and design company Washington Group. Norsk Hydro and Rio Tinto reportedly are considering making bids for Alcan.

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.

Among the nine major U.S. sectors, six rose and three fell. None moved more than 1.00%.

The ratio of the EAFE (international developed country stock markets, ex the U.S. and Canada) relative to the S&P 500 appears short-term neutral. In the bigger picture, foreign stocks outperformed U.S. stocks since the Bull Market started in 2002, and that is a powerful major trend that continues.

The ratio of the NASDAQ Composite relative to the S&P 500 rose slightly but remains in a 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 has recovered modestly since the low on 5/16/07, but the larger trends remain Bearish.

The ratio of Small Cap stocks relative to Large Caps (Russell 2000/Russell 1000) has been heading down since 4/19/06, so the major trend is Bearish for Small Caps relative to Large Caps.

Semiconductor Holders (SMH) had a very unconvincing two-day rally and now could turn down again.

The U.S. OIL FUND ETF (AMEX: USO), which reflects the market price of crude oil futures, fell to its lowest price level since 5/9/07, confirmed by rising volume. That ought to be Bearish.

The Energy Select Sector SPDR ETF (XLE) also fell on rising volume. XLE outperformed USO again, as usual. Since 3/2/07, the stocks of the oil companies have been much stronger than oil as a commodity, and that looks like an important continuing trend.

StreetTRACKS Gold Trust ETF (NYSE: GLD), which reflects the market price of gold futures, has lost some downside momentum but still is probably in an ongoing and significant downside correction.

iShares Silver Trust (AMEX: SLV) possibly could be in a short-term recovery mode, but the larger silver trend is no better than neutral since the top on 5/11/06.

The Gold Miners Index (XAU) has been underperforming GLD since 4/16/07. Longer term, XAU has underperformed GLD since 5/31/1996. Apparently, XAU remains out of favor.

The ratio of the price of bond TIPS to 10-year U.S. Treasury Notes has been in a rising trend since 4/16/07, indicating rising inflation expectations.

iShares Lehman 20+ Year U.S. Treasury Bond ETF (AMEX: TLT) fell to its lowest price since 8/15/06, confirming the main trend as Bearish.

The U.S. dollar rally since 5/1/07 appears to have stalled out over recent days, and the short term trend now looks neutral. Long-term trends remain Bearish. 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.

The U.S. stock market has shown impressive Bullish resilience since the major low on 10/10/02, more than four years ago. Stock prices have been buoyed by abundant global liquidly (following years of fiscal stimulation, rapid money supply growth, and rising corporate profits), M&A, and earnings comparisons above expectations. Still, periodic downside shakeouts are normal, and the world is a volatile place where the unexpected is always possible, so stocks are never without risk.

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.