Tuesday Market update

It was impressive while it lasted. The S&P 500 managed to remain above it’s 50-day moving average for five days before succumbing to a sell off in the last two sessions – a pull back that has not only retraced most of last weeks’ Monster Monday rally, but has closed below the difficult-to-dominate 50-day moving average.

You will hear on the news and read in the headlines that the government’s balking on the automakers restructuring plan or the need for more bank bailout money is the reason the market fell today, but if you followed our updates last week the writing was on the wall.

The market was technically overbought to the extreme, and has been for many days. Any reason at all could have been given for the sell off during the last two sessions.

My personal thinking is that the news on the automakers was more positive than negative. The automakers need a real good excuse to be able to negotiate more sternly with the unions, bond holders and creditors. They got it today, when the administration refused to accept the automakers’ restructuring proposals.

To the viewing public, it should have been a breath of fresh air that for once, a no-questions-asked bailout was turned down. The public is growing weary of trying to solve every business problem that comes along with a basket of money.

And yet the stock market chose this comparative good news on the automaker’s troubles as an excuse to take profits.

A more meaningful reason for the recent sell off might be what Geithner had to say last Friday and over the weekend on the Sunday news programs regarding the mighty big holes that still exist in the banking system – holes that the administration remains convinced can only be filled with more and more money.

You see, the $700 billion TARP funds are almost gone. Geithner admitted that only $135 billion remained and that a number of banks will need a great deal more to achieve sufficient solvency to not threaten the US financial machine. There is no question than the current banking system has turned more than rusty since coming to a halt over six months ago. Realistic estimates to fix the financial system are in the several trillions of dollars.

One could easily make the argument that the entire banking system could have folded up, gone away, and the trillions of dollars of bailout monies could have been used to set up a completely new banking system that would be devoid of “toxic legacy assets” and have boatloads of cash to lend.

Don’t you love the new “legacy assets” moniker the government is starting to use rather than “troubled assets” or “toxic assets”? Why politicians think they can put lipstick on a pig and decide it looks so much better is beyond me – and the opposite side of the aisle is letting this one go, too. Clearly, both parties are in bed on this one.

And there’s the real rub. Blue collar workers in the largest US manufacturing industry are being told to get a little thinner – that the $20-$50 billion needed to keep them going is just too much to ask. And while I agree from a philosophical viewpoint that bankruptcy and re-negotiated union contracts and pension programs are the only real long-term salvation for the dying U.S. automotive industry, I venture to say that thousands, if not millions of workers in the extended automotive industry feel differently and are quite bitter about the preferential treatment given to their white-collar counterpart failures in the banking system.

The differential in magnitude of dollars committed to these two too-big-to-fail sectors is breathtaking.

The tone appears set for the week with chances for another week of gains at very low odds. Short interest has already taken off again, particularly in the financial sector. This strongly suggests that much of the March rally was short-covering that lasted much longer than usual, as short positions were pressured over and over again. But with a consistent return to short interest, the long-term confidence needed to sustain a bullish trend may not be there yet.

This financial weakness is global in nature, as Spain announced today that their government has taken over a major Spanish savings bank and their country has just experienced a year-on-year decline in consumer prices – the first European country to declare such news.

Should the S&P 500 remain below its 50-day moving average once again, then a retracement decline and possible test of the March lows could be on its way. I am doubtful that the March lows will be extended to the downside with new bear market lows and feel that the strength of the recent rally over the last three weeks was sufficient to create a higher low in the coming days.

I am watching for a higher low and then a higher high to develop before I conclude that the initial bear leg is “in” and that a bear market breather may allow a reasonable advance for a few months – before a big and hopefully final assault on the 2007-2009 bear market lows, later this year or next year.

If you are long right now, be careful and be prepared for retracement in the coming days. If you are considering buying the dips, be forewarned that the short-cycle technical tools may not be reliable for determining the depth of a pull back in prices, just like they were unreliable in determining the extent of the recent advance.

Overbought and oversold conditions are likely to be extended, much like we have seen in the latest two huge swings in prices.

Too many investors and institutional players are trying to time the market as a technique for capturing gains to offset recent losses. This may be one of the more treacherous times for an individual investor to try and beat the market.

The market doesn’t know which way the next trend will likely be or how far it will run, let alone the technical analysts charting and monitoring, as they try to get their hands around this beast.

I continue to recommend caution and a defensive posture, feeling we are now in a pull back period.

Monday Market Update

Buying exhaustion may be setting in. The selling today reversed yesterday’s gains and leaves the market about a percent below the Monster Rally seen on Monday of this week.

The DOW finished at -1.87%, the S&P 500 at -2.03% and the Russell 2000 at -3.66%.

But the week still ended nicely up because of the Monday Monster. The DOW finished the week at +6.8%, the S&P 500 at +6.2% and the Russell 2000 at +7.2%. And all major indexes remain in a hovering pattern over their 50-day moving averages.

So how often do you think the S&P 500 has seen three consecutive weeks up since the economy and the stock market began to fumble in the summer of 2007?

Twice!

