Monday, May 9, 2011

Equity Week in Review and Preview of the Upcoming Week/Month

Last week I wrote the following about the markets:
Last week, the market moved higher, which I did not think would happen. As I have stated for the last few weeks (see here, here and here), my underlying concern is the macro environment which is turning neutral (see NDDs Friday high frequency indicators report for more information) which I believe would have prevented the move higher. Obviously, the market did not agree.

So -- the question going forward for this week is the current rally a technical development -- that is, is the market merely acting on technical data -- or, is there a strong fundamental reason for the market to move higher? Currently, we don't have any confirming underlying data for the rally which is my primary criteria to believe the advance is for real. But this week, we get a slew of data which will either provide the requisite confirmation -- or not. The most important for me is Friday's employment report. The last few reports have been encouraging, but we have seen an unwelcome increase in initial unemployment claims over 400,000 for the last few weeks which could indicate the employment situation is weakening (see this link for a good discussion on the topic). We also get both ISMs - with the manufacturing ISM being of particular importance considering the recent drop in three regional manufacturing indexes.

A third possible explanation of the market is that of leading indicator; the market is saying the first quarter is an anomaly and growth will return in the second quarter. As such, traders are getting in on the rally at the earliest possible moment. That is always a possibility; that we are seeing a hiccup in growth and things will get better soon. I'm not completely sold on that idea as of yet, although it is a reasonable explanation. I'd be more comfortable with that analysis if prices at the pump were cheaper and initial claims weren't increasing.

At minimum, I'd wait until the unemployment report before moving into the market. But even then, I'm not thrilled by this advance. Overall, gas prices are high, 1st quarter GDP was low, other commodities' upward moves have stalled, and the bond market is also moving higher. And if we are seeing an advance rally that indicates the economy is experiencing a "hiccup" rather than a stall, there will be other buying opportunities.
My concerns last week are the same concerns I have this week: a fundamental situation that does not support a rallying stock market. First, let's take a look at the daily, 5-minute chart:

Prices dropped consistently on Monday, Tuesday and Wednesday and leveled out on Thursday. Notice that on Friday we see a gap higher in reaction to the better-than-expected jobs report, but prices could not hold those gains going into the close. This chart is important for two reasons. First, despite a better than anticipated jobs report, prices could not continue higher after the open. Secondly, traders did not have enough confidence in the possible weekend news cycle to keep positions over the weekend. That indicates traders are still concerned about the macro situation.

The daily chart shows very negative price action last week. All the bars of red -- not the stuff of rallies. In addition, we see increased selling action over the course of the week, telling us more people are heading out the door. Also of import is the 10 day EMA which is moving lower and the 20 day EMA which is moving sideways.

Prices have fallen to the 134 price area, which was an important area of technical resistance for prices. This means the price action going forward is extremely important; a technical bounce from this level would indicate the bulls are sill in control, but a move lower would obviously indicate the bears are taking over.

The IWMs -- which had broken to new ground -- have fallen back to the EMAs. Also note the increasing volume on the sell-off over the previous week.

The QQQs hit resistance and fell back.

I am still very concerned about the fundamental situation. As NDD has pointed out in his weekly high-frequency posts, most of these indicators are slowing. While the latest employment report was surprisingly positive, the spike in new claims is concerning. With the austerity movement taking hold in Washington, the "G" part of GDP is going to be weak for at least one more quarter. Although commodities moved lower last week, their overall prices are still high. In short, I don't see any strong fundamental reason for the markets to move higher right now.