Monday, September 08, 2008

Week of Liquidation Ends with Bounce

- Week of liquidation ends with a bounce off July closing lows.
- Jobs report fuels more downside, but look at history for a real lesson (a history lesson?)
- What evil lurks in the varying economic data? The market knows.
- Treasury plan for FRE, FNM bounces stocks after hours.
- Looking to play an upside rebound off the July lows but then . . .

Labor Day hex returns with hedge funds unloading positions.

Labor day can be a bad time for the market and that is particularly true when it is struggling and the economy is questionable or worse. It doesn't help when hedge funds are heavy into a particular trade or two and need to liquidate positions that have turned against them. That is exactly what happened this past week as agriculture, commodities, and large cap tech were dumped. The former were already under pressure, and with the liquidation of a big hedge fund and the likely same kind of action with other hedge funds (though they managed to keep it behind closed doors) there was something of a crescendo of selling in the former leaders in agriculture and tech. That joined in with a general collapse of the low volume summer rally and ended up sending SP500 and DJ30 to their July closing lows on Friday.

The economic news on the week was not bad at all and oil was down further. Still, investors favored focusing on declines in the rest of the world economies and thus ignored any decent news such as the major tax cut the 28% drop in oil prices bestows on consumers and businesses.

Friday the news was negative regarding jobs with unemployment jumping to 6.1% and NOK issuing a warning. Again the market focused on the worst, i.e. jobs, even though it is a lagging indicator at odds with other economic data, it added to the overall angst. The data dropped the futures and the market made another push lower for the week; after three prior down sessions (four if you count the prior Friday), this fifth straight push lower tapped out the liquidation in the commodities and was good enough for the shorts to start covering. That brought stocks back up and indeed to positive on the NYSE though NASDAQ lagged but just modestly. Kind of sums up the week for NASDAQ, i.e. lagging.

The interesting point is WHERE the indices decided to turn. SP500 and DJ30 both came within 'gimme' range of the July closing lows and that is where they turned for the day. Of course it was midmorning where it happened, right at 10:30ET when it always seems to happen. The rest of the afternoon was all upside with all of the indices but NASDAQ and NASDAQ 100 turning positive by the close. That suggests the market is trying to make a bottom off of that July low, pretty much as the textbook would call for.

Of course textbooks don't often apply to the market. VIX moved higher but it was nowhere near high enough, capping the move at 24.17, basically where it gapped up to from 24 Thursday. Even at the height of the selling Friday it was a piker. Volume was lower than Thursday. Bottoms can form on low volume, but typically not if the pattern is a double bottom. That suggests this was not THE bottom, just a lot of short covering after a harsh drop putting an end to the summer rally.

That means look for another sharp selloff Monday and Tuesday to finish things off, right? Maybe that was in the cards, but after hours, as if on cue from Bill Gross' comments Thursday, the WSJ reported the Treasury was ready to announce a 'backstop' put in place for FNM and FRE that would entail replacing management but also basically wiping out common shareholders. FRE and FNM rallied then dove lower after hours, but the rest of the financials and generally the rest of the market rallied sharply after hours. That could put a hold on any renewed test, at least for 2 to 3 sessions. After that we likely get the outcome of other actions by the feds: once the initial excitement is gone, so is the bump.

TECHNICAL. Classically bullish intraday action with an early dive continuing the Thursday slaughter and then a turn and a steady rally higher into the close that took the NYSE indices back to positive. Again, classic.

INTERNALS. Flat breadth on both NYSE and NASDAQ. Volume was lower. That was key. When you have a reversal session such as the intraday action shows, to get a true key reversal you need high volume. Volume was still above average on NASDAQ but lower. It remained below average on NYSE and was also lower. No surge of new buyers, no key reversal that leads to a sustained rally higher.

CHARTS. After a dive lower on the week ended with SP500 and DJ30 coming within 2 points and 75 points of the July closing low, respectively. NASDAQ came within 4 points of its July closing low, though that is not the low for the year. Still a good place for NASDAQ to hold. SP500 and DJ30 reversed and closed positive, NASDAQ did not. Some commentators called this the bottom while others said no. It definitely has the action of a bottom, but as noted above, there is more to it than price action, and the other factors were not there.