The most recent 3-week gain was in April of 2008 and prior to that in September of 2007. This marks the third time since the bear market truly began in the summer of 2007 – yes, the worst of the pain was last fall, but the writing was on the wall in mid 2007, if you remember any of my old updates.

Something different is happening in the equity markets and I want to illustrate it for you.

Notice the market swings in the Wilshire 5000 during the end of last year through the first week or two of February, this year. Note that all of the swings on this chart are large – much larger than seen in previous years.

But even these large swings (seen in late 2008 and early 2009) have changed dramatically. They have gone from 10-15% to twice that volatility. The last two market swings have been in the 20-30% range.

Why might this be so?

Prior to this bear market and especially in the late 90’s the mantra was “Buy and Hold”. Investment advisors made their living deciding what sector to buy versus evaluating overall market risk. There was virtually no real reason to be “out of the market”. Allocation was the name of the game, not timing by any measure at all.

The bear market in 2001-2002 shook things up a bit, but not for long, as the year-long bull run in 2003 convinced nearly all professional investors that the traditional allocation and diversification methods taught in all the top business schools was the only effective way to create wealth in the stock market. It would always go up.

The 2007-2009 bear market has changed that opinion – dramatically.

Even the talking heads at CNBC wince when they talk about buy and hold allocation strategies. And you will never hear an investment advisor boldly proclaim the gains his buy and hold allocation strategy has created for his clients. They don’t exist.

In fact, these buy and hold allocation advisors all feel lucky to even be in business anymore.

I have often mentioned the “window dressing” period, from the last week or so in the month to the first week of the new month. This is where large institutional buyers who have for decades subscribed to the traditional buy and hold allocation strategy often make their monthly allocation purchases.

These large institutional groups have been hurt like no one else in this bear market. They have held on much longer than you or me.

It is the opinion of some very intuitive and insightful analysts that the institutional players have finally opted out of the buy and hold mentality, realizing that some sort of timing is essential to try and gain back their huge losses.

So now instead of a small number of investors using swing indicators for entering and exiting the market based on intermediate cycles the big boys are now trying to play the same game. And the net effect is the destruction of what we have normally thought of as short cycles (1-2 weeks) and intermediate cycles (one to several months).

We now are seeing an intermediate cycle of extreme volatility crammed into an expanded short cycle time frame, accounting for the unbelievable 20-plus percent swings seen in early 2009.

I would also like to draw your attention to the Fibonacci Retracement I have drawn on the above chart. The Fibonacci retracement lines are often a reliable tool for gauging how much the market will swing back the other way. It has now swung back to the positive side a Fibonacci retracement of 61.8%.

61.8% is the typical maximum retracement seen in large market movements, and presents another reason for being cautious about joining the bull’s train at this point.

I’m not saying that there will be no further upside potential, here in 2009. I am just saying that another big swing down is queued up and could take off any day.

Once a decent pull back has been completed we may very well have an excellent opportunity for an0ther strong advance, especially if the institutional buyers are committed to exploiting the swing opportunities in the marketplace.

The Euro was hammered today on poor economic news in the European press. I will let you research what happened. What matters to me is the direction of the Euro.

I rarely talk about the dollar and the euro in the same breath, but I know many of you follow the currency market and also know that the dollar and the Euro often run inversely to each other.

I have been charting the Euro for several months now because of a unique leading relationship that it is showing for the U.S. equity market. Check out the chart:

The black line is the Euro, with values on the right side. The green and red lines are 13-day and 5-day moving averages of the Euro. The grey candlestick pattern in the background is the S&P500, with prices illustrated at the far left.

Do you see the correlation between the direction of the Euro and the stock market? Do you also see that the Euro changes direction slightly before the U.S. stock market?

Do you also notice that the lagging crossover of the two moving averages has coincided pretty closely with the major swings in the U.S. stock market?

This kind of effect is called a leading indicator because it leads in the direction of trend changes in the stock market. I don’t know how long this relationship will last, but it has done fairly well for the duration of this bear market.

Now notice what the Euro has recently done. It appears to have set a lower high about the middle of last week and was really knocked down today. Also notice that the moving average crossover point appears to be converging – another indicator of caution for you “long” investors out there.

I will try to keep you regularly updated on this Euro leading indicator chart over the next few months.

Friday market update

Well the bulls did it – the S&P 500 has managed to stay above the 50-day moving average for more than three days, a feat not seen since May of last year. And it was accomplished amid extreme overbought conditions and virtually no significant political or economic news.

Oh, we did get the final version of Q4 GDP, which was revised downward to -6.3%, the worst quarterly GDP figure since the 1930’s. Perhaps today the traders felt that the ugliest water is now under the bridge and downstream.

If it were only that simple.

The intervention / manipulation I discussed yesterday created a lot of discussion, both in email to me, telephone calls and among writers at MarketWatch.com – apparently a larger and larger number of people are concerned about the disappearance of a free equities market and recognize the unusual volatility created when too much intervention is applied.

Regardless of how the market has managed to elevate above the 50-day moving average for a fourth consecutive day, there is a psychological effect when this kind of event occurs.

