Uptrend, Nearly a Clean Sweep

SPX – 1115.01

DJIA = 10,525

July 27, 2010

“The Satan of bad news always hits hard and suddenly. It is his nature. The good news ‘angels’ work gently and slowly. That is why a market drops by itself, but it takes hard work to push it up.”

-George Seamans,1954

The Street just sighed when Europe released stress test scores for its banks last week, a better outcome than the quick selling triggered by sovereign debt fears accompanying first quarter earnings releases, indicating potential bad is mostly priced in for now, including a new 2,300-page bill regulating the lifeblood of U.S. capitalism. Rowdy day-to-day swings, positive more often than not, compelled momentum traders back to the long side. Technically, it’s important for price to follow-through enough to drive prices over the halfway point of the March 2009 low-October 2007 all-time high (SPX-1121.44) and then above the June 21 highs (1131.23).

As it often is, NYSE net volume was first to signal a possible change in the downtrend, a +74.0peak reading on July 9 overcoming its (61.0) hurdle rate. The Market Trend Indicator (MTI) confirmed on last Thursday’s close, switching to UPTREND, followed Friday by the 21-day rule and 3-day swing chart pattern for the S&P 500 (SPX). Dow Theory and NASDAQ net volume joined the parade yesterday, nearly a clean sweep. Those not interested in technical minutiae may want to jump forward a few paragraphs.

The 21-day rule signals uptrend when the SPX trades above its highest level of the previous 21 trading days and the indication stays in effect until the SPX trades under the lowest point of the prior 21 days. As for the SPX’s 3-day swing chart, an uptrend is indicated by a pattern of lower lows and higher highs. Within the MTI, the New York Advance/Decline line was the first index to close above its 18% weekly exponential average, the troops leading the generals, but the SPX and DJIA are now back in step, both above their 18% average, 1089.05 and 10,246 respectively this week. The A/D line is 7,074 net advances above its 18% average and only 1,102 net advances below its all-time high.

Net volume recycled on the last short-term decline after the close July 20 with a peak readings of (43.5) for the NYSE and (18.0) for NASDAQ, neither greater than the prior short-term rally peaks, followed yesterday by the NYSE reconfirming uptrend with a +72.2 and NASDAQ indicating uptrend with +62.7. Weekly net volume was +24.3 for the NYSE and +23.7 for NASDAQ, still under their (28.3) and (29.8) respective hurdle rates but a strong rally this week could swing this indicator. For new readers interested in understanding how I use net volume, it’s time well spent, in my opinion, to read my June 6, 2010 post, Tactics and Discipline Matter.

Dow Theory indications are based on closing prices. The following charts show the pattern of lower highs and lower lows (below the flash crash lows) in May, revealing the primary trend as down under Dow Theory. However, note the nonconfirmations on that decline when the DJIA fell below its February low but the DJTA held above its. Both the DJIA and DJTA closed above their June highs yesterday, indicating uptrend and the possibility the bear market signal was invalid. I would give yesterday’s signal greater credence if price and time hadn’t overbalanced for the SPX but they did. Still, it’s the sort of market action that is generally followed by further gains.

Here’s one last technical observation I picked up from Ken Winans to minimize whipsaws after long-term market reversals. Prices often rebound after the first signal to an area around or just above an index’s 200-day moving average. Confirmation that the primary uptrend is reasserting itself (or vice versa) comes when the candlestick bodies on daily charts trade above the 200-day moving average of the highs for three consecutive days, or 1120.97 on the SPX as of today.

After underperforming a couple of weeks, small cap stocks rose the most last week, likely aided by short covering to some degree. Small cap companies start reporting earnings in earnest next week and it’s always fascinating to track the stocks react on both makes and misses.

Much like small cap, the Materials and Industrial sectors were up the most, with strength in Steel, Coal, Copper and commodity-based emerging markets as well as Home Builders. Tobacco moved up to number one on the top ten group relative strength list as Gold Mining fell to sixth place. Healthcare stocks were hit last week for multiple reasons, including earnings and guidance. There’s little in group action to confirm the market’s rise to date will carry it out of its trading range, thus raising another dilemma for trend followers such as myself. “Range-locked price action is prima-fascia evidence of control by contrarians, who ten to blunt advances by selling into rallies and then support prices by buying into strength,” explained Gary Anderson in this week’s equityPM commentary (www.equityPM.com).

