Evidence Supports the Bears' Case for the S&P 500

I am not one to discuss fundamentals or macro views, but this situation in Europe is beginning to morph into a media frenzy. Price action in the marketplace is changing rapidly in short periods of time based on the latest press releases coming from the Eurozone summit.
 
I cannot help but comment on the seemingly arbitrary actions coming from this high-profile meeting. Nothing has happened that market participants were not already privy to. The European Union is going to strengthen their EFSF fund by levering it up roughly 4:1. I have yet to hear how exactly they plan on doing this, but this action was no surprise to anyone who has read an article about the sovereign debt crisis in the past month.
 
There was also discussion about backstopping European banks' capital position. Since European banks are holding billions (euros) of risky sovereign debt instruments, it would make sense that their capitalization is a primary concern of eurozone leaders based on current fiscal conditions. I would argue that the banks should be well capitalized regardless of economic or fiscal conditions in order for a nation to have a strong, vibrant economy that has the potential to grow organically.
 
The final piece of this week's political nonsense involves write-downs on Greek debt in the neighborhood of 50% to 60% percent in order to stabilize Greece's debt-to-GDP ratio. Apparently eurozone leaders want to structure the write-down so as to avoid payouts by credit default swaps, which act as insurance against default. How does a bond take a 50% to 60% valuation mark-down without creating an event that would trigger the payout of CDS swaps?
 
If a write-down of that magnitude does not trigger the CDS swaps, then I would argue they are useless as a tool to hedge against the default risk carried by sovereign debt instruments. If the CDS swaps do not pay out as projected by European politicians, the risk assumed by those purchasing government debt obligations around the world would be altered immediately.
 
The impact this might have on the future pricing of risk for government debt instruments could be extremely detrimental to their ability to raise funds in the private market. Additionally, the write-downs would hurt European banks' capital positions immediately. If the CDS swaps were to pay out, bank capital ratios would suffer as those who took on counterparty risk would be forced to cover their obligations, thereby straining capital positions even further potentially.
 
Price action today suggested that the equity markets approved of the package that European leaders were working on. However, the biggest push higher came when news was released that China was interested in purchasing high-quality debt instruments as a means to help prop up poorly capitalized banks and sovereign nations in the eurozone through an IMF facility.
 
The market did an immediate about-face that saw the Dollar selloff, while the S&P 500 rallied higher into the close, reversing a great many of Tuesday's losses. Inquiring minds wish to know where we go from here? I would be lying if I said I knew for sure which direction Mr. Market favored; however, that did not stop me from looking for possible clues.
 
It has been a while since I checked out the short-term momentum charts that are focused on the number of stocks in U.S. domestic equity markets that are trading above their 20 and 50 period moving averages. The charts below illustrate the current market momentum:
 
Equities Trading Above the 20 Period Moving Average
 


It is rather obvious that when we look at the number of stocks trading above their 20 period moving average that momentum is running quite high presently. This chart would indicate that in the short-term time frames equities are currently overbought.
 
Equities Trading Above the 50 Period Moving Average
 


A similar conclusion can be drawn when we look at the number of stocks trading above their 50 period moving averages. It is rather obvious at this point in time that in the short to intermediate term time frames, stocks are currently at overbought levels. This is not to say that stocks will not continue to work higher, but a pullback is becoming more and more likely.