The probabilities for a pull back that takes prices back below the 50-day moving average are still pretty high. But even if that does happen, as I expect it will, a new die has been cast. The March 6th lows are now likely to hold up for a while. And this was probably the motivation behind so much of the recent “intervention” buying, regardless of who was doing it.

Check out the S&P 500 prices versus the 50-day exponential moving average:

Notice the rally that followed the November lows. The S&P 500 slowly zig-zagged up to the 50EMA only to quickly fall back after a couple of days. And even though there were two other attempts in late January and early February, the psychological impact of prices being turned away so quickly allowed another round of selling to take place – and did it ever take place!

I suspect there was a clear realization among the “market makers” and institutional buyers that the November lows may not hold. So most buying was set aside while a further deeper hole was dug, ending in the lows seen on March 6th.

The extreme oversold condition early this month allowed for a new rally to take hold. And a lot of short-covering helped make it happen in spades. It is likely that the interventionist / bulls (for want of a better description) seized the opportunity to make a difference on this latest attempt at the 50-day moving average.

It appears that all the stops were pulled out to keep prices advancing for a sufficient time to affect a psychological difference. It looks like it may have worked.

While I have little confidence that this bear market is over or that prices will continue this steep climb without a decent pull back, there is a very good chance now that the March 6th lows could hold for a good while – even with a strong retracement.

However, this is not the time to become a buyer, i.e, to believe the spin and jump on the train with both feet. The probability of a strong pull back grows greater with each passing day that the market dances above the 50MA.

Technically the market is more overbought than I have seen in a very long time. For example, let’s take a look at the Nasdaq McClellan Oscillator. If you will regularly follow this indicator you will find that when it reaches extreme lows the market has been through a sell-off and a rebound is close in the wings.

Conversely, when this indicator reaches extreme highs the market has experienced a strong rally, often a spike rally straight up (like we have seen the last 2 weeks). When this indicator reaches these extreme heights a pull back is often just around the corner.

Check out today’s Nasdaq McClellan Oscillator:

The Nasdaq McClellan Oscillator has been at extreme highs since the middle of March. Today it reached a level (88.8) that has not been seen since the middle of January, 2001. If you go back and check what happened in January of 2001 you will find that a strong pull back occurred when this indicator climbed over the 80.0 mark.

No indicator is perfect. Were it so, everyone would follow it and everyone would be wealthy investors. But this one has been right so often that I wanted to draw your attention to it lest you be prompted to buy a ticket on the train which some think is now leaving the station.

I know it is hard to trust anyone. I know it may even be hard to trust me. But for those who still have the confidence in our technical tools, please trust me – this is not an opportunity to become a buyer.

A pull back of significant magnitude is more than overdue.

Unexpected good news brought the buyers back to the window today, when the Durable Goods report showed a +3.4% increase on the backs of increased demand for equipment and capital goods.

Economists missed the boat on this one, forecasting a decline of 1.2%. The spread between actual and forecast was a resounding +4.6% and the market liked the news, rallying strongly as the market opened and staying near the highs of Monday until mid-day.

Were these durable goods numbers representative of real buying or was this a statistical blip?

Traders must have sensed the same thing mid day as concern over the sustainability of this rally set in and selling quickly became the order of the day. Geithner didn’t help much when he was interviewed about China’s desire for a different world currency. He tended to agree on his initial response. The market dropped over 4% in just under three hours mid day.

Geithner quickly corrected himself and declared boldly that a strong dollar was still in the best interest of the U.S. I don’t know how many really believed him, though.

Late in the day it appeared that the interventionists were not going to be denied as the financial and building sectors saved the day on another strong spike advance – very nearly reaching Monday’s highs in less than thirty minutes of trading before the close.

How often this last year have we seen the markets jerk in an opposite direction shortly before the close, when the average investor has no time to change his mind on what to do.

In spite of these strong manipulated buying sprees, a topping pattern appears to be settling in right around the 50-day moving averages.

The unbelievable volatility continues to concern and amaze me, even on an intra-day basis, let alone for the short cycle time frames. In the last two months we have seen 12 days where the S&P 500 closed over 3% different from the preceding day, often with more than 6% swings during intraday trading. And two times in March we have seen closings greater than 6% on the day.

The intervention we are seeing in the markets right now is blatant and strong – apparently hoping to convince J.Q. Public that the train is leaving the station. There is a strong and concerted effort by the Fed, the administration and their cooperatives to paint this tape higher and higher, without any pull back.

The problem with such strong swings in opposite directions is that it destroys confidence for the average investor. No one in their right mind wants to deal with the swings we have recently seen. For example, the Russell 2000 fell 27.1% from February 9th through March 9th. It has now rallied from March 9th to the highs seen today for a total of 26.4%. In a 6-week period the Russell 2000 has seen a 53.5% movement in price – all in only two short-cycle swings!

The market is about where it was two days ago, Monday, the 23rd – near the high following the huge monster rally induced by the Geithner and Bernanke 2-trillion dollar promises. This market rally is being held up on promises and more promises.

The normal process of backing and filling has not been allowed to take a normal course, possibly out of fear that it will get out of hand and seriously challenge the new bear market low set on March 6th - just a few weeks ago.

