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by John Nyaradi

Recent stock market action has been remarkable, to say the least, confounding bulls and bears alike. The former say it’s a new leg higher while the latter say the end of the world is nigh.

Can the stock market and ETFs go higher or is this a blow off top like so many others that have preceded significant declines?

Our view is that both the fundamental and technical picture point to significant downside risk for investors ahead.

On My Wall Street Radar

Below are two charts of the S&P 500 (NYSEARCA:SPY) with varying views and time frames. Click on each to enlarge:

Chart courtesy of stockcharts.com

The above chart is a year to date view comparing three strong advances that were followed by significant downturns and you can also see how the 50 Day Moving Average has curled over from its previous upward trend.

Chart courtesy of stockcharts.com

This chart goes back to the March, 2009, lows and shows the uptrend that was just recently broken and how the index is fighting to reclaim and hold that level. A sustained close below this trend line will be particularly bearish for the major markets as that will become new resistance while a climb from here would, of course, be bullish.

Also, in the first chart you’ll notice that the recent rally had a number of gap opens, and gaps like these typically get filled in subsequent days which would indicate the likelihood of lower prices ahead.

To further complicate the picture, volume remains light and insider selling remains heavy.

For another view of today’s patterns, my friend, Jeffrey Hirsch of Stock Trader’s Almanac, introduces an interesting discussion of a forming head and shoulders pattern and Three Peaks and a Domed House Pattern in his article, “Right Shoulder Arms!”

The Economic View From 35,000 Feet

The economic news continues, frankly, to be nothing less than shocking. So much is happening and so much has been written about all of this that perhaps it’s best to take a look at a few of these bullet points with relevant commentary attached:

  • June Non Farm Payrolls report says U.S. added 18,000 jobs compared to 125,000 expected: a truly shocking number from any perspective.
  • Wages declined: another headwind for the economy
  • Unemployment edged up to 9.2%: no progress at all here
  • 16% underemployment: 8.5 million people want to work fulltime but can only find part time work: I see a significant structural problem here rather than the much discussed “soft patch.”
  • 14 million people unemployed: first time over 14 million this year and definitely not a trend in the right direction.

(For a sobering recap of the unemployment picture and its effect on the middle class, read Michael Snyder’s recent article article, “Rampant Unemployment = The Death Of The Middle Class – 40 Facts That Prove The Working Class Is Being Systematically Wiped Out”)

  • European Union is going to have an emergency meeting on Monday about Italy which had a serious selloff on Friday: the European nightmare just won’t seem to end and now Italy, with the 3rd largest economy in Europe, appears to be tottering which could spell bad news for the euro (NYSEARCA:FXE)
  • Greece “settlement” still under debate: all three ratings agencies say a rollover plan will be a default which throws a huge monkey wrench into the ECB plans to buy more time for the Greeks to solve their problems.
  • China (NYSEARCA:FXI) inflation surged to 6.4% in June, a three year high, while food prices accelerated 14.4% and they raised interest rates for the 3rd time this year on July 6th while imports declined to a 20 month low: the dragon is headed for a hard landing.
  • Congress and the White House can’t agree on deficit reduction and tax increases and so the “grand bargain” of serious deficit reduction is off the table: so much for “serious adult conversation” about the nation’s fiscal woes as politicians from both sides of the aisle continue the “extend and pretend” game that is being played around the world. Only problem here is that this is a rapidly growing snowball as it rolls down the hill, and the farther we let it roll, the bigger it will inevitably get, threatening the Dollar (NYSEARCA:UUP) and the US Treasury Bond market (NYSEARCA:IEF)
  • Moody’s downgraded Portugal’s debt to junk: another PIIG story
  • Italy, (EWI) Portugal and Greek Credit Default Swaps at record highs: markets think risk of default is high; what a surprise.

With so much going on, it’s important to try to keep some perspective and this article, “20 Warning Signs of a Global Doomsday,” points out at least one potential red flag on the current economic landscape.

What It All Means for Stock Market and ETF Investors

All in all, we are living in simply fascinating times, a sort of global financial “fun house” like you might remember when you were a kid at the county fair wherein reality was completely distorted in every room you entered.

The recent rally in global equity markets and the Dow Jones Industrials (NYSEARCA:DIA) really has no foundation in technical or fundamental facts and so one can only guess that it’s a conditioned reflex to “buy the dips” which has been the best strategy since the Fed started injecting liquidity into the markets.

Or perhaps everyone is hoping that “bad news is good” and that Dr. Ben will bring back his magic punchbowl for another round of quantitative easing and easy money.

I suspect that we’ve entered a new phase of this post-Crash environment as “kicking the can down the road” only works until you come to the end of the road which seems to be racing up to meet us and that “extend and pretend” is not a viable financial policy.

My view is that even scarier rooms await us on our journey through this global financial fun house.

The Business and Financial News Week Ahead

Earnings season kicks off this week with Alcoa (NYSE:AA) on Monday, Yum (NYSE:YUM) and Borders (OTC:BGPIQ) on Wednesday, important tech (NASDAQ:QQQ) heavyweight Google, (NASDAQ:GOOG) and financial sector (NYSEARCA:XLF) heavyweights JP Morgan/Chase (NYSE:JPM) on Thursday and Citibank (NYSE:C) on Friday. Earnings are expected to shrink; however, it seems that recent analyst downgrades have set the stage for positive earnings “surprises.”

We’ll also get important economic news about the retail sector, inflation, and manufacturing and consumer sentiment.

Tuesday: FOMC Meeting Minutes

Thursday: Initial Unemployment Claims, Continuing Claims, June Retail Sales, June Producer Price Index

Friday: July Consumer Sentiment, June Consumer Price Index, July Empire State Index, June Industrial Production

ETF Spotlight

Leaders: (NYSEArca: THD) Thailand, (NYSEArca: EPU) Peru

Laggards: (NYSEArca: EWP) Spain, (NYSEArca: EWI) Italy

Certainly we have our problems, but we are all a part of a unique nation at a unique point in history. If we’re smart, if we’re courageous, committed and bold, our best days are yet ahead.

Disclosure: Wall Street Sector Selector actively trades a wide range of ETFs and positions can change at any time.

Source: Bull Market or Blow Off Top for Stocks and ETFs?