Rebound Rally Likely Over

SPX – 1073.69

DJIA – 10,152

June 25, 2010

“Profits always take care of themselves but losses never do. The speculator has to  insure himself against considerable losses by taking their first small loss.”

-Jesse Livermore

I still think most pros remain in the bull market camp, explaining levelheadedly that following an attractive risk/reward bottoming process higher prices and a more speculative psychological phase lie ahead. I noticed several quoting Warren Buffett on buying when others are fearful, sound advice once panic is prevalent but dangerous, in my opinion, early in a bear market before the depth of the bad news is understood. It’s clear these folks don’t understand or believe the SPX’s price and time overbalance indication or Dow Theory bear market signals.

I think the bear market’s “complacency” psychological phase is behind us but it’s early in the “concern” phase. A good example this phase is underway are business story headlines, including several these I’ve plucked from The Wall Street Journal in the back half of this week offset by a few more positive this morning.

June 23, 2010 = States Face New Pinch as Federal Stimulus Money Ebbs

Outlook for Housing Prices Worsens

Middle-Class Tax Boost Is Broached

Business Group Slams ‘Hostile’ Policies on Jobs

Obama Tangles With Insurance Executives Over Pay

U.K. Unveils Severe ‘Unavoidable Budget’

June 24, 2010 = Fed Grows More Wary on Economy

Sales of New Homes Plunge

Confidence Waning in Obama, U.S. Outlook

Negotiators to Ease Finance Rules

Merkel Rejects Obama’s Call to Spend

June 25, 2010 =  Jobless Bill Dies Amid Deficit Fears

Cost-Cutting Detroit Will Close 77 Parks

Lennar Reports Profit, But Home Orders Slip

WPP Sees Advertising Improvement

Seeing Rebound, Firms Spend

Jobless Claims and Layoffs Decline

Further confirmation the concern phase is underway is shown by stock price action as the news unfolds, no better example than the persistent weakness in retailers since the top and as shown in the following Retail HLDRS (RTH) chart. The concern phase is generally the longest in a bear market and once it evolves, the third phase (capitulation) is sure to follow, bringing real fear to the forefront as investors liquidate stocks regardless of value.

After the bear market’s first section down ended on May 25, the S&P 500 (SPX) retraced slightly more than 50% of that decline in an A-B-C rally before reversing Monday, at which point I thought at least one more short-term rally retracing even more of the first section was possible. Market action since indicates that scenario is unlikely.

Peak net volume readings on the rebound, +44.8 for the NYSE and +49.1 for NASDAQ werenot only were unable surpass their hurdle rates but were overbalanced yesterday, (60.6) for the NYSE and (57.3) for NASDAQ, indicating the trend looking out weeks to months is back in synch with the primary trend. The Market Trend Indicator (MTI) swung back to DOWNTREND yesterday as the New York Advance/Decline line fell 1,657 net declines below its 18% weekly exponential moving average, joining the SPX and DJIA which were already below their 18% averages, 1116.18 and 10,406 respectively.

Next week, if June ends with the SPX below 1122.30, it would show an outside reversal pattern on quarterly candlestick chart, yet another indication of lower prices in coming months. That’s close to the 50% level for the 2002-2007 bull market of 1121.44 and it’s also negative from a longer-term technical perspective if the SPX is unable to rise and stay above that point.

Fundamentally, reality eventually intrudes. Broad definitions of money supply are shrinking despite trillion dollar plus deficit spending. If people want to hold more money as opposed to buying goods and services, prices decline, home prices particularly vulnerable despite the lowest average 30-year fixed mortgage rates on record. It looks like nothing but bad choices for the Federal Reserve and Treasury attempting to keep the economy afloat in an increasingly hostile political climate regarding deficit spending, potentially resulting in a dangerous decline in the prices of risky assets, including commercial real estate loans stuffed in bank portfolios. On the other side, there’s the risk of currency debasement and a bond market crash if central banks keep cranking out paper money at full speed.

How is all this reflected in the price action of other key markets? I threw in the towel on looking to short long-term government bonds. Prices rose steadily despite the reflex rally off the May lows in stocks and I don’t like the way markets are acting as though potential deflation is a concern. Ten-year bonds are the strongest.

Despite the recent new highs, I’m not crazy about the light volume on the last rally as reflected in the gold ETF. However the price action looks better in other currencies as flight-to-safety capital moves to the dollar.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

June 25            (Friday)

June 28*          (Monday)

July 1*            (Thursday)

July 9              (Friday)

July 14*          (Wednesday)

July 16            (Friday)

July 22*          (Thursday)

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

Conclusion:

I recommend maintaining stops for long positions for ETFs tied to the SPX just below the June 1 low (1069.89) and under the June 2 low for the NDX (1832.58). I would prefer to initiate shorts as the rally fades but you can’t always get what you want. I would place stops for new shorts above the June 21 high or below the equivalent low for inverse short exchange traded funds (ETFs).

Inverse ETF buy candidates to establish short positions include the ProShares Short S&P 500 (SH) and for double leverage, ProShares UltraShort S&P 500 (SDS). For an index likely to fall more than the SPX, I think the ProShares Short Russell 2000 (RWM) and ProShares UltraShort Russell 2000 (TWM) make sense. Other leveraged inverse ETFs based on sectors I think could fall more than the  general market include ProShares UltraShort Basic Materials (SMN), ProShares UltraShort Consumer Goods (SZK) and ProShares UltraShort Financials (SKF). A little further out the risk curve and after the next short-term rally fades, I may also take a shot with the iPath S&P 500 VIX Short-Term Futures exchange traded note (VXX).

For non-investment professionals, especially those with retirement at risk, it is no time to be exposed to stocks. I recommend raising cash and holding Treasury Bills if you haven’t already taken this action. My technical studies indicate lower prices and panic lie ahead in coming months and that’s when you want to buy, not sell.

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.