LEADERSHIP. This drop is thinning the ranks some but it is also flushing out the sellers and giving some solid stocks a test of the 50 day EMA and others are basically ignoring the selling, still working over their near support at the 10 and 18 day EMA. Retail remains surprisingly strong for all of the economic gloom. Small caps sold off below the 50 day SMA but then rallied back to the 200 day SMA. Most leaders, however, are getting tested, and how they come out of this will tell a lot about how close the market is to a bottom. If they cannot hold on then the market is in for more downside. A positive: even without the FRE/FNM after hours announcement some financials were looking much better, trying to be leaders in their sectors, e.g. WFC, HCBK, AMTD.


What else is out there? It isn't the jobs report: just look at the dates.

The jobs report was a case of worse economic data. The non-farm job losses were not huge at -84K (-75K expected), and the downside revisions were not outlandish at -58K for June and July. The thing that scared many was the jump in unemployment to 6.1% from 5.7% and the highest since September 2003. The dramatic jump was the fodder for both political campaigns as both said they could change that. Now both sides are claiming they are the change choice.

Anyway, I always say that jobs data lags the rest of the economy because employers wait to rehire until times are good, and when the economy starts a recovery there is slack that the current employees can (theoretically) take up as things improve. Companies continue to thin employee ranks even as things improve out of fear of overstaffing. Human nature and thus jobs lag the actual economy: too many jobs when it is turning down, too few when it is turning up.

Of course that didn't stop the political parrying and others obsessing over this data. In all of the fuss, however, they overlook the most key factor that popped into my mind as soon as I checked up on some history. Actually I didn't have to check on it; it just came to me. Got to take a vacation I suppose.

This was the highest level since September 2003 when it was at 6.1% as well. Back in Q3 2003 (September is the last month of that quarter) what was going on with the economy? It grew 7.5% that quarter. The 6.1% was not the high in the cycle; it hit that in June at 6.3%, spending 7 months (starting April) at 6.0% to 6.3%, averaging 6.1% over that span.

The point: the August unemployment rate and its statistically aberrant jump matches the high average of the last recession, and that prior high was hit as the economy left the recession. Given the relatively shallow overall recession (though aided by exports that many of us don't directly benefit from), we are likely hitting the peak of the unemployment right now and the August number will likely be revised lower in any event.

So is the economy recovering?

Thus you cannot rely on the jobs data as your litmus for the economy's health. The US economy knocked out its fastest growth in 20 years in Q3 2003 even as the unemployment rate peaked. In Q2 2003 GDP rose at 3.5%, and in Q2 just 1.2%. Thus far in 2008 Q1 posted a 0.9% advance and Q2 a 3.3% advance (though that was all exports as discussed two weeks back). Very similar and this time we had to deal with $147/bbl oil and a credit crisis that is still dogging the economy.

Does that mean we are about to spurt 7.5%? No. The drop in oil is helping but it just occurred and has not filtered back through the economy other than in some improved consumer sentiment. Credit issues are still a problem as bond yields remain very low and credit spreads remain wide: the market has tightened credit even if the Fed has not. These low bond yields suggest something is still out there bad waiting to happen. Maybe the Treasury's pre-emptive move re FNM and FRE will change that. Indeed, yields were on the rise after hours, up to 2.29% on the 2 year (hit a low of 2.13% Friday) and 3.70% on the 10 year (hit 3.57% Friday). They are going to ramp higher on the Treasury action just as they did with the prior Fed facilities. The key question is will they hold the gains now, indicating that the 'issue' is out of the way.

As chronicled the past two weeks, the economic data is improving. Factory orders are strong, durables are very good, manufacturing and service industry indices are moving to expansion again. Oil is down 28% and that is an effective tax cut on consumers and businesses. Housing has bottomed. Retail stocks are surprisingly strong. On the other hand, ECRI's 4-week annualized growth rate came in this week at -11.7%. While that is up from -11.8%, it is still indicating recession.

The ultimate issue is the market. Unlike Q3 2003, this market is not making a prior run. It had a weak summer rally that fizzled and the indices are now testing cycle lows. SP500 was up roughly 25% from its March 2003 low (that was not even the cycle low hit in October 2002) when the unemployment data peaked. Not quite the same picture here, and the market leads the economy in most cases.

That suggests this growth in the economic data is illusory, that it is going to turn back down unless the market bottoms here at the July lows and starts some serious rallying. It is definitely not the same prognosis as in 2003 even though there is some correlation with the unemployment rate and improving economic data that no one believes. They didn't back then either, but the market was rallying better, answering the critics in its own way.

