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Weekend Technicals: Markets Failed to Break the Upper Trend Line

10:13 p.m. on Sunday, June 6, 2010. Publication times vary from one publication to another and this article may or may not be dated depending on when or where it is read. The author currently holds no position in the equity markets.
As noted in my Thursday post, the market indices were sitting at a major inflection point in this correction (the upper trend line), and the employment report was clearly the catalyst that was either going to put an end to this correction or lead to a 3rd leg down in this overall sell-off. Many pundits on Wall Street and in the Federal Government were expecting an exceptional employment report and when we didn't get that, the markets resumed the correction and began its inevitable trek to a 3rd leg down.
More importantly, the character of this sell-off sheds a lot of light on where the markets are headed in both the short and intermediate terms. At the get go I should disclose that I'm neither short nor long the markets and I'm 100% in cash and have been since after covering a short position in the middle of this correction (though I made a few short term trades 1-2 days). I need to see confirmation before I take any position one way or the other and haven't seen a definable market direction since the beginning of last week.
The intermediate term from a technical and global macro-economic viewpoint remains decidedly bearish, while the short term from a technical standpoint isn't as bear friendly as this sell-off might lead some to believe. First, I should say that when I use the term "markets" I'm referring broadly to the U.S. equity market and more precisely to the DJIA, S&P500, NASDAQ and QQQQ. Remember, the trend is your friend.
The S&P 500 (Broader Market Index)
The short term technicals on the S&P500 are giving us very mixed signals. Some bullish and others relatively bearish depending on how the S&P trades over these next few days. As we mentioned above, the S&P500 on Thursday afternoon was sitting right at its upper trend line which also happened to be the 200-day moving average. Had we broken and closed well above this major line of resistance, the markets would have likely completely reversed course.
However, the markets failed to break this key line of resistance and now a different short-term scenario is unfolding on the S&P. Looking just at the trend lines, the lower trend line is sitting at the 1010 to 980 range on the S&P. Whether we have a large enough of a supply of sellers to get us there is a different story. If we do in fact get to this trend line, the markets would very likely get a strong bounce as we have the previous two times we hit the lower trend line in this correction. I would likely take a long position in the QQQQ if we get down to the lower trend line in anticipation of a bounce and a possible breach of the upper trend line.
Yet, the reason I'm very skeptical that the markets will even get to this lower tend line is the fact that selling momentum has been gradually dying out since the beginning of this correction, which is clearly indicated by the recent positive convergence on the MACD as well as the definable decline in volume. Every sell-off in this correction has occurred on less and less volume. In fact, volume on Friday's 40-point sell-off has been outright abysmal for a sell-off of that magnitude. I would feel a lot more comfortable buying into the theory that the markets will get a full 3rd leg down if the volume would have been at least double what it was on Friday.
Thus, though I'm looking for a 3rd leg down in the markets based on Friday's action, I remain very skeptical unless we get a huge reversal on volume early next week. Yet, as I noted above I think the 980 - 1010 level would likely be the bottom of this 3rd leg down and a huge bounce at least to the upper trend line would be in order. So in summery, the bear case is that we failed to break the upper trend line on Friday's climax employment report while the bull case will argue that though we had a broad based sell-off in the markets, it was done on very light volume. The bulls will also point to positive convergence on the momentum indicator as a sign that a 3rd leg down will be exceedingly difficult to fully accomplish in light of the fact that there might not be a large enough of a supply of sellers to get us there.
The Dow-Jones Industrial Average (DJIA)
The DJIA is very much in the same boat as the S&P 500. Failed to breach the upper trend line on climax employment report, dropped on a lot lower volume than in the previous sell-offs in this correction and its short-term target range is sitting 9600 to 9400. Yet, the close on the DJIA was a little weaker than on the S&P500. The DJIA also simultaneously failed to break the 200-day moving average when it didn't rally on the employment report.
The NASDAQ is also in a similar holding pattern as the S&P and DJIA. Yet, unlike the S&P and DJIA, the NASDAQ's lower trend line is significantly lower in terms of percentage points than the Dow and S&P. Because the NASDAQ somewhat outperformed the other indices on this leg up over the past week, it has a lot lower to go to get back to the lower trend line on a potential 3rd leg down. The lower trend line for the NASDAQ is sitting between 2075 to 2025. That would be nearly a 10% move lower from its close on friday. Also, unlike the S&P500 and DJIA, the NASDAQ actually broke and closed well above both its 200-day moving average and more importantly its upper trend line on Thursday. Over the past 15 months, any time the NASDAQ has breached its upper trend line it has lead into a new big rally. Yet, it appears buyers of the NASDAQ were prematurely overzealous before the employment report and that's why I personally chose to wait and see how the employment report played out before considering a position in the NASDAQ. See last Friday's post.
