Downtrend line broken; X-mas rally?

With stocks up 10% in the rallying we’ve seen, the downtrend line broken and a lot of technical buyers of index ETFs, are we seeing an X-mas rally take shape?  Seasonally we do have a few factors that could point this direction, but it all depends on market sentiment.  Options expiration is December 19th, which is traditionally a volatile day with the potential to drive a tremendous bear market rally (or sell off).  We also have had a slew of economic news that was nothing less than terrible and the market has reacted in a neutral to positive manner with amazing resilience.

The bottom?

That’s not how it looks at this point.  In fact, the uptrend itself is only beginning to show itself.  We aren’t out of the bear market until the worst volatility is behind us and there’s optimism regarding the future.  I feel that this has more potential to be a short-lived seasonal bear market rally.

How high can we go?

It’s possible with the current pattern we’ve formed, which resembles an inverted head and shoulders, that the S&P 500 could hit 1000.  At that point there is major resistance that would probably cause some consolidation and perhaps profit taking.

Patterns predict markets?

Sometimes patterns and other technical analysis can help to show where the market is going based off prior behavior.  There are plenty of charts on the bottom of the sea from failed navigation and the market is no different.  You can be just as wrong as you are right.

What happens next?

We need to see a close above 920 on the S&P to fundamentally change the picture.  From that kind of close we have the potential to rally up to 1000.  Long term my bias hasn’t changed.  I still believe we could break below our 741 lows to the 450-600 area.

Non-Farm Employment Change -533k

Today’s non-farm employment change was nearly twice as bad as consensus expectations and the worst in 34 years, slamming futures on all major US indexes sharply lower.  This economic data confirms that the US economy is in a deep recession and puts in jeopardy the consensus GDP estimate of -4%.  We may see a number as bad as -8% on the next quarterly GDP report because of the massive contraction in employment and ISM data.

Should the negative sentiment continue, this sell off could push markets much lower.  Futures are hovering at support levels and could be pushed significantly lower at open.  Watch this market closely today.  The price action will be extremely important in determining the next likely move.

Volatility could surge on VIX technicals

Volatility is potentially poised to surge as the VIX six month chart is showing a large ascending triangle formation.  Below is a chart showing both the Bollinger bands with 50d moving average and the ascending triangle with resistance at about 80 and a support trend line from September until now showing the massive surge.

I think there is a high likelihood of a retest of the 80 area and possibly a break above in the next few days.  Right now the NYSE and NASDAQ McClellan oscillators are showing that the market continues to be overbought and must correct.

It’s worth noting that a lot of false bullish signals in the stock market can occur when volatility is this high.  I’ve seen many skilled technicians get suckered in to buying the tops of these rallies.  Be careful!

Before we get ahead of ourselves

Much of yesterday’s rally was predicated on a rumor being circulated about the US Treasury planning to price fix new home mortgage interest rates at 4.5% and other whispers.  Many who selectively watch the news or ignore it may fail to fully realize how this short term optimism can impact markets.

We had a sleu of negative economic data yesterday, but it was trumped by the aforementioned rumor and speculation that the TARP be brought back to fund more bailouts.  Today we see terrible same store sales from every chain but Wal-Mart.  We also have unemployment claims at over 500k and factory orders at 10am that promise to be nothing short of terrible.

There will be plenty of Fed speak today.  I can’t for the life of me imagine any optimism they could install after yesterday’s gloomy beige book.  Most of the chatter will probably be about how the Fed wants to avoid cutting to 0% by using quantitative easing strategies, such as buying long bonds and forcing prime interest rates lower.

The futures are weaker by about 2% this morning, giving back much of yesterday’s gains.  Market gains made Tuesday and yesterday are still part of a bear market rally.   Markets are facing the upper resistance line of a falling six month wedge pattern on all major indexes.  Don’t get BULLied!  Remember the trend is your friend.

Bernanke wants to party like its 1999

He plans to potentially cut rates to 0%, creating a liquidity trap, much like our friends in Japan did in the late 90s.    This is an absurd solution to a problem that originated with too much cheap credit availability.  It is also naive to speculate with trillions of dollars, mortgaging our next generation’s future for the mistakes of bankers and regulators.

What if it doesn’t work?

There is a strong likelihood that this “fix” will create stability (not necessarily growth) in other asset classes by sacrificing the dollar.  If it doesn’t work, however, we could see a protracted global depression with many central banks already having expended their monetary policy ammunition prematurely.  Japan’s crisis never technically ended.  Their stock markets never regained their 1990 highs.  Since then they have been in a deflationary environment for 18 years.

Won’t the bail outs help the country?

Probably not.  Capitalism was built on the philosophy of letting the strong prosper and the weak fail.  If a company can not make a profit or has made terrible investment decisions, the tax payer should never be held accountable.  Bailing out the weak also stifles real growth and innovation.   Other companies are usually poised to fill the gaps left behind by the weak companies failing with better products or services.

If it won’t help, why try?

Central planning rarely works, but is often utilized in times of crisis to provide moral support.  We are going down a dangerous road that could end in the socialization of corporate America while leaving the middle class to decay.  The favoritism employed by Treasury and Federal Reserve officials to arbitrarily choose what lives and what dies is the polar opposite of free market capitalism.  It undermines the very framework that could have been the solution to our credit woes.

How do you make money in this environment?

So far short term trading, while risky, seems to be more reliable than any buy and hold approach.  Some folks are playing the double and triple leveraged ETFs based entirely off of technical indicators and having good success.  Others are accumulating positions in commodities for what they expect to be an extremely inflationary environment.  My take is that both strategies are applicable, depending on your risk tolerance, time horizon and availability to watch this volatile market.

Recession is official; economic data worsens

Now that the recession is official, many are taking their queues from economic data and yesterday we saw very negative readings on ISM.  In fact, the worst in 30 years.  This shockwave sent the markets down sharply, giving back much of last week’s gains.

While yesterday’s vicious selling may seem overdone, and may even yield some light buying ahead of the next wave down, I believe we are simply confirming the six month falling wedge pattern and will be retesting the intraday lows of 741 in short order.

On a side note, the tremendous easing the Fed is implenting by buying bonds, cutting rates and opening the lending windows to all will eventually yield to a very inflationary environment.   Commodities and currencies will begin to become attractive early in 2009.