We don't want to commit the opposite yet similar sin the jobs report followers are making, i.e. relying on that report to guide our read of the economy or the market. In other words, just because unemployment hit 6.1% to 6.3% on the highs back in the last recession we don't want to conclude that it has peaked in this recession. The more leading economic data is positive, but the best leading indicator of all, the financial markets (stock and bond), are not.

Another explanation why the market is lagging the economic data.

Now there is another explanation here. There is no question that hedge funds are much more prolific now than in the last recession. We have had a big export economy as the dollar collapsed making our goods cheap. That also led to a bubble in commodities prices. When that bubble popped they sold. Then they collapsed lower. When they started to really fall some hedge funds got out others are not being forced to sell due to leverage requirements. One announced last week it was liquidating. Others are likely going to do the same albeit involuntarily. This liquidation of so much cash in these export and dollar related stocks depressed the market on top of the financial selloff. In addition, with Europe clearly in recession (Friday more data showed trouble as Germany's industrial production fell 1.8%, down four of five months, easily topping even the worst forecasts; year over year it fell 0.6%, the first decline in 5 years).

This liquidation of stocks related to the export and weak dollar trades is overshadowing the improvement in the US economy even as foreign economies that bought our exports slide into recession and won't be buying the same number of goods.

Once that massive liquidation is complete and turns to buy the rising US economy and the stocks that are tied to the US success, the market could make a very quick recovery and be on the way to a 2003-like rally.

That is a very interesting and some would say Polly Anna-like view of the current conundrum of rising US economic data yet falling stock prices. Hedge funds have changed the game in the market, however, and we should not underestimate their clout, particularly when there is wholesale, panic liquidation of positions that are threatening the very existence of the funds.

All of this makes the current test of the July lows by SP500 and DJ30 extremely important as the key litmus test of where the economy and of course the market are in the cycle. This decline thus far is roughly one-third of the decline logged by SP500 in the 2000 to 2002 bear market and is half its duration (September 2000 to October 2002 versus October 2007 to September 2008). Of course the surge prior to that bear market dwarfs the one in this past bull run, and thus a correction of that magnitude is not warranted. It is still a very short bear run given all of the headwinds (housing, credit, oil) that are still not fully resolved. Again, that makes this test very important and a hold at these levels, in the bigger picture, a bit less likely. Just being pragmatic, and if wrong, we can be pleasantly surprised.



VIX: 23.06; -0.97. Hit 24.71 on the Friday high on continuing selling, hardly the indication of the fear and anxiety you want to see at a major bottom. It needs to get up to 40+, and that means likely some pretty harsh selling after a short term bounce off this test of the July low.
VXN: 26.66; -0.9
VXO: 25.43; -1.3

Put/Call Ratio (CBOE): 1; -0.08. Back to 1.0 and at least that is a positive for this selloff though it is not leaping higher.

Bulls versus Bears:

For the second time this year bears are crossing above bulls, doing so basically where they did in March on their way to much more extreme readings just about the time the market made the March low and started the last rally. Positive for the market and if SP500 is going to hold the long term trendline is the place to do it.

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 37.8%. Down from 39.3% and 40.7% on the high during the rally off the July lows. Heading back toward 35%, below which is considered bullish for the market as the number of upbeat investors is relatively low. A long way up from the 27.8% on the low this round. Hit 31.9% two months back and the 30.9% low hit in March. Steep drop from a rebound high at close to 50% on the run through May. In March the indicator did its job with the dive below 35% and the crossover with the bears. Now it is going above and beyond. Bulls and bears have crossed over again, doing so even before the prior lows are hit. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 40.0%. Up from 39.3% and 38.4% the week before. Moving toward 50.0%, the high on this move, but a long way off. As the NYSE indices test the lows you would want it higher. Still above the 35% threshold so still a bullish indication. A steady rise to 50% on this move: 48.9%, 47.3%, 44.7% and 39.3% before that. Well above the bullish level and the highest since 1995. Again, that is one of the best indications that sentiment is getting extreme on the negative side. It is again past 35%, the level that historically indicates too much pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. Up sharply from a low of 19.6% on the last rally. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that run. That June peak eclipsed the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). This is a huge turn, unlike any seen in recent history.


