Impressive day

Market Commentary:

This was an impressive day – in my mind, far more than yesterday, as the S&P 500 closed above its 200-day EMA (936) at 940.

I don’t know if prices will be able to hold above the 200-day EMA, as this will probably depend on whether we really are seeing a meaningful recovery in corporate earnings, but this was certainly a big achievement for the bulls today, even if it was manipulated higher.

I think a big part of the reason for this breakout is attributed to a late in the afternoon article from Bloomberg which said economist Nouriel Roubini now believes the economy will bottom this year, which appears to have spurred late day buying.

After the close, Roubini said he was misquoted.

“ It has been widely reported today that I have stated that the recession will be over 'this year' and that I have 'improved' my economic outlook. Despite those reports - however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

“ I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19 months into that recession. If, as I predicted, the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year’s end.

“ Indeed, last year I argued that this will be a long and deep and protracted U-shaped recession that would last 24 months. Meanwhile, the consensus argued that this would be a short and shallow V-shaped 8 months long recession (like those in 1990-91 and 2001). That debate is over today as we are in the 19th month of a severe recession; so the V is out the window and we are in a deep U-shaped recession. If that recession were to be over by year end – as I have consistently predicted – it would have lasted 24 months and thus been three times longer than the previous two and five times deeper – in terms of cumulative GDP contraction – than the previous two. So, there is nothing new in my remarks today about the recession being over at the end of this year.

“ I have also consistently argued – including in my remarks today - that while the consensus is that the US economy will go back close to potential growth by next year, I see instead a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%.

“ I have also consistently argued that there is a risk of a double-dip W-shaped recession toward the end of 2010, as a tough policy dilemma will emerge next year.”

In any case, whether the Roubini misquote was the reason why the stock broke above the 200-day EMA on late-day buying or if investors are expecting solid earnings from Google and IBM on Friday, the bottom line is that prices closed above this key technical measure.

Now we get to see if prices can, indeed, hold above this mark.

I have made it clear what I want to see to see from a technical perspective for a confirmed bull market:

1) We need to see the 50-day EMA trend above the 200-day EMA for the S&P 500.

2) We need to see the S&P 500 close above the 12 month moving average EMA on a closing month basis.

3) We need to see the indexes begin trending above the monthly middle Bollinger Band lines.

4) We need to see the McClellan Summation Index expanding well above zero for both the NYSE and the OTC.

5) And … it would be nice if volume was expanding too!

We may be close to seeing these achievements reached but we aren’t there yet.
The next couple of weeks may hold the answer to this riddle. There is still a clear pattern of lower lows and lower highs on month end prices. So, stocks need to take out the June highs to power into bull market territory.

Let’s put the last few weeks into context.

I think most investors have been very skeptical, including myself about what kind of growth we would see in the second quarter corporate earnings, given soaring unemployment, very little consumer demand or spending, home prices that are still falling and extremely tight lending conditions.

Today, for example, we saw foreclosures jump 4.6% in June. The Philadelphia Federal Reserve's general business conditions index declined 5.3 points in July to -7.5. While stocks go through periodic spike rallies, we just aren’t seeing much a recovery in the economic numbers.

This uncertainty showed up as technical weakness in the stock market, producing a head-and-shoulders formation and triggering a number of technical sell signals and once again aligning investors negatively towards the stock market, ahead of second quarter earnings.

A lot has been made about the confirmed bearish head and shoulder’s pattern that did not play out as many technical analysts had been illustrating over the last week or two. In fact, the last two days have clearly stamped “failure” on that bearish head and shoulders pattern. See the chart below:

Prices took out the lows of June. So going into this week, the market was bracing for weaker corporate earnings and further selling. This week was quite a head fake.

I think we have to accept that the Fed, regardless of earnings, is protecting the stock market with all of its monetary powers. Whether through Goldman Sachs which can borrow at the Fed window at no interest or through its plunge protection team, the Fed can force a short covering squeeze at will – and they likely did it this week.

Fundamentals do not justify the prices we are seeing in the stock market, but the Fed has the power to punish the bears (short positions) and that was painfully obvious this week. It is hard to argue with the Town Hall!

I think once the stock market can confirm a new bull market in the technical terms I have discussed, volume will return.

That hasn’t happened yet … but we’re close.