Daily State Of The Markets: Look For A Bounce, But Beware Of...

Includes: DIA, IWM, QQQ, SPY
by: David Moenning

markets Well that was interesting. One minute the sky was falling with the Dow down more than 550 points and the S&P 500 having broken an important line in the sand. And the next, well, pundits were falling all over themselves trying to get on record calling the bottom. Such is life in the wacky game of the stock market these days.

After a 565 point dive in the Dow, a 450 point rebound, and a final 130 point dive into the close, the question of the day is if there was any meaning to the manic behavior.

Some will argue that stocks were SO oversold that the big bounce, which was clearly led by the issues that have suffered the most this year, was a sign that things had simply become overdone to the downside. The stock market had become uncoupled from the economy, we were told. The "price of tea in China" has little bearing on the companies doing business in the good 'ol USofA, the bulls opined. And with the Fed surely ready to mount their white horses, the smart money is buying right here, right now, they said.

On the other hand, there are those who contend that yesterday afternoon's joyride to the upside was the work of the "PPT." For those not familiar with Wall Street lore, legend has it that the Plunge Protection Team only enters the game at critical moments and then comes into the market with orders of such size that shorts cover, buyers buy, and the trend-following algos tend to chase their tails trying to catch up.

Some say the PPT is mere folklore and that the type of dramatic moves we saw yesterday are instead the work of "ignition algos" that are intended to get things moving in one direction or the other.

In any event, the bottom line is the U.S. stock market went from knocking on death's door to green numbers for the NASDAQ, the biotechs, the Russell 2000, the Mid-caps, and the semis -- all in a matter of a couple hours. So, call it what you'd like, but whatever it was, it was effective.

From a technical perspective, yesterday's action amounted to a "stick save" for the bulls. Instead of a clear break of important support, the S&P managed to rally back just far enough to put doubt into the technical picture.

S&P 500 - Daily

Chart purists will likely argue that a break of support is a break of support and that the day's action, at best, merely established a new level of near-term support. However, anyone watching the game over the past couple of years will likely agree that precise levels are no longer critical in a game dominated by algos trading in milliseconds. Therefore, from my perch, the pressure is still on the bulls to produce something more substantive than an intraday rebound.

The Macro Fear

Prior to the afternoon's excitement, the focus was on the big picture issues related to the oil/commodity bust. The fear seemed to be that the monstrous dive in oil could produce all sorts of failures, bankruptcies, and defaults in both the equity and debt markets. In other words, traders are worried that some sort of high profile bankruptcy could become the "Lehman moment" of the oil debacle.

In addition to a "loud" default or bankruptcy, traders are also worried about what types of problems may be lurking on bank balance sheets in relation to their exposure to both domestic and emerging market energy companies. Remember, a great many shale companies need oil over $50 to remain viable and most oil producing emerging markets require oil at even higher levels in order to balance the budget.

As an example of this issue, there was talk yesterday of the $100 billion of debt issued by Glencore plc (OTCPK:GLCNF), the big commodity house in Switzerland that has fallen on very hard times of late. The report I saw made it clear that this massive debt is not to be dismissed as being "handled" should further difficulties arise.

Then there was this headline: Cullen/Frost Q4 Loan Loss Provision climbs 5X due to "ongoing downturn in the energy sector." I don't know about you, but a five-fold increase in loss reserves suggests the bank wasn't exactly prepared for what is happening right now. And my guess is that there are more banks like Cullen/Frost out there.

And then there is Honk Kong. Paraphrasing UBS' Art Cashin's comments after the close on Wednesday, there is a boatload of derivatives tied to commodities floating around the financial district in Hong Kong. And according to Cashin, if things get much worse in the commodity space, this could become a very big problem in a very big hurry.

And THIS is the key point. The severity of the 2008 crisis wasn't about mortgages or houses. No, it was about the "financial weapons of mass destruction" (the ABS, CMO, CDS, etc.) on the balance sheets of nearly every major financial institution in this country.

As a card-carrying member of the glass-is-half-full club, I do hate to sound like a Debbie Downer here this morning. But I think it is important to recognize that there are "derivative" issues associated with the oil mess that may not be accounted for yet -- and may not be for quite some time. And if these securities start to bite, we would likely start to see funds blow up, forced sales, margin calls, etc., etc. And we all know how that turns out for the average investor.

Thus, I'd rather be aware of the possible dangers and attempt to manage the risk of the situation instead of turning a blind eye to the matter and telling everyone to just buy the dip.

But - Be Ready For the Bounce!

To be sure, the type of possible scenario I'm describing takes a while to play out -- if it indeed does ever play out. So, anyone with a shorter-term time horizon should probably take a cue from Wednesday's action and be prepared for a bounce of the dead-cat variety in the near future.

What would cause Wall Street's traders to forget about these macro fears and start pushing the buy button with regularity, you ask? How about some "jawboning" from Fed officials here in the states, some dovish words from Super Mario (Mr. Draghi is speaking this morning, btw), and maybe a rate cut in China?

In my humble opinion, any of the above would likely do the trick. But if all three were to somehow magically occur at the same time (and yes, the detected sarcasm here was intentional), well, the last part of January might just help us forget about the first part!

Turning to This Morning

In the early going, stock futures were following Asia and European markets lower and were pointing to another decline at the open on Wall Street. However, ECB President Mario Draghi changed all that with one simple sentence. After the ECB left rates unchanged, "Super Mario" said that the bank will "review policy in March" and that the risks to the current environment are to the downside. Draghi added that inflation expectations have fallen considerably since December (this is key), that there is considerable uncertainty at the present time, and that a more in-depth review of oil's impact on the economy will be available at the March meeting. Markets have taken this as a sign that more QE is on the way from the ECB and have spiked from red to green. U.S. futures now point to a triple-digit gain for the Dow at the open.

Today's Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:

Japan: -2.43%

Hong Kong: -1.82%

Shanghai: -3.25%

London: +0.96%

Germany: +1.28%

France: +1.16%

Italy: +2.80%

Spain: +1.29%

Crude Oil Futures: -$0.16 to $28.19

Gold: -$7.80 at $1098.70

Dollar: lower against the yen and euro, higher vs. pound

10-Year Bond Yield: Currently trading at 1.974%

Stock Indices in U.S. (relative to fair value):

S&P 500: +20.47

Dow Jones Industrial Average: +144

NASDAQ Composite: +48.32

Thought For The Day:

"Banking institutions are more dangerous to our liberties than standing armies" -- Thomas Jefferson (1802)

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of the Oil Crisis

2. The State of China's Renminbi

2. The State of the Earnings Season

3. The State of Global Central Bank Policy

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Negative

(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Negative

(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Neutral

(Chart below is S&P 500 daily over past 2 years)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

  • Key Near-Term Support Zone(s) for S&P 500: 1860ish
  • Key Near-Term Resistance Zone(s): 1980(ish)

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

  • Trend and Breadth Confirmation Indicator (Short-Term): Negative
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator(NASDAQ): Negative
  • Breadth Thrust Indicator (NASDAQ): Negative
  • Short-Term Volume Relationship: Negative
  • Technical Health of 100+ Industry Groups: Negative

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • S&P 500 Overbought/Oversold Conditions:

    - Short-Term: Oversold

    - Intermediate-Term: Oversold

  • Market Sentiment: Our primary sentiment model is Positive

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.

  • Weekly Market Environment Model Reading: Negative