This kind of intervention often ends badly though, as no selling relief leads to a pressure point where eventual selling erupts into a volatile profit taking decline over a day or two that can quickly remove weeks of gains.

We need to see the traditional backing and filling return to the market place. These unbelievable short-cycle swings are evidence of speculation and lack of confidence.

Speculators are only too happy to help run up prices and then jump on the selling bandwagon, and I can’t blame them in a way. But it does make it hard to make sense of the technical and economic data when there is so much manipulation and speculation driven by the enormous spending plans announced repeatedly by the Fed/government.

Technically the market is struggling to hold its footing above the 50-day moving averages. This level was breached on Monday, only to see prices fall back and barely hold on today. Today’s late buying splurge was the interventionist/bulls’ attempt to keep prices above this critical measure.

I told you a few days ago that the S&P 500 prices have rarely remained above the 50-day moving average for more than three days in this bear market. Well, today is day three. If the S&P 500 continues to trend above the 50MA for a few more days, then it will have set a new trend and we must then treat the 50MA as a support rather than resistance.

In my mind the 50MA test is still going on – but I give the bulls and the interventionists and the Fed and the government a quiet hand of applause for all their efforts, right or wrong. They have kept the S&P 500 above the 50MA for three days now.

It will take more to convince me, though, and earnings season is coming up fast!

Remain defensive.

Wednesday market update

Unless the Fed has another trillion dollar package up their sleeve the stock market is now starting to look ahead and evidently the idea of another big surge in the unemployment rate next week and rotten corporate earnings to be announced in early April is still an issue.

We all hope these many bail out programs help, but it doesn’t change what is happening now or about to happen in the next quarter or two. The direction of corporate earnings is down and even with these grandiose plans it is just simply not going to make a difference in this quarter or the next. Earnings are in free fall and until we see some signs that the economy is reviving, it is extremely dangerous to get sucked into these bear market rallies.

You have to understand the powers that be will do everything they can to entice you to buy, to play on your greed and to make you feel that if you don’t move now you’re a fool. Make no mistake, the media and their constant barrage of so-called bottom experts are all part of this game.

I want to explain a few things about how the markets work that are worth discussing right now.

I want to set the stage by asking an important question first.

In February to early March, when the DJIA fell 1,491 points who was taking the other side of these trades? For every sell to occur, someone has to be a buyer and if most are selling who is it that ends up owning all of these shares of stock?

To answer this question, we need to understand who the Specialists are on the NYSE and who Market Makers are on the OTC.

A specialist is a member of an exchange who acts as the market maker to facilitate the trading of a given stock. Market makers are investment firms who trade electronically, rather than on the floor of the exchange.

The specialist holds an inventory of the stock. They post the bid and ask prices, manage limit orders and execute trades. Specialists are also responsible for managing large movements by trading out of their own inventory.

If there is a large shift in demand on the buy or sell side, the specialist will step in and sell out of their inventory to meet the demand until the gap has been narrowed.

However, what happens when the Specialist or the market maker runs out of money to meet all of the demands of the sellers? They have to borrow money to meet this need and that is where the Federal Reserve comes into play. They provide the capital in extreme situations.

We have just seen one of the biggest sell offs in the stock market history. The S&P 500 index (1,586) fell from its highs in 2007 to its lows this month (665), a loss of 921 points, or 58%.

It is essentially the Federal Reserve who is loaded up to their eye balls in stocks of corporate America and it is in their best interest to change that and get you to take that stock on a “buy”.

Now let’s shift our attention two weeks ago, when the market had taken out the November lows and everyone was piling into the short side of the market.

The Federal Reserve had to pull out some powerful guns to stop this selling and induce a massive short covering squeeze. First they floated talk about removing the Mark to the Market idea, which sent the financial shares higher.

More talk of implementing the uptick rule to squeeze the shorts.

Then to follow up, the big guns were announced with Bernanke’s trillion dollar plan and Geithner’s trillion dollar toxic assets program, timed for maximum effect on the stock market.

We see Geithner writing opinion pieces for the Wall Street Journal in an attempt to attract investors back to the markets. They want you to take the risk instead of them.

It is the Fed’s job to get the markets moving again and to restore confidence, but in the end, you must decide if the reward is worth the risk in this quarter, in the next quarter and the future because the Fed doesn’t care squat about whether you make or lose money – or whether they tell you the truth or not.

This is how the game is played and the media have a big role in it. If you haven’t learned this lesson by now, you need a reality check.

Let’s talk about the technicals and what they are telling us.

After breaking above the 50-day moving averages, selling was invoked today. It is not about breaking above this resistance. It is about staying above this key resistance level in a bear market and for over a year we have not seen prices remain above this average beyond two or three days – that’s about it.

I thought it was very interesting that despite yesterday huge move, volume actually declined for the Wilshire 5000.

I still think the market is short-term overbought and due for a correction. The daily stochastics for the S&P 500 turned negative today with %K at 92 and %D at 92 and given the news ahead I think we will at a minimum retest the daily middle Bollinger Band line, which is at 743.

What happens after that is very much dependent on how investors feel about the first quarter earnings.

Remain defensive.

Treasury Secretary Timothy Geithner finally laid out his plan to rescue the trouble banking industry. Before we look at this, it is important to understand the “shadow banking system”.

