Markets Rolling Over

Uncertainty over the global economic outlook yesterday took its toll on stock markets around the world as risk aversion favored safe-haven assets such as government bonds, the U.S. dollar and Japanese yen.

In the U.S., stocks declined to their lowest levels since the end of May as investors await the start of the second-quarter earnings season.

I referred to the CBOE Volatility (VIX) Index in a post on Tuesday, and specifically to its use as a contrary indicator. The VIX, also known as the “fear index”, closed the day 6.4% higher.

All ten U.S. economic sectors fell, confirming a pattern of the defensive-oriented sectors such as utilities, health-care and consumer staples outperforming the cyclical sectors like energy, materials, industrials and consumer discretionary. The chart below shows the performance of the sectors since the high of the S&P 500 Index on June 2, 2009 - a relative pattern as one would typically expect during a corrective phase.

Click to enlarge:

Source: StockCharts.com

The key moving-average levels for the major U.S. indices are given in the table below. The S&P 500 Index yesterday breached the key 200-day line (for the third time in 26 trading days), joining the Dow Jones Industrial Average and the Dow Jones Transportation Index in bearish mode. With the exception of the Nasdaq Composite Index, the indices are also all trading below the 50-day moving average.

Click here or on the table below for a larger image.

Additionally, the Dow Industrial Average and S&P 500 Index also yesterday broke through the “neckline” of a head-and-shoulders formation - a bearish event. For more on this, key levels and the most likely short-term direction of the S&P 500 Index, Adam Hewison of INO.com prepared another of his popular technical analyses.

Click here or on the chart below to access the short presentation.

Turning to Richard Russell, 84-year-old writer of the Dow Theory Letters, the excerpts below cast light on how he sees the lie of the land.

I’ve repeated the bearish factors so many times that I hardly have the energy to go over them again.

• The Lowry’s studies indicate steady deterioration in the strength of the stock market.

• On top of that, we have the still-operative non-confirmation by the Transports.

• We have the overvaluation from the standpoint of Dow and S&P dividend yields.

• We have the recent breakdown of the Industrials from a head-and-shoulders top formation.

• We have the Dow graded as bearish (it’s below 10,725) under the 50% Principle.

• We have NYSE volume tending to contract on days when the market is higher and expand on days when the market is lower.

• We have the market acting poorly in the face of ‘brightening’ business news and numerous Fed ‘green shoots’.

• Above all, the primary trend of the market was last confirmed as bearish under Dow Theory.

We have the majority of analysts insisting that March 9 was the bottom of the bear market. Here I apply contrary opinion.

‘So how will this work out?’ I ask myself. The market could just continue to sink with very little in the way of rallying ability, until the March 9 lows are tested and violated. The damn trouble with this market (from the bulls’ standpoint) is that it shows no signs of becoming oversold, the Selling Pressure Index just keeps creeping higher, and the Buying Power Index continues to deteriorate. This is one nasty bear market if there ever was one.

The technicals undoubtedly look ugly, and investors will now focus on the second-quarter earnings reports as a test of whether stock prices have run away from fundamental reality. As Randall Forsyth said in yesterday’s Barron’s: “‘Less bad no longer is good enough’ has become the new market mantra.”

Comments

[Seeking Advice:]

Always very imformative, Prieur. Thanks for the analysis!

Jul 08 08:25 AM

[enigmaman:]

Yes but- logic has no place in a market that is driven by Greed and Fear, emotions rule, the market turning + or - depends on what companies, the administration and the media are willing to report. Neither light nor glasses will help those that refuse to see! This meat grinder of a market will continue to chew up and spit out investors as long as investors are willing to play the game. Only when the majority refuse to play along will true light be shed on the state of the economy and the market, until then the meat grinder will be working 24/7.

Jul 08 08:37 AM

[CautiousInv...:]

I had occasion to reread a study of finanacial crises.......country level not global........and the median equity loss has been 56% over a 3.5 year period.

The recent high in the S&P was 1565 in October, 2007 and if the averages from the study are applicable we should expect a low of 688.........remarkably close to the 667 we got March 9th.

Given that we are recovering from a global financial crisis, that past equity price depressions have lasted 3.5 years and that markets as a rule retest their lows one or two times, I am personally investing around the thesis that the March lows will be tested.

As part of a recovery from a massive financial crisis, we have a host of structural issues to resolve and this will take the assistance of our best friend time.

Jul 08 09:21 AM

[Larry House:]

It is generally true that the deeper the market decline, the stronger the base must be for a sustainable advance from there. The market has one touch at the low. That does not build a base of any kind, even in a mild downturn, let alone the largest drop in 70 years.

Jul 08 10:33 AM

[Carl Spackler:]

Right On! We almost certainly must revisit 666 for their to be a sustainable advance.


On Jul 08 10:33 AM Larry House wrote:

> It is generally true that the deeper the market decline, the stronger
> the base must be for a sustainable advance from there. The market
> has one touch at the low. That does not build a base of any kind,
> even in a mild downturn, let alone the largest drop in 70 years.

Jul 08 11:40 AM

[Aweepup:]

Seems the market has spoken: S&P @ 871

Jul 08 12:43 PM

[Mad Hedge F...:]

Even the most obstinate, nay saying perma bulls now concede the head and shoulders is in on the S&P 500. That great barometer of global risk taking, the Euro/yen cross, didn’t just break key support at ¥132.50, it completely melted down to ¥128.00. Oil traders have had an epiphany, rediscovering fundamentals like wayward sinners finding a new religion, which, by the way, are terrible. So how did crude double in the face of a collapsing economy? Was it speculators? Was it Goldman Sachs? “Green shoots” have returned to being those pesky things you get dirt under your fingernails ripping out of your back yard. If I get any more negative I am going to have to change the name of this letter to the “Assisted Suicide Daily.” So I have to finish on an up note. I’m not in the Armageddon camp, which sees us going to new lows below Satan’s 666. I think 750-800 is more realistic. But then I was always the one to take the easy money. If you get another Lehman bankruptcy type event, you could see a real crash. For the last two years, the market has had an unceasingly ability to come up with these shocks.

Jul 08 02:34 PM