Technical And Fundamental Factors That Increase The Risk Of A Market Trend Reversal

Includes: IWM, QQQ, SPY, UUP, XLF
by: Michael Harris

Fueled by promises of infinite QE from the FED, the market has overlooked some sources of potential high risk, like the Europe debt problems, for example. The situation in Europe is getting worse and it is just a matter of time before it gets uncontrollable in my opinion. At the same time, major market indices (NYSEARCA:SPY) are facing strong overhead resistance in their effort to defy gravity and move higher. Given that any gains in earnings were dismal and the fact of a lack of broad retail participation, the probability of a change in trend is high at this point.

Fundamental concerns

The situation in Europe is getting a lot worse. Greek politicians and IMF representatives are in disagreement over budget cuts necessary to finance a new austerity plan without causing social chaos and an even deeper recession in that country. What is even more important in my opinion is that a political scandal has erupted in Greece about Swiss bank account holders that puts in risk the existence of the already weak coalition government. It is likely that the coalition government in Greece will not last long. The probability that a leftist party wins the next elections is very high, close to certainty at this point. Then, Greece will necessarily default and revert to own currency. The full impact of this cannot be estimated at the moment but it won't be good for the markets, resulting in a substantial correction.

Spain will have to eventually surrender national sovereignty to the EU and the IMF and accept an aid package. The longer the politicians there are delaying this decision, the worse the impact on the financial markets will be down the road. I believe that the exact size of the Spanish debt problem is unknown. Recent bank stress tests showed a lower than expected deficit of $76 billion but the tests can be trusted only if one knows the exact assumptions used. I think that the Spanish problem has been overlooked for too long by focusing on the Greek problem.

Needless to say that there must be a major restructuring of policy and objectives for the EU to survive but there are no signs that Germany is willing to do what it takes and the focus is on more austerity. The internal devaluations instituted in several countries in EU are pushing the limits of social cohesion. If social unrest erupts, the impact on financial markets will be devastating.

One thing that is certain is that the ECB giving money to the banks by buying assets and in turn the banks lend the money back to the states at a generous 500 - 700 basis point spread gain will only make things worse in Europe and lead to a breakup of the EU and the euro to its demise. The dollar will gain substantial in this case (NYSEARCA:UUP). The way this works is that the banks put as a collateral government issued bonds with the ECB and borrow at 1%. Then they lend the proceeds to the governments by buying more bonds and in this way earn a generous spread. This is a mechanism for recycling large deficits of central governments in Europe and does not solve the structural problems. This is one reason the Germans are not much in favor of the ECB plan to buy more debt and they would like to see the deficits eliminated first.

The above fundamental concerns have peaked at a time when major indices in the U.S. have retreated from their recent highs and are making another attempt to rally. On top of these fundamental concerns there are also some technical concerns that raise doubts about the sustainability of this rally.

Technical concerns

Out of 6,700 stocks traded in major U.S. exchanges, 4549 are above their 200-day simple moving average, or 68%. Regarding the S&P 500, 371 stocks, or 74.20%, are above their 200-day simple moving average and 74 stocks are at levels of 20% or more above their 52-week high. This is a very good performance achieved by the rally that started last June but it may be unsustainable in the short to medium term.


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After founding support at its 30-day simple moving average, SPY is about $1 away from strong overhead resistance at $147.17. Probability of a double top is high.


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The NASDAQ ETF found support at its 30-day simple moving average yesterday and it is about 70 cents away from strong resistance at $70.08, having defied bearish classical chart patterns. The probability of a top of some kind is high.


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The Russell 2000 ETF shows that the broader market has not participated in the recent up moves. Here the weakness is clear in the presence of very strong resistance at $85.51. The probability for a drop from these levels is high for this ETF.


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The financial sector ETF has recovered most of the ground towards its recent high as a natural reaction to infinite QE, and it is now only 21 cents away from strong resistance at $16.28, while the RSI(14) is approaching overbought territory. However, this one is unpredictable because it is fueled to a large degree by the QE talk and speculation. It is possible to see a violation of the resistance and a new short-term high before a correction occurs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Charting program: Amibroker.