The shadow banking system is all non-bank lenders such as investment banks, structured investment vehicles (SIV), hedge funds, monolines, etc.

These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls.

Further, these entities were vulnerable because they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices.

This is the heart of the problem as Industry analysts estimate that the nation’s banks are holding at least $2 trillion in troubled assets mostly residential and commercial mortgages.

Will this program jump start the economy by rescuing the banks?

THE PLAN

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government."

" The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate."

" Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets."

For more on Geithner’s plan investors can read Geithner’s article in the Wall Street Journal here.

CRITICS

The critics of this plan argue that while banks will largely be able to get bad debts off of their balance sheets to prevent them from being declared insolvent, this doesn’t guarantee that banks will be quick in lending again.

“ The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.

This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work.

What an awful mess.” Paul Krugman, NY TIMES.

You may want to also listen to noted economist James Galbraith’s opinions.

TECHNICALLY SPEAKING

With the help of the Fed and the Treasury, the bulls have managed to push stocks above the major market indexes’ 50-day moving averages.

This may seem like we are at the beginning of a new bull market but technically speaking that is just not the case. You must view this as any other bear market rally that could without notice end and trap investors, viciously.

If we look at the primary trend in the stock market there is nothing bullish about the primary trend. The monthly ranges for all the indexes are still making lower highs and lower lows. The 50-day and the 200-day moving averages are still descending and the gap between the 50-day verses the 200-day moving average is so huge it would take months if not a year or more before the 50-day can trend above the 200-day.

For the S&P 500 to even test the monthly middle Bollinger Band line at 1223 is just not in the cards in the near term.

The McClellan Summation Index for the NYSE is at -553 and the OTC is at -738, so we clearly remain in bear market territory and as such, investors still need to view bear market rallies as apt to fail.

As strong as today was, new lows on the NYSE actually climbed higher than Friday’s – a jump from 40 new lows to 75 new lows.

Let’s look at the intermediate-term cycle.

The surprise move by Bernanke last week and today’s move by Geithner has invoked a powerful short covering squeeze.

Today’s move now has the S&P 500 index testing its weekly middle Bollinger Band lines.

We closed today within 10 points of this intermediate-term resistance level.

Furthermore, we are now approaching resistance at the back test of the wedge formation that formed in the upward slope of November through January. This suggests that most of this intermediate-term move is played out.

At best the November/April favorable time period has largely produced a sideways trend. The six to nine month cycle is now overbought again with the stochastics at %K 82 and %D 79 according to the Fidelity Select Family Stochastic Oscillator and by mid-April, the next major down leg is likely to be set up.

Sell in May and run away is very likely to happen this year as investors realize there is no improvement in corporate earnings on the horizon this year, despite the efforts of the Fed. How far can stocks go up if there is no signs of an up turn in corporate earnings?

First quarter earnings are about to begin their appearance in just nine more trading days and before that another jobs report. Hasn’t the market already discounted earnings? We’ll see. The gravity of the situation is still before us.

In the meantime, the short-term cycle is extremely extended as measured by the daily stochastics and the McClellan Oscillator, so this is no time to be chasing the bulls with the 50-day moving average still descending, despite one day above this resistance level.

Monday Market Update

Last Friday I warned that a second consecutive week of gains following the strong rally last week was a big hill for the bulls to climb. Well, with Bernanke’s willingness to throw another trillion dollars around, the bulls were able to hold on to record a second week of gains – but barely.

I really didn’t think they would do it. And, truth be know, they shouldn’t have.

The shell game of monetizing debt by the Fed where they are buying and selling treasuries reaches the public through the press as though all stops have been pulled out to get this economy on track.

The real truth is that things are so bad there is literally no one in the world willing to buy up any more US debt. So the Fed acts like a hero on a white horse and pretends that they can actually buy up US debt. The problem is that the Fed doesn’t have any money to do this - - - - - unless they print it up! … which they have just done.

And that is where the risk just became even higher. The real truth about the implications of the Fed monetizing US debt is starting to sink in. While there is definitely a stimulating effect by pumping fiat money into the system, the real effect is that the dollars in your wallet aren’t going to be able to buy as much stuff in the future.

If the Fed can put the brakes on fast enough, then perhaps a hyperinflationary period can be avoided, but the actions of the Fed this week are like playing with matches in a garage of gasoline soaked rags. Sure, they can light a fire under a rag or two and everyone in the garage can enjoy the light and heat, but what happens if all the rags catch on fire - - - down comes the garage with the occupants inside.

This is a time to think short term. Long term success of the Fed action is fraught with question marks. It is almost like somebody behind the curtain really wants the US dollar to collapse, the implications of which could be horrendous for the average US citizen.

You have to keep asking the question, “Can we really bail out anything and everything?” Or should we just let some things fail so there will at least be some pieces to pick up. There simply isn’t enough money to fix all these financial problems. Someone needs to fail or everything will fail.

Sorry to sound like a doomsayer this week, but the steps being taken by the administration and the Fed so far in 2009 are at levels never seen in my lifetime and it makes me concerned about the long-term prospects for the economy.

