A Trepidatious Trader

By Peter Prudden  SEP 26, 2012 2:05 PM

For the first time since 2009, earnings growth for S&P companies has turned negative, which is a significant warning sign.

 


MINYANVILLE ORIGINAL At this time, I am seeing the post-Fed sideways to down market as a minor correction, which should give way to a rally so long as past resistance, 1420 holds. 
 
The Federal Reserve has initiated a program of unintended consequences: Unlimited, open ended, unending unsterilized money printing.

Prior to this course of action, the underlining strength of the broader market displayed a significant number of daily, weekly, and monthly divergences against the prior highs established in 2011 and 2012. Yet since I highlighted the price action in July, SPX 1325, as a rather bullish explosive set-up based upon the convergence of moving averages witnessed prior to market tops in 2007 and 2011, the market has reverted itself to a neutral yet bearish undertone. Many of the internals that registered during spring months have been washed or will likely be negated on a further rally in equities.  

At this juncture, what is more important than actual price movement in equities are the movements of technicals to confirm price. This is something we did not witness in May 2011 or June 2011 and this provided sufficient reasoning for turning outright bearish on the market. While there are still signs of a top forming, I am seeing signs that a case is to be made for a new bull market. Here are my primary thoughts on where the market stands and where we are headed. 
 
1. We are still in a counter trend rally that began in December and should peak shortly. From here, we will eclipse the June 2012 low and bottom in between this low and the October 4, 2011 low, marking an end to the bear market in equities and establishing a new bull market. 
 
2. The SPX will rally back to 2007 highs, 1550-1570, and mark an end to the bear market rally in stocks that began in March 2009. As you may recall, this was my market surprise for 2012. The following move will be a larger move down and this will mark an end to the bear market while setting the stage for a new multi-year bull market. This is likely to fall within the June 2012 low and the October 2011 low. 
 
3. The SPX began a new bull market in March 2009 and established a new trading low in June 2012, which would bring 1600 into the picture and ultimately higher. 
 
Let's go to the charts... Crude oil has coiled itself tightly and a significant move appears imminent. An upside breakout bodes well for a bullish bias toward (and a re-test of) 2008 highs. Remember that commodity timing leads equity price. If you are in the camp that believes that the Fed will be successful in creating the reflation trade, as it was post WWII, crude will be a guide higher. A break of $100 per barrel will likely set in motion a run to $150-160 in WTI. Below $80 and we will likely have the deflation case diagnosed.


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In August, I highlighted the looming breakout in gold. Seeing the reaction in the headlines to MBS purchasing and an extension to keeping rates substantially low by the Fed, gold has broken out of a large consolidation zone. My target remains $1900, which is where a potential double top would present itself. Interesting to note the shift in gold. Once labeled the "fear trade," that is no more. Gold has traded inline with equities for the better part of a year and should be viewed as a risk on - risk off vehicle. Thus far, it is leading the risk on trade.


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What are the more concerning sectors that suggest the bull case is not clear? The transportation index is not confirming Dow theory and looks to be breaking down from a set-up similar to WTI crude, which has yet to tip its hand. Lowered guidance by FedEx (NYSE:FDX) and Caterpillar (NYSE:CAT) are contributing to the breakdown. Although the market can rally without them, history dictates that it's not a sustainable move. It should also be noted that the SMH is mirroring the TRAN, and both are breaking down from their respective trendlines of support established in March 2009 and validated in October 2011. It should be noted that semiconductors led the rally out of June and are now lagging.


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The US dollar should be a major headwind going forward as the asset class continues to be debased. Again there is a clear technical picture forming here and it's rather bearish. What we need to be on the lookout for is a bullish shift that negates the bearish pattern and forms a bullish bias, as other asset classes have had the previous 100 days.


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The broader market reached my first upside target of 1440 on the back of Bernanke. This is a significant pivot point on a weekly time frame as shown by the chart below. A prolonged break above this upper channel along with a daily chart look of a cup-and-handle pattern that triggered at an identical juncture point to a test of my second upside target of 1550-1570, which is where a cluster of Fibonacci retracement levels reside. This early stage breakout can still be voided, and with a move below 1420-1400. As you can see, I originally called for a market top at 1440, with a final end to the bear market residing near 1175. Europe's recession, China's growth stalling, and the domestic election are all variables that would lend credibility to this trade.


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It wasn't long ago that operating earnings per share on the SPX was a reliable guide to forecasting growth and finding a proper valuation on equities. The same can be said for technicals as reliable conditions pointed towards a major top. The Fed has stepped in and made a statement of "check with me" before placing your bets, thus making it difficult to position oneself based upon pure fundamental or technical belief. Case in point: For the first time since 2009, earnings growth for S&P companies has turned negative, which is a significant warning sign. As a whole, corporate earnings are expected to drop 2.2% in the third quarter. At this point, cost-cutting through employee headcount reduction is likely the only way to salvage profits, thus placing further strain on the economy.

But the Fed has told you, "We are here," and that makes it tough to be short. Massive intervention by the Fed and global central banks has  made it clear that there is a high probability that internal supply and demand dynamics of asset classes have been altered significantly, turning minor moves into head fakes, and reducing the value of one's usual tactical trading toolbox.

We now have a set of asset classes within defined ranges to monitor for the markets next direction, which won't be a minor move in either direction. In the near term, market conditions seem extended and a retracement should be expected shortly, setting the stage for an additional move higher. Please note that this report was compiled with the SPX trading at 1465, and the retracement should likely be viewed as well underway.
No positions in stocks mentioned.

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