Bad Moon Arising

Even as the short term firms up, dark portends persist. Today, we review the interim positives – and longer term negatives – as they apply to US equity markets.

The positives are mostly obvious: The line in the sand was drawn on Friday’s low. I expect that to be a very significant number going forward. Prior to Friday, markets struggled to make any forward progress. We saw 6 consecutive down days for the Nasdaq, (8 of 11 red days); the SPX was hardly better, with 6 of 8 days down. Are Buyers running low on fuel, or are participants simply losing interest?

The bounce off of that Friday low has some interesting short term positive attributes. The sharp decline in the put/call ratio, and an increase in the Bearish advisors to over 31% are two signs that too much bearishness had permeated the crowd. Contrarians know these indicators reveal when a sell off creates sentiment that is too negative. That sets up conditions for a needed relief rally – which began Friday.

Further, the rally in US Bonds on the weak retail sales data lend some support to a market rumor circulating that the Fed was ONE and DONE. This helped send the S&P500 to new highs, levels not seen since March 2001. Index highs tend to feed upon themselves. We note also that leadership, which has been sorely lacking in this market, has also appeared: The financials rallied strongly on the back of Goldman Sachs blowout earnings (Lehman, too), with the Amex broker Dealer index up big versus the Bank index.

The negatives involve the usual end of cycle data: The increasingly small number of 52week highs, the weak market breadth, new 52 week lows rising even as markets rally. With fewer stocks participating in the upside, we become overly reliant on shorter term issues like Option expiry. Transports look extended while the Utility average has broken its 50 day moving average. The short interest ratio for the Nasdaq-100 – typically a source of fuel for rallies – is at its lowest level in 3 years. Also of note: next week begins the Q2 guidance/pre-announcement period. Macro issues – especially housing related – abound.

Given how tired the market looks, I suspect that this may be the last run towards our upside target numbers before the old gal gets put out to pasture. There is a very high probability of the indices breaking out to new highs. A failure, however, is potentially very negative. Look for the Dow to make a run at 11,350, the S&P500 to try to reach 1,335, (maybe even 1,350). The Nasdaq 100 could tag 1,795 theoretically. What the hell – let’s just call it 1,800.

I expect this lunge to reach new highs, then fail. We have discussed the many signals prior, while the market has ignored them. We now enter the period where it will become increasingly difficult to disregard these concerns. 

I see trouble on the way.

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