Stats: -3.16 points (-0.14%) to close at 2255.88
Volume: 2.263B (-4.12%)

Up Volume: 1.081B (+883.84M)
Down Volume: 1.171B (-985.563M)

A/D and Hi/Lo: Decliners led 1.18 to 1
Previous Session: Decliners led 3.97 to 1

New Highs: 28 (-6)
New Lows: 178 (+21)
The new high/new low ratio is much better on this test than on the prior selloffs in March and July.


NASDAQ was a downside leader last week until SP500 and DJ30 caught up on Thursday. It is still well above its March and July lows though it did come within a few points of its July closing low (2212) Friday before rebounding. That 2200ish level is key as NASDAQ tries to avoid a bearish 8 month head and shoulders pattern. It is now fighting to put things back together after breaking its long term trendline to again test the lows.

NASDAQ 100 (-0.37%) was the downside leader this past week, crashing a nice cup with handle base and Friday undercutting the July low and indeed making a new closing low since March. Still well above the January low at 1700 (closed at 1768) and the March lows below that. Lower high, lower low. It has work to do after this round of distribution.




Stats: +5.48 points (+0.44%) to close at 1242.31
NYSE Volume: 1.2B (-7.83%). Volume never reached average on the highs last week, but its highest levels were on the selling. The Friday trade on the reversal was not the caliber of key reversals that lead to sustained rallies.

Up Volume: 714.239M (+619.373M)
Down Volume: 478.056M (-715.783M)

A/D and Hi/Lo: Advancers led 1.01 to 1
Previous Session: Decliners led 4.96 to 1

New Highs: 19 (-1)
New Lows: 301 (+57)
The new lows are jacking up, but the high/low ratio is still much better than it was at the July low. This shows potentially more strength on this test, an indication it could hold.


Not bad action at all. SP500 undercut it's the 2002/2003 up trendline (1231) and was two points off the July closing low when it reversed, of course aided by a rebound rally in the financials as they sparked back for a fifth session of gains out of six (the down day being the Thursday gutting). As noted above there are some very interesting financial patterns developing, but alas, they are the few, the proud, the aberrations. Need to see a lot more improvement in financials overall for this to be a bottom, but it is encouraging that the financials continue to base, and that lends support for an attempt at a bottom here.

SP600 (+0.15%) sold again as well, but it found support at the 370 support level and rebounded to close just over the 200 day SMA. That intraday test hit the 50% give back or retracement level from the August high after the July low. The significance? That is often how far an index will test any move, up or down, before resuming the trend. Small caps held up well overall, and it is key for them to rebound to keep the idea that at least part of the market, particularly the economically sensitive small caps, maintain a bullish pattern. Work to do to recover, but as of Friday it held.

SP600 Chart:



Also diving toward the July closing low, coming within 70 points and then rebounding for a gain. Lower volume, back below average, though still solid. An initial hold where it had to hold but this test is not likely over with this end of the week short covering bounce off the lows.

Stats: +32.73 points (+0.29%) to close at 11220.96
VOLUME: 198M shares Friday versus 229M shares Thursday. Volume was still decent but was lower on the reversal.



The short week saw volume climb on the Labor Day jinx. More will be back at work this coming week and an even clearer picture will emerge.

After a reversal off the lows that lacked a high VIX, high volume, and occurred on a Friday afternoon after four and one-half hard downside sessions, it is hard to say this was a reversal that will last. It was interesting as it showed support there. It will take more testing, however, to make that case.

Indeed with those figures you would expect some kind of hard selloff again Monday and/or Tuesday; that is the way history has often played these things. That might, and might, set the bottom if VIX jacks up and there is a high volume reversal. After hours Friday, however, the Treasury tried to alter the natural course of things with a supposedly agreed to 'backstop' plan for FRE and FNM. While those stocks tanked on the news given the impact on current shareholders, stocks overall, including the financial ETF's and financials themselves, were jumping.

Thus the feds have thrown their weight in once more, trying to fend off whatever catastrophe is out there. As noted earlier, the market rallied after the Fed formalized its lending facilities through 2008 and beyond. Interest rates shored up and stocks perked up. It did not last, however. This news looks as if it will perk up the market just as many of the slaughtered commodities, agriculture, metals, etc. stocks were ready for a relief bounce. So it accelerates that move. Whether it sticks is another question.

We want to play that rebound even if it is for just 2 or 3 days. Some of these big name stocks are beaten down and can move 20 points in short order. If things don't gap away on Monday then we will look at getting in on some of those moves. We will also continue looking at stocks that held up during the selling similar to URBN that we took some new positions on Friday as it tested and then recovered