Technically Speaking, the Shorts are Hanging By A Thread

With positive earnings reports released from the likes of Caterpillar, UPS, and 3M outweighing news of an increase in jobless claims and sluggish home sales, the S&P 500 rallied 2.25% to 1,093.67.  This was a strong reversal from the 1.25% drop that was seen only the day before and a continuation of the whipsaw-like trade that has come to characterize equity markets during the past month.  Volume continued its summertime depression with an expectantly anemic reading of 4.1 billion shares changing hands on the S&P 500.  While a slightly better reading than what was seen yesterday, the market continues to give little insight (from a volume perspective) into whether the bulls or bears have the upper hand.  For the last couple of weeks, it was looking like down days may have been getting the better of rally days, but considering the increased volume readings seen in today’s and Tuesday’s rallies this notion is beginning to look nullified.

Interestingly, a trend appears to be materializing on trading days with large price movements (positive or negative).  Three of the last four trading days have seen daily movements of at least 1.25%, which is a fairly high daily volatility range.  In each of these cases, the intraday ranges were quite small after the initial moves higher or lower.  For example, after running to the 1,095 level just after today’s open, the S&P 500 traded within a 5 point range for the remainder of the session.  Excluding the period prior to Federal Reserve Chairman Ben Bernanke’s testimony to the Senate Banking Committee, yesterday’s sell off stuck within a similarly sized range.  This is yet another indication, in my opinion, that the equity markets are continuing to search for some sort of meaningful direction and remain at the mercy of the daily news flow and program-based traders.  This tendency is also likely part of the reason why the technically-based price channel (shown below) is holding up as well as it is.  Until momentum traders and institutional managers begin to get comfortable with their visibility on the U.S. economy’s prospects for the back half of 2010 (and thereby equities as well), their willingness to buy into strength and/or sell into weakness will remain constrained.

Despite the market’s best efforts to shake me out of my short position today, they couldn’t quite do it.  As I’ve said before, I’m looking to the 1,100 level as my point of exit and the S&P’s only managed to trade 1,097.50 intraday.  While my fundamental outlook has not changed, a meaningful break above 1,100 will be enough technical evidence for me to say that the move to 1,000 that I have been expecting (and wrote about last week) has been invalidated.  Based upon the futures activity this evening, it looks like we may be headed for a slightly lower open tomorrow thanks to a disappointment from Amazon.  But as with most trading days, the true story will be told towards the end of the session as traders begin to position themselves for the weekend.  With a rally of 2.70% for the week in the S&P’s, I suspect that many will be enticed to take some gains tomorrow and, consequently, push prices lower on the day.  Especially in light of the negative economic data that was released today (Existing Home Sales Decline, Weekly Jobless Claims Rise); I find it hard to believe that managers will want to take the risk of a negative comment or development over the weekend spooking the action on Monday. 

Here’s how the technical stand after today’s action.

As you can see on the daily chart, the S&P 500 has closed above the downward sloping trend line that it had minded so well for the past couple of months.  This is not a good sign for us bears.  However, looking at the longer term weekly chart, all is not lost as yet.  In general, trends within longer term charts tend to be stronger in nature than their shorter term counterparts.  It is for this reason that I set my sell point at the 1,100 level, which corresponds with the upper bound of the weekly price channel rather than the one seen on the daily chart.  As you can see, it is obvious that we are sitting right at resistance as the upper bound of the downward sloping trend (on the weekly chart) and the 38.2% Fibonacci retracement both intersect around 1,100.  So it’s put up or shut up time for the market.  If tomorrow’s action plays out as I suspect it might, my short will live to play another day.  But for now, it’s holding on by a pretty thin thread.  I always hate to put on a losing position, but knowing when cut losses is among the most critical skills an investor can have.

My final point this evening has to do with the comments I made about the U.S. Dollar and what that may portend for the action in other markets.  As I mentioned, the dollar and U.S. Treasury Bond prices have diverged over the past two months, which is a curious development.  This normally positive correlation can diverge from time to time, but it tends to come back in line in relatively short order (see comparison chart below).

What is interesting to me is the way in which the U.S. Dollar’s technical picture is shaping up in light of this divergence with Treasuries.  Have a look at the charts below:

As you can see on the daily chart, momentum indicators like the RSI and MACD are in an oversold position, which indicates that a rally in the dollar is likely to be seen over the near term.  Looking longer term, though, it appears that the dollar is mired in a longer term down trend as these same momentum indicators are either neutral (RSI) or outright bearish (MACD).  So what does this mean?  My read is that the choppy, range bound trade we’ve seen in equities is likely to continue as a near term spike in the dollar’s value would likely cap any stock-based rally and likely send it on a quick dip lower.  Additionally, the longer term weakness in the dollar (likely over several months) will likely put pressure on Treasury Bond prices as foreign investors find their earnings eaten away by the change in currency value and, thus, trade into more attractive assets.  Equities could be beneficiary of this asset rotation, but if the economic outlook looks challenging, you could see outright capital flight.  To an extent, this is what happened in 2009 as capital came out of Treasuries and the dollar and redirected into global equity and debt.  That said, given the fear that reigned during the Greek sovereign debt scare, it stands to reason that the dollar would see some pressure as these concerns fade (it was flocked to for safety reasons). This could mean that we’re just getting back to ‘normal’ after this scare.  As before, it’s worth keeping an eye on.

In closing, I want to encourage each of you to share Fundamentally Technical with anyone and everyone whom you think might find it interesting.  This has been a wonderful experience so far and I hope that each of you have found my commentary useful.  That said, this is blog is for you, so please do not hesitate to give me a little feedback on what you would like to see.  Comments are always welcome and you can email me directly (click the envelope icon at the bottom of each post) if you prefer your comments remain anonymous.  Thank you all for your readership and know that I’m working hard every day to make these posts worth the time it takes read them.  Until tomorrow…..