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June Gloom
The last two weeks have been fraught with uncertainty for the stock market. Friday's spike in the unemployment rate, along with soaring oil prices and foreclosures hitting an all-time high, jolted the market severely (The Dow shed close to 400 points that day). This came just one day after the Dow rallied 200 points in anticipation of a benign report from the labor department. By looking at the closing number on the ISEE equities index on Thursday (a number near 200) indicating twice as many calls as puts being purchased, you could surmise that the majority got it wrong once again.
Fed Chair Bernanke was out making headlines as well this week. For the first time in his tenure, he squarely addressed the inflation issue. The market reacted negatively as they took it for a sign that the easing cycle is probably ending. My guess is that by making this statement, the Fed chief is preparing the market for a policy change in the fall, that is, a possible rate hike. But, how can this be? The housing market is still in a shambles, the economy continues to soften, and consumer confidence hasn't been this low since I was a college freshman (1980). Four words address this question: The United States dollar. If the US Dollar strengthens, oil and other commodities will drop thus easing some of the inflation pressures that now exist. The stock market perhaps will not take this action as lightly in the near-term. Although, I think in the long run it will be a positive.
The recent spate of bad economic reports has been enough to suspend - "the worst is over" trade - at least for the time being. The good news for contrarian thinkers such as myself, is that this information adds more stone and mortar to the wall of worry. This concept comes from the view that when everyone is negative on stocks, then it's safe to say they are probably under-invested, and hence, are sitting on a pile of cash. This also implies lots of buying power on the sidelines. Moreover, short -sellers who have been profiting from a protracted decline will be forced to cover when the market turns, thus increasing the odds that a rally will ensue. On the flip side, as the market rises, more and more investors chase performance by plowing money into equities. In turn, their buying power begins to dwindle, forcing them to become net SELLERS. The higher stocks rise, the smaller the pool of buyers, as everyone wanting to get involved in the market is already in. What's left is a crowded trade - a crowd of SELLERS. At this point, the highest probability is for stocks to fall. The reason this view is important to understand is because, as humans with emotions, we need to fight our natural impulse to chase trades. Realize that when you enter the market after it has had a big run or has sold off sharply, the risk-to-reward ratio is not very favorable. Therefore, restraint must be exercised. Always keep this quote in mind: "The market always travels the furthest with the least amount of participants on board". What this suggests is that by the time everyone finally gets on board, the bulk of the move is done.
In this week's technical review, I'm going to contrast the Russell 2K (ER2), and the S&P 500(ES). What's noteworthy when observing the daily charts below is the relative strength of the ER2 compared with the ES. I draw your attention to the fact that the aforementioned strong contract is still trading above its 50-day exponential moving average and is maintaining the uptrend that began in mid-March. Whereas, the ES has broken well below its EMA and has now begun a correction.
Russell 2K (ER2)
S&P 500(ES)
That big cap (S&P) is weaker partly because of the impact of the toxic financial sector, which continues to be a drag on this index.
In the short-term, all the major indices are in a downtrend, as illustrated by the 15-minute chart of the ER2 below. Notice, however, that a basing pattern is beginning to emerge. The 728 and 736 levels will be key in determining the near-term direction of the market.
The Bottom line: In my last newsletter, I wrote that the ER2 was likely headed higher. Indeed, that was the case until Friday's drubbing. The ER2 peaked at 764.70 on Thursday and has corrected nearly 35 points since then. The market is now trying to regain its footing from that sell-off and is looking forward to this week's inflation number. My view is that this market is wobbly, but is not down for the count just yet. I'm finding way too many people now, calling for oil to go to $150 a barrel or higher. In the past, this has signaled a blow-off phase. In addition, the Bush administration is finally starting to jawbone the Dollar higher. So at this point, I find all these factors supportive for the stock market in the near-term.
Until next time, I hope everyone has a profitable week.
If you have questions, comments or you'd like a specific topic covered, please email me at gvelazquez@tradingacademy.com |
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the