Like the NASDAQ, the QQQQ broke its upper trend line by a considerable margin on Thursday ahead of the employment report and has now created a relatively large gap from the lower trend line. To get to its lower tend line, we would need to see a 12% move to the downside from here as the target is sitting between $41.50 and $40.00 on the QQQQs. That's a $5.00 move to the downside just to sustain this correction. The total move in the QQQQs if we get there would put it in bear market territory as the high before this correction was at $50 and change. That's a 20% move. And like the NASDAQ, S&P500 and the DJIA, the QQQQ sell-off on Friday was met with relatively lighter volume than in the previous sell-offs in this correction and the overall volume throughout this correction continues to rapidly contract indicating that this third leg down might be shallow and short lived. We need to see a more extensive volume-based sell-off early this week or I will becoming increasingly skeptical that we will get to the lower trend line.
Intermediate Term Decidedly Bearish
In my last post published this past Saturday, I noted that there were major intermediate term concerns for the market to work through. The markets have formed an exceedingly bearish 10-month Broadening Ascending Wedge which is bearish nearly 80% of the time according to Cobra's Market View. What's interesting is that the markets are currently at a cross-roads with its intermediate term formation. The DJIA and S&P500 are currently trading right at their 10-month lower wedge line. A breach of this wedge line on heavy volume indicates a short-term target of about 1010 on the S&P500, 9400 on the DJIA, 2025 on the NASDAQ and $40.00 on the QQQQs. These levels are coincidentally all near the lower trend line of this correction. If we get some major weakness and larger selling volumes next week, I'll be looking to take bets at these levels.
However, if on the other hand, we get a reversal and the markets break above their upper trend lines before bouncing off their lower trend lines, that is overwhelming evidence that the market has bottomed and I would likely be taking a substantial position in the markets. Thus, this week's big technical story is the following: do we get to the lower trend line after breaking our 10-month wedge line? Or do we get a reversal before getting to the lower trend line and break the upper trend line after a weak leg down in the markets? In either scenario, there are definable technical levels on which market participants should be focused. I'll be looking to go short or long depending on what I see early this week.
Regarding Bulls & Bears
I've been recently asked whether I'm generally a bull or bear. This is an issue that I feel very strongly about, and I am of the opinion that once someone assumes a permanent bias one way or the other, they become very susceptible to losing in a major way. I assume no bias one way or the other, and let the objective market technicals make my call for me. I've made considerable gains buying both calls and puts over the past month. My sentiment changes based on the technicals. If we get to the lower trend line on the QQQQs, I'll go long in anticipation of a bounce to the upper trend line. If we break the upper trend line, then I'll hold until the new up trend or bounce is in question and then will consider a short position. I try my best to trade with the trend. It would be a patent misunderstanding of this writing to think that I'm either bullish or bearish on the markets. In fact, at the current moment I'm entirely agnostic. I hope we get to the lower trend line because I think that presents with a better buying opportunity than having to buy after a break of the upper trend line. Once a market makes a definable move one way or the way, at that point I will assume a short term bias in the markets.
Regarding AppleAs Apple heads into the WWDC this week, we saw a relatively significant sell-off in the name due to broader market concerns. Yet, if we see continued selling pressure into next week from the markets, I fear that unless Apple wows the public with its new iPhone, we might get some major sell on the news as we have the previous two times Apple released an iPhone. Its not uncharacteristic to see some selling pressure in Apple until mid-to-late July when the fall tech rally kicks off with earnings. How Apple trades next week will be very crucial in judging its direction over the next few weeks. Personally, I would be far more interested in the name if it pulled back after going from $78 to $271. A pullback to $200 would be an outstanding opportunity. Though higher than expected resilience in the stock in the midst of this correction indicates that this possibility is growing increasingly unlikely. I'm looking to buy the stock when I feel more comfortable that broader market concerns are behind us.
Regarding Goldman SachsI would start to become interested in owning this name if and only if we get a double bottom after some major selling pressure in a second leg down. If GS can pull back to $135, rebound and then break $145, I would be a buyer of the stock.  GS is one of the only financial stocks I would consider owning.
Regarding AmazonWhat is there to say about AMZN that hasn't already been said about the housing market in 2005? When will these morons figure out that AMZN's 55 P/E is entirely unwarranted? This stock needs to follow in RIMM's footsteps. I'm not going to pay a 55 multiple for AMZN if I can pay a 15-20 multiple in AAPL which incidentally grows just as fast as AMZN but with significantly more profits.
Regarding GoogleGoogle is too rich for me. Get this thing down to $420, form that beastly inverted head and shoulders and I might take a bite. For now I'm not happy at this level.

Disclosure: At the time of this writing (Sunday, June 6, 2010 10:13 pm), the author holds no position in the equity markets though continues to explore taking both long and/or short position at any time. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.