Don’t get me wrong – I am comfortable guiding you and my clients through these rough waters. Heck, I think we might even make some good money with the short term long/short opportunities that are likely to exist for a very long time now.

But the slow and steady recovery that the US economy needs after the bloodbath we have gone through is clearly no where to be found. All this government manipulation to keep the ship upright and heading forward may end up being just the thing that tips it over.

Perhaps they should let the ship take on a little water, let it slow down a lot, and then go to work fixing the ship rather than trying to gun the engines and put fingers in all the holes to keep the water out.

From a technical perspective, prices for the broader market have quickly reached resistance at the 50-day moving average. Check the S&P 500 out on the following chart:

If the market overcomes this resistance level and puts in a third week of gains, it will be remarkable, given the current environment. But if the reality of the Fed intervention by monetizing debt becomes clearly understood and appreciated, then I expect to see a retest of the March lows.

If the spin that the Fed and administration put on this monetization is successful in convincing the public that they are closely at the controls and it is not going to get out of hand, then perhaps a 50% retracement of the recent rally is what we will see.

If the truth about monetizing debt can be well hidden from the public and the short term traders dominate the market, then a very slight retracement could result – even so much that the markets could retrace early next week and still rally to a positive conclusion by the week’s end. This would be a very bullish, but risky proposition – one that could see the markets climb rapidly, but likely set up to fall even harder.

For a longer term picture of how significant the 50-day moving average is take a look at the following one year chart of the S&P 500:

You can see clearly that the May 19, 2008 high (at 1440) began a treacherous path downward, even though October is where the real pain was administered. And the low point was set only a few short trading days ago, on March 6 (at 666). The precipitous drop over ten lousy months was – 54%.

Notice that over the last year, once the S&P 500 prices fell significantly below the 50-day exponential moving average (in early June of 2008), that they have never ventured above this resistance line for more than two or three days. That is why betting on the bulls is a formidable choice to make.

On the other hand, an intermediate advance is long overdue. With the recent disappearance of the November lows as the Bear Market Low and a new Bear Market Low set in March I am forced to declare that the initial bear leg is still in play and was NOT set in November. Hopefully it was set in March.

When you see prices on this chart trend above the 50-day moving average for a couple of months then you can feel assured than the initial down leg of this bear market is “IN”.

But you can be just as sure that after a retracement of 40-60% (maybe less) that another hard leg down will likely be attempted – one that could easily be even lower than this first leg down. This is going to be a long and drawn out bear market, I am afraid.

Remain defensive unless you have clear and focused guidance on long/short opportunities. Once in a lifetime events are unfolding.

Friday market update

Yesterday, the charts made a pretty compelling argument that the market was extremely extended and at key resistance at the 50-day moving averages.

This is where you get technical sellers in bear markets and sellers did materialize today. However, selling wasn’t severe so we may yet see another retest of the 50-day moving averages.

With as overbought as we are right now, the probabilities favor a sell off going into the end of March and with corporate earning announcement to come in early April, we are about to find out how brave the bulls really are.

The ugly fact is that corporate earnings dropped 57 percent on average for the 480 companies in the S&P 500 that have reported results since Jan. 12th, according to Bloomberg data. Earnings are nose diving at a speed we have never seen before.

If we have literally no or very little earnings in the P/E ratio for the S&P 500 in the first quarter, rising prices are simply not sustainable. These bear market traps are seductive but deadly.

The Fed’s decision yesterday to buy back some of its debt is something the Fed has not done in 50 years and illustrates that it is operating within a worte case scenario in a desperate attempt to stop the economy from falling into a depression.

What the Fed did yesterday is called deficit monetization and it has resorted to this scenario because we have been moving into a deflationary spiral and a protracted credit tightening (money supply contraction).

If you have been watching the rate of growth of M2 it has been dropping like a rock recently as money flees getting caught in a banking crisis.

Some have interpreted as hyperinflationary with the fallout being a plunge in the dollar the last couple of days and a surge in commodity prices.

However, if you think about what they did yesterday, the Fed is issuing $750 billion in debt to recapitalize Freddie and Fannie, but is buying back $350 billion worth of long-term debt.

Still, the US dollar was slammed by this news and is under heavy selling pressure. Also, pressuring the dollar is talk that a U.N. panel will recommend ditching the dollar as its reserve currency in favor of a shared basket of currencies.

Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday.

This caused a huge jump in gold which jumped $69.60 an ounce to close at $958.3. Remember, the key number here is $1,017 for gold, which was last year’s high.

The sell off in the dollar over this news sent crude oil prices up $3.47 a barrel to $51.61. It is looking more and more like crude oil prices have put in a long-term bottom but where from here?

Are we looking at $75 a barrel this summer? This is all consumers and corporations need – to see another surge in commodity prices with corporate earnings deteriorating at the fastest pace in history.

All of these issues give me a headache, which is why we need to remain focused on the technical underpinnings of the market.

Despite this rally, market breadth remains subpar. The McClellan Oscillator is at a short-term high and the McClellan Summation Index is well below zero, with NYSE at -611 and the OTC at -782. Any rallies under zero, with numbers this bad should be viewed as an opportunity to sell into rallies.

