ON THE LAUNCH PAD? OR ON THE EDGE OF THE ABYSS?

It's been extremely difficult to asses the direction of the equity markets. If most of my readers are like myself, they've been torn between "going long", going to cash, or "going short" (either directly shorting, or as I've been toying with, via Ultra-Bear ETFs). It's been extremely difficult to do more than day trade these ETFs as the crosswinds of the market have whipsawed investors).

There are very reasonable cases to be made on both the bearish and bullish side, although I find the bearish case more convincing. So I thought I might review the arguments of both in this post, consolidating and/or reviewing some of the thoughts I've focused on previous posts.

The Bullish Case

The most cogent argument that the Bulls can make is that this market is extremely oversold. Normally this is an effective indicator since it follows the old Baron Von Rothschild adage "Buy when there is blood in the streets".

As I posted earlier, the Arms Index, created by Richard Arms is an indicator of "max panic", where selling outpaces buying, indicating a "flushing" of the marketplace and transfer of shares from weak hands into stronger ones. The index registered the 4th highest level in 70 years, according to Arms:

ARMs Index at 4th highest level in 70 years.

We're seeing negativity everywhere in the markets... We've had the Flash Crash of May 6th (which remains insufficiently explained, IMO) which dropped the DOW 1000 points within 10 minutes. Prominent market analysts are urging their readers to sell stocks, we have the problems in Europe, war drums beating in Korea and the Mid-East, the BP oil catastrophe, and some would suggest the sky is falling. To a contrarian investor, this represents "max fear" and therefore, max opportunity to get in at a market low.

Furthermore, we have Investor's Business Daily, and a number of major investment analysts, including Abby Joseph Cohen of Goldman Sachs, now declaring the market correction is over and a new bull market is beginning:

Dusting off Abby

IBD calls end to correction.

Another argument the bulls use is that US corporations are flush with cash and apparently ready to spend it:

Corporations ready to spend record cash holdings

So what would they spend it on? Productivity enhancing technology, new machinery, communications upgrades, including computers. The question is whether this spending, when it occurs, would lead to an increase in employment. Increasing productivity normally means there is less of a need for hiring workers.

There's also the currency argument. The Euro had been previously threatening to seek parity with the USD. That would greatly impact the competitiveness of US corporations against Europeans exports. It would also likely play havoc with currency swaps. So having the Euro transit back above the 1.20 mark is a positive sign the Bulls are lashing their hopes to.

And finally, there's the technical argument that the S&P 500 has held it's 200 Month MA at approximately 1040. A violation of that level would have likely confirmed this correction was actually a resumption of the 2008 bear market, with new lows to be seen in the future:

SPX monthly chart

In sum.. the Bulls are arguing that the negativity is so great that it's lost all sense of perspective and that creates opportunity to move the markets higher.

That's about the best I can make of the Bullish case at this time.. If there's more, I'll update with an "Edit" comment, so be sure and check in from time to time.


The Bearish Case

Lordie.. where do we begin?

Well.. here's a chart that I found very interesting. It was pointed out to me by another TA analyst on the TZA Yahoo thread:

SPX Weekly chart with 100 Week MA

If one changes the period to "all data" instead of 10 years, it will be clearly seen that there have been VERY FEW INSTANCES where the SPX violated the 100 Week MA without a major decline occurring thereafter. We saw this in 2001 and again in 2008, the first times since the SPX went "parabolic" in 1994, that the 100 Week MA was substantially violated. And each violation has resulted in "lower lows" being seen in the SPX, the last low being seen in March, 2009.

Since that time the SPX has risen roughly 83% until it fell below the 100 Week MA during the Feb correction for two weeks, and then violated it again in the days after the May 6th "Flash Crash", where it's remained for the past 3 weeks.

When I first saw this chart, it struck me as rather important and it seems to confirm the comments I made about Monthly Parabolic SARs "flipping" downward:

SPX Monthly SAR flips downward

As Carl Swenlin of DecisionPoint.com states, "Technical Analysis is a windsock, not a crystal ball." Therefore, one has to be willing to change with the prevailing winds and not seek to fight them.

When one is applying Technical Analysis to the market, it's always wise to find confirmations that support one's theories, not only technical, but fundamental.

SPX Gallery View

On the short term, there is an indication the SPX will rally this week (looking at the PPO on the daily chart indicator a reversal to the upside). However, the weekly remains decidedly bearish and the PnF chart still indicates a target of 925.

Now.. this is an interesting PnF chart. It reflects that the "Bullish Percent for the S&P 500" has reached a trend line that signals "Bear Confirmed":

DOW Bear confirmed on May 7th, 2010:

Bullish Percent DOW (INDU)

S&P 500 Bear confirmed on June 9th, 2010:

Bullish Percent SPX

Nasdaq Bear Confirmed:

Bullish Percent Nasdaq

Bullish Percent Index explained

And now.. we have Barron's telling us to "Call a Bear a Bear":

Call a bear a bear?

And this is a DEFINITE read for those making the Bearish case:

"Wall Street seems to have no concept at all that every bit of growth we've observed over the past year can be traced to government deficit spending, with zero private sector expansion when those deficits are factored out. As I noted last week, if one removes the impact of deficit spending, "the economy has recovered to the point where the year-over-year growth rate since early 2009 now matches the worst performance of any of the 50 years preceding the recent downturn." In effect, Wall Street's is seeing "legs" where the economy is in fact walking on nothing but crutches.

Similarly, it is apalling that Ben Bernanke can say with a straight face that many of the "investments" made by the Fed have been repaid "and some have even made a profit," without immediately noting that the two primary sources of these repayments have been, directly or indirectly, the U.S. Treasury, and savers who are receiving near-zero interest on bank deposit instruments.

If we fail to recognize that the "good news" reported over the past year is due not to a recovery in intrinsic economic activity, but instead to massive government intervention, we risk being blindsided as those synthetic effects gradually erode.

On that point, it is notable that the Economic Cycle Research Institute (ECRI) reported Friday that its Weekly Leading Index has slumped to the lowest level in 44 weeks, and has now gone to a negative reading."

Born on Third Base

More later....

Scrutinizer