Among groups, second quarter results at major U.S. banks confirmed bad debts are shrinking but there’s not much demand for credit in a soft economy, The Economist headline summing up the situation, Surviving but not thriving. Deleveraging is ongoing with no easy way out of the debt burden in developed countries. At some point the U.S. is likely to have a hard time selling its debt and the Fed will have to be the buyer, greatly expanding the money supply.

Note how Barclays 20-year+ Treasury ETF (TLT, my proxy for long-term government bonds) is sitting right on its rising trendline, a trendline I think is likely to break if and as the rally in stocks continues. The easiest way for stock traders to go short this market is via inverse ETFs, including ProShares Short Barclays 20-year+ Treasury (TBF) or for more leverage, ProShares UltraShort Barclays 20-year Treasury (TBT). My recommended stop position on any shorts is just above the TLT’s July 21 high (102.28).

As for gold, I’m still receiving “get rich” direct mailings but there are no shortage of warnings in the financial press, reminding me of  Internet stocks in the back half of 1999. I suspect the pullback doesn’t last as long or carry as far as the cycle guys expect but that’s bias and remains to be proven. A 2^nd London fix below 1136.50 would warn me I’m wrong. My recommended trailing stop sell levels are just under the February 5 low ($1058 2^nd London fix) for more recent purchases and under last September’s low ($989.50) for long held investment positions. There’s nothing new on the dollar at this point other than it’s back to being one sick puppy.

Highlights from 1910

Beyond immediate concerns, there’s little doubt democracy and capitalism are accelerating the path of progress. A friend sent me a list (making the rounds via Internet) of what life was like just 100 years ago.

The Eiffel Tower was the tallest structure in the world.

The American flag had 45 stars.

There were only 8,000 cars and only 144 miles of paved roads.

The maximum speed limit in most cities was 10 mph.

Fuel for the Model T and other cars was sold only in drugstores.

Marijuana, heroin, and morphine were available over the counter in drugstores.

The average life expectancy for men was 47 years.

Pneumonia/influenza was the leading cause of death.

More than 95% of all births took place at home.

Ninety percent of all doctors hadno college education.

Only six percent of all Americans graduated from high school.

Two out of every ten adults couldn’t read or write

The average U.S. wage in 1910 was $0.22 per hour.

The average U.S. worker made between $200 and $400 per year.

A mechanical engineer could earn about $5,000 per year.

Hetty Green was worth more than $150 million.

Only 14% of the homes had a bathtub and only 8% had a telephone.

Sugar cost $0.04 a pound, eggs $0.14 a dozen and coffee $0.15 a pound.

Most women only washed their hair once a month, using Borax or egg yolks.

Canada prohibited poor people from entering into their country for any reason.

There were about 230reportedmurders in theentire U.S.

The population of Las Vegas was 30. How desperate were these folks?

Canned beer, and iced tea hadn’t been invented yet.

The Milken Institute reported California lost 10,600 jobs in the ten years through 2008 plus approximately 25,000 related jobs, totaling about $2.4 billion in lost wages over the decade. Making matters worse for Hollywood types, radio frequency tags are making it harder to steal underwear from Wal-Mart.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

August 3*       (Tuesday)

August 9         (Monday)

August 11       (Wednesday)

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

Conclusion:

I know I said I would defer counter-trend trades, but I’ve got a rule to buy when the MTI, net volume, 21-day rule, and 3-day swing charts all signal uptrend, regardless of how wary and distrustful I may be. These sort of conditions often carry higher than anticipated but no one really knows. Given the contrary nature of group action, I’ll stick to ETFs tied to the Nasdaq 100 with stops under July 20 3-day swing low, 1056.88 for the SPX and 1784.55 for the NDX). For existing shorts, I wouldn’t have stop positions any higher than just above the June 21 high (SPX-1131.23). If stopped out, the plan is to short again on the next signal. As for investors, don’t lose sight of  the operating realities of the businesses you own in a world in which the major economic powers are still deleveraging.

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.