We have seen some positive changes in the new low/new high indicators. It is constructive to see new lows below 50 in the NYSE and below 75 in the OTC. The 10-day differential is very close to turning positive, but we have gotten very close on every bear market rally only to see it fade at the 50-day moving averages, so the jury is still out here.

Remain defensive.

Thursday Market update

Wednesday market update

The stock market seemed to like the news coming from the housing sector, which showed a huge surge in housing starts today. In fact, housing starts jumped 22.2% in February, which is the largest since the early 1990’s.

What is interesting about this number is almost all of the gain (82.3%) was supported by a surge in multifamily construction. This is construction in apartments, duplexes and condos to meet the growing need for people who need to rent.

Single family homebuilding rose a modest 1.1% nationwide. However, in the West housing starts are still falling sharply. There is still too much supply (10 months) and this has to be narrowed before we can expect existing home prices to recover.

In other news, the Producer Price Index remained barely above zero at 0.1 for the top line number. The stability in the crude oil prices since December and the subsequent advance in oil prices to near $50 are evidence to some that deflation is becoming less of a threat.

I don’t happen to buy that argument, especially with the money supply continuing to fall. M2 dropped again this last week down from 9.7% to 8.1%. Inflation comes about when the money supply is rising rapidly, not falling but there are a lot of issues here that are not transparent and geopolitical trade wars relative to our currencies that make this a challenge.

For now, it appears that seasonality factors and all of the talk of the stimulus package have speculators buying energy again. But the economy is not the same as it was in 2007. There is a lot of technical resistance at the $50 level, so this sector is due for a pullback with intermediate-term cycles at %K 99 and %D at 98.

Let’s talk about the stock market and this six day rally. How many of these spike rallies on low volume have we seen over the last 18 months?

In a healthy market, a rally sees volume increase. In a bear market trap, volume decreases and this is exactly what we have seen over the last few days. This isn’t broad based buying.

Also we are starting to see a wedge formation developing---higher highs but lower lows in the daily ranges, which is typical market behavior as we approach short term resistance in overbought conditions.

Notice, that the daily stochastics are now at %K 97 and %D at 85 for the Russell 2000. We are also approaching the 50-day moving averages.

You can see from this chart the overhanging resistance that stocks face under the 50-day moving averages.

Low volume wedges into resistance/and or moving averages invites another bear attack as long as prices keep taking out critical support levels as happened by breaking the November lows. The bears are still in charge.

I do want to make note that pessimism reached extreme conditions a couple of weeks ago and this is why we have seen such a powerful rebound. The short sellers take profits, but these same short sellers are also looking to retake new positions at key resistance levels.

Technically, the market needs to set up a higher low, so the probabilities favor a need to retest and prove last week’s lows.

In the meantime, the technical underpinnings remain poor.

Tuesday Market update

The stock market ran out of steam today following last weeks impressive short covering rally. This seems par for the course as nervous shorts take profits but with the market lacking real buyers, the rally then fizzles after a few days.

We may see another attempt by the bulls to perhaps test the 50-day moving average, but nothing has changed that signals the birth of a new bull market.

This has been the pattern. Whenever pessimism gets too extreme, the Fed releases something to scare the shorts into covering, as we saw with the “Mark to the Market” talk and with the suggestion of changing the uptick rules to spook the shorts. It worked.

However, for the market to be sustainable on the long side there needs to be a reason to expect economic growth to attract a steady flow of buyers. I sure don’t see it.

The March and April period is a favorable seasonality period that could repeat this year. After last week’s advance the intermediate-term cycle seems poised to climb if one looks at the weekly stochastics and the McClellan Summation Index, which appear to be nesting here.

Yet, after last week’s advance, short-term cycles have moved into overbought territory again. It looks to me like we are setting up for another retest of the lows.

Remember, the primary trend pattern remains the same, lower highs and lower lows. The Nasdaq Composite has retraced in the latest rally about 50% of what has been lot from the peaks in early 2009, so we are running into short term resistance levels.

TRUST BROKEN

I have told you before that I was a stock broker for 12 years with Shearson Lehman Hutton in the 1980’s. I was vested in their retirement program, which Lehman managed.

I got a letter the other day from Lehman Brothers, which said if you have any questions about changes to your retirement plan, contact the new Plan Administrator of Lehman Brothers Holdings Inc. Retirement Plan at 1-800-LEHMAN6

If you call that number it says, “We’re sorry, your call can not be completed as dialed. Please check the number”. I guess I have to say I am not surprised.

The smartest business decision I made was to leave this firm back in 1989. There used to be a saying at Shearson Lehman Hutton: “The brokerage firm makes money, the stock broker makes money and two out of three ain’t bad!”

This is the attitude that led this firm to ruin because they put their interests ahead of their investors. They had little regard about risk their clients faced and it was reason why I left this firm.

Trust is the foundation of our financial system. Two years ago when Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson told us everything is okay, don’t worry, forget housing, forget soaring crude oil prices—look at how strong the economy is--- I knew we were in deep trouble. They knew then we were in deep trouble.

This is the heart of the problem---you can’t trust anything they say.

