Impending Crest

SPX – 1197.52

DJIA – 11,092

“The trend is your friend unless the trend is about to end.”

-Tom DeMark

A Jerry Favors “sell-the-next-rally” daily swing chart pattern came into play April Fools day for the S&P 500 (SPX). That pattern is complete, warning that the tax deadline April 15 high (SPX-1213.92) likely ended the intermediate-term advance that started February 5 at 1044.50. Volume picked up on the last breakout, a tape reading tell that the swing chart might sing the right tune.

I think it’s late in the move either way. My plan is to cinch trailing stop sell orders even tighter, particularly alert for technical evidence to identify a change in trend when it occurs. Other than overbought/oversold indicators, non-confirmations are conspicuously absent, evidence that intermediate-term weakness, when it arrives, is likely a correction in an ongoing cyclical bull market.

The Market Trend Indicator (MTI) continues to signal UPTREND with each key index above its respective 18% weekly exponential average, 1156.00 for the SPX and 10,726 for the DJIA. With a positive weekly streak alive at ten weeks and counting, the New York Advance/Decline line, is 6,780 net advances above its 18% average. If one or two averages trade below their respective 18% average, the MTI shifts to neutral; if all three do a downtrend reading comes into play.

The 21-day rule stays on uptrend status until the SPX trades below the low of the prior 21 trading days. The SPX’s 21-day low is 1152.88, rising to 1161.48 in a couple of days. Net volume readings remain in synch with the uptrend. Hurdle rates that need to be overcome to indicate a change are +53.3 for the NYSE and +44.5 for NASDAQ.

Small cap stocks outperformed large cap on the advance since February and since the bull market began. The headings don’t match up but that’s just me having trouble working with WordPress. The first column is performance on the rally from the February low and the second column is performance for the bull market.

Index Feb-Apr Rally Cyclical Bull Market

Russell 2000                           +24.9%                                   +111.7%

S&P SmallCap 600                +24.0%                                   +111.5%

S&P MidCap 400                    +22.3%                                   +109.5%

Nasdaq 100                             +19.1%                                   +100.3%

S&P 500                                   +16.2%                                   +  82.1%

DJIA                                         +13.4%                                   +  72.4%

Sector                              Feb-Apr Rally Cyclical Bull Market

Industrial                                 +44.3%                                   +115.9%

Financials                                +26.7%                                   +191.2%

Consumer Discretionary       +23.7%                                   +116.4%

Materials                                    +19.3%                                   +  98.4%

Infotech                                      +17.9%                                   +106.2%

Telecommunications               +17.3%                                 +  64.1%

Technology                                +16.2%                                   +  85.9%

Energy                                         +14.9%                                   +  62.8%

Consumer Staples                    +  9.6%                                   +  46.2%

Healthcare                                  +  9.5%                                   +  53.3%

Utilities                                        +  7.2%                                   +  42.7%

Among sectors, Materials and Energy haven’t surpassed prior highs through mid-April, an indication these areas could fall more than average on any correction. Healthcare is barely below an earlier high (double top?) and Utilities are well below a prior high, but I suspect money moves to defensive groups at the margin, so they don’t make good short candidates. Within Healthcare, Pharmaceuticals have been underperforming for three months, including last week. Of the 100 Dow Jones groups I track, it’s the worst performing and a likely good place to hide for investors that need to stay fully invested.

As for Financials, they performed well until the Goldman Sachs fraud charge came out of left field. Banks bounced back yesterday; nothing like financing costs near zero in a steep yield curve environment, exemption from marking the worst assets to market and large trading profits and fees from derivatives transactions to boost profits despite declining lending volumes.

No shortage of pundits leapt to Goldman’s defense. For my two cents, I don’t think the Abacus transaction passes the smell test, at the least highlighting the conflicts of interest in a large connected brokerage gaming the system. At least we don’t have to worry about Goldman having access to the best legal representation money can buy.

Is there any reason for synthetic credit default obligations (CDOs) to even exist besides the fat fees? Loan originations aren’t necessary. A synthetic CDO is a portfolio of credit default swaps (CDS), financial agreements between two parties to exchange the credit risk of a reference entity or user. The CDS buyer pays a periodic premium for credit protection on a notational (specified) amount of debt exposure while the CDS seller receives the premium but assumes the risk of large losses in event of default.

As for government bonds, and despite no shortage of looming supply, the rally is near short-term resistance but I think it could carry further if stock prices correct. Using TLT (Barclays 20-yr.+ Treasury ETF) as a proxy, I’m keeping trailing stop buys on short positions just above the March 18 high (91.98).

The U.S. Dollar index continues to only mark time in spite of Euro concerns. A trade above the March 25 highs (82.24) would indicate higher prices lie ahead in coming weeks in my opinion, perhaps even testing the early 2009 high, while a trade below the March 17 low (79.50) would signal to me the rally is over, ultimately followed by weakness dragging the dollar below its 2008 low.

Gold is holding its steep trajectory but it’s hard for me to imagine the blow off move I envision without dollar weakness. My recommended stop level for new positions is under the March 25 low ($1093 2^nd London fix). If prices were to crack, a trade below the June 2009 high ($981.75 2^nd fix) would indicate to me the bull market ended with a whimper, but that’s not what I expect.

“Congratulation, you’ve just finished working for the government. April 9 was Tax Freedom day, the day on which Americans earned enough to pay their federal, state and local taxes as calculated by the Tax Federation,” wrote Bloomberg’s Caroline Baum. Arthur Brook pointed out that IRS data shows that the top 5% earn 37% of total income and pay 60% of Federal individual income taxes while the bottom 50% account for 12% of total income but pay just 3% of Federal income taxes.

Harmonic Preview:

(High Probability SPX Turning Point or Acceleration Days)

April 28           (Wednesday)

May 3              (Monday)

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

A SPX rally starting today that doesn’t carry above last Thursday’s high (1213.92) and followed by a decline below yesterday’s low (1183.68) would indicate a shift in the short-term trend. As for the hourly chart, the SPX likely moves back above its rising trendline from the February low on the open and if it then again breaks the trendline, it would hint that change in the short-term trend is forthcoming.

Conclusion:

I think it makes sense to keep trailing stop sell orders at tighter than normal levels. For exchange traded funds (ETFs) tied to both the SPX and Nasdaq 100 (NDX), I recommend a stop sell levels just under the 20-day moving average or 1183.46 as of today for the SPX and 1980.48 for the NDX. I had been recommending a point 1% below the 20-day moving average.

When the trend reverses, and given the contrary nature of group rotation, I plan to short the strongest areas not the weakest; those would be ETFs tied to small cap indexes and materials. Appropriate inverse ETFs include SBB (ProShares Short S&P SmallCap 600) and RWM (ProShares Short Russell 2000) and for double leverage, SDD (ProShares UltraShort SmallCap 600), TWM (ProShares UltraShort Russell 2000) and SMN (ProShares UltraShort Basic Materials).

For investors, it’s a good time to kick out issues you really don’t want to hold during a correction. As for broad exposure to stocks, the SPX is a long way from any sort of signal that would say to run for cover.

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.