Downward Correction Could Be in Store for the Markets

Despite some intra-week volatility, we closed out last week near unchanged on the major indices. Earnings reports this week are heavy in the retail/consumer sector, with names such as DLTR, RL, SPLS, BIG, COST, HNZ & TIF due in the coming days. On the economic calendar is Home Sales, Crude Inventories, and Preliminary GDP among other reports. Also in the news is an upcoming GM restructuring plan and North Korea military activities.

Stocks have been faltering a bit, but the underlying uptrend in place since the March 9th bottom has not yet been breached. On the S&P 500 Index (SPX) Daily chart below, you can see that Percent R has failed to complete another bullish re-test ... however, we currently remain in the top half of Acceleration Bands and above key exponential moving averages; so it may be premature to call an end to uptrend at this time. In addition, Daily Percent R has yet to break below the key 50 mid-level.

SPX Daily Chart

We've mentioned several times the importance of the 30 level on the CBOE Volatility Index (VIX), and you can see on the chart below that we closed above 30 after testing below that level intra-week. The VIX does look likely to at least hold 30 as downside support, which would indicate that potential stock upside will be tempered ... and a bounce higher in the VIX is a fairly strong possibility, which would likely be bearish for stocks.

VIX Daily Chart


Bond prices continue to fall, and government bond yields continue to rise. You can see on the following chart of the 10 Year Treasury Rate Index (TNX) the steady uptrend in yields basically since the beginning of 2009. Some of this is likely due to economic recovery hopes as well as potential inflation fears -- but it also must be remembered that there was a massive "flight to quality" in bonds when things looked very dire late last year, and this is being "unwound" to some degree.

TNX Monthly Chart

The Dollar has been moving lower recently. The following chart is the Dollar Index (DXY), which tracks the U.S. currency's movement against 6 major trading partner currencies. The Euro is a majority component of the counter-currencies to this Index. You can see from this longer-term Weekly Chart that a 2006 to 2008 downtrend in the DXY was broken during the worldwide financial crisis, as there appeared to be a "flight to quality" into the Dollar. However, we have since entered a wide choppy range, and the current downtrend appears likely to continue. For example, Weekly Percent R on the DXY has breached its bottom levels for the first time since the volatility began in mid-2008.

DXY Weekly Chart


Bottom Line: The underlying stock uptrends remain in place for the time being, but risk levels are high, and a downside correction could be coming soon. The VIX, Interest Rates, and the Dollar are all contributing to a potential negative underlying tone for the U.S. markets.

Disclosure - none.

Comments

[DVW:]

I love these chartists with their fancy lingo and new indicators and "history did this, so the future will do that" doctrine. The previous poster saying it's a coin flip probably shows better odds than chartists. I'd love to see an actual verified investment track records of anyone posting on this site. Both YTD and overall. Let's see how your system really works!!

May 27 09:11 AM

[proactivetr...:]

Our money flow signals are cloning the signals of the last bottom. Compare our 2003 signals with the current signals at our website. No question we are ready to test the downside. Remains to be seen whether we test the bottom again as in 2003.

May 27 09:35 AM

[Billy Ford:]

I think the purpose of the blog is to warn you of chasing this rally. Of course we all want the market to keep moving further and further along, but lets face reality, we have came a long ways in a short amount of time. What is this recent move based upon? NOTHING!! We are still losing massive amounts of jobs every week, all aspects of housing are still moving down, and the only positives are sentiment reports (which are based primarily on this unjustified rise in the equity markets). I personally would love to see a nice healthy pull back to the 780-800 mark, because there is a ton of money still on the sidelines. If we pull back, then more money and NEW money will enter the markets and give us a potential beginning to a solid bull market. I personally just dont think that is possible without some sort of healthy pull back 15-20%. But again , just my opinion, and I am just like you....

May 27 09:36 AM

[Maxe Paul:]

Because everyone expects a sharp sell off, i expect the market will go higher. We may have seen our mini correction before heading for S&P 1000.

The market will not turn back around (down) untill we see a record optimism and bullishness return such as we saw in late 2007.

May 27 09:50 AM

[robert.b.fe...:]

I completely agree with futurestrader there really is nothing I can see supporting this rally. I am expecting a pullback and retest of the March low. I will take profit at an 8% decline on stocks in my portfollio that are up past target price.

May 27 10:18 AM

[Larry House:]

It may rain today too; which also means it may not.

May 27 10:18 AM

[seekingnorm...:]

I don't think there's enough money in the world for the market's "mistake" to extend as long and as strong as it did during the 4 year internet bubble.

I have put,
my recent gains in puts,
This is my bet,
a higher VIX will raise the value of my bet,
Will hold to the end,
and lose 100% of the investment or make something in the end.

May 27 10:30 AM

[silverfox:]

the announcement coming very soon is that General Motors our infamous money buring machine is about to declare bankruptcy
All i can say for all North American tax payers is good riddens to bad rubish.
My appinion somtimes wrong is that this market will see a fairly substantial correction 20 - 30 %
I see the S & P 500 going back down to at least 800
TSX Composite probably 8000
Dow back to 7000
Sell your positions, this market is overbought

May 27 11:27 AM

[MarkitWacha:]

I'm no chartist. I'm up about 570% this year, and I'm a contributor.

I use leverage wisely to get results. I put my money where my mouth is, too.

On May 27 09:11 AM DVW wrote:

> I love these chartists with their fancy lingo and new indicators
> and "history did this, so the future will do that" doctrine. The
> previous poster saying it's a coin flip probably shows better odds
> than chartists. I'd love to see an actual verified investment track
> records of anyone posting on this site. Both YTD and overall. Let's
> see how your system really works!!

May 27 11:32 AM

[Mad Hedge F...:]

It's way overdue. Today is the 60th anniversary of the launch of the Intelligent Investor, by Benjamin Graham, the Bible for all fundamental analysts. So it behooves us to recognize that multiples for the S&P 500 have just leapt from 13.1 to 15.5 times in a mere two months, the sharpest and most rapid multiple expansion in history. Did I say multiple expansion? Have the fundamentals really gotten that good, that fast? I think not. If anything, we are enjoying the calm between two back to back hurricanes. You only have three days left to sell in May and go away.

May 27 12:01 PM

[joes:]

I still don't understand why this market is being talked about like it is on a tear of some sort, unless you just showed up in the last 6 months then you know that we are 5,500 below on the DJIA. The rise from 6500 isn't a rally of any sort in my book, just some aimless wandering as we slog through the troubles.

As for the American consumer being down and out, remember that 10% unemployment means 90% employment. There are some very good companies getting ready to make serious headway on problems like energy, transportation and agriculture. Tons of money will be made on water, and not just the $8 a gallon bottled version, the US is ahead in all areas of that industry.

We aren't out of the wood, hell I'm nearly 60 and we've never been out of the woods. We just get into clearings where we can see a little better, I think we are heading into one now.

May 27 02:30 PM

[buoy:]

Wild charts.

May 29 07:41 AM