Today we learn the AIG was set to pay out $165 million in retention bonuses.

“ I was happy to see that AIG finally handed over the counterparty information we’ve been requesting for months,” said Representative Elijah Cummings, a Maryland Democrat on the House Oversight Committee. “However, I am deeply concerned that Goldman Sachs received so much money from AIG considering the relationships between the two companies. We will certainly be investigating this further to ensure that this is merely a coincidence.” Bloomberg

Yeah that is what it is alright, just merely a coincidence. It is merely a coincidence too that Former Treasury Secretary Robert Rubin under the Clinton days was a former arbitrage trader with Goldman Sachs, that Treasury Secretary Henry Paulson was a former head of Goldman Sachs.

I guess it is a mere coincidence that our present Treasury Secretary Timothy Geithner is a former protégé of Robert Rubin and his chief of staff is a former lobbyist for Goldman Sachs.

… just a mere coincidence.

Friday market update

For a third consecutive day, the broader market enjoyed a nice advance. In fact, nearly 50% of the losses seen over 20 plus days of trading prior to Tuesday’s rally were recouped by the end of today.

But it was likely a lot of short covering, when those who have the least confidence in the long term prospects are forced to bank their gains being short and buy some stocks to cover their short positions.

Sure, a retail report came in better than expected and there are a lot of bulls who feel that since Novembers lows have now been tested and since prices of many indexes have moved back above this important low that a spin could be made that the fearful statements of dropping back to 1996 lows is way overplayed and the broader market has actually succeeded in holding the test of support at the November lows.

Technically, this is only true for the Nasdaq indexes. The broad market indexes, such as the Wilshire 5000 and the S&P 500 convincingly broke below the November lows. And while a rebound could recover much of the recent losses, the die seems set.

So what sparked today’s rally on the heels of Tuesday’s oversold short-covering?

It’s the subject of “mark-to-market” for the banks. It is finally getting some real attention. You see, a hearing was convened today in Washington to consider alternative methods of valuation rather than the current mark-to-market rule.

This rule is not very old, only brought into play since November, 2007. Do you see a striking coincidence to when this rule was made and the beginning of trouble in the financial sector?

Here’s why. In a strong economy, when assets are appreciating, i.e., the housing bubble, the investment banks and other financial institutions wanted to be able to state the market value of their collateral, thus giving them higher capital to loan ratios – hence the desire on their part for a mark-to-market rule.

But in a weak economy, when assets are depreciating, i.e., the current bursting of the housing bubble, this new rule bites the financial guys firmly in that large rear muscle.

When assets collapse in value and are then sold at a fire sale, such as what occurs in many foreclosures, the “market” value of comparable collateral is now forced to be valued similarly, forcing banks to write off billions of paper losses, even though the majority of their current loans are being serviced according to the original mortgage terms.

When the government later bails out the banks by purchasing shares and capitalizing the banks the cash inflow does nothing but sit there on paper helping the bank with their capital to loan ratios. All those billions of dollars in essence did nothing by going into the banks as capital even though it did keep them from going under. It really could have been done a different way.

If the toxic assets had been purchased from the banks then the banks would have had cash, remained private, and the asset to loan ratios would have kept them in business and possibly able to re-loan out the new money.

The average person is likely offended at the proposal to suspend or ameliorate the mark-to-market ruling for the banks. They know that if the price of their homes goes down they can’t pretend that it is still worth more and get a loan based on its old 2006 value. Individuals are simply stuck with the losses in home equity.

But stock investors see the picture a little differently. The feeling is that a fire sale of an asset at even lower than market prices forces 90% of their loans that are being serviced just fine to have too low a collateral value. The reasoning being that if these long-term loans instruments are serviced and held to maturity then the real value is at least the face value of the mortgage, not some fire sale price by comparable foreclosures, etc.

And so when a hearing is convened to discuss this subject, shortly after Ben Bernanke even says something different should be done, traders holding short positions became nervous. They bought stock this week to cover their short positions and a spike rally is the result.

This kind of buying is usually over in a few days and the real market bias begins to return, in this case, a decline in prices, coincident with a weak economy.
But this instance may be different.

It is suggested that over the next few weeks a proposal to modify the current mark-to-market rule will be presented. I suspect it could allow banks to state the value of their performing assets much closer to face value rather than the lower fire sale values.

This re-evaluation alone would change the reserve ratios at the banks and in essence free up a lot of capital that is currently locked down. The lending that could result may actually provide more real stimulus than the better known Stimulus Plan just passed by congress.

However, there is motivation to keep the mark-to-market as is. If banks are forced to liquidate these performing assets at fire sale prices and private capital enters the fray to pick them up at these discounts, then who benefits when the loan is serviced to maturity? Right – the private money that came to the rescue of the banks and took the toxic assets off their balance sheet at a bargain price. The banks don’t want to do this.

You will hear strong arguments on both sides of this rule, but my bet is that it will be modified. The market will react positively if this happens. Whether it will be enough to make a difference over the long run is a subject for another day – but I have my doubts.

But for now, the stock market likes the talk that is going on and is hoping for a change in the rule. A change they can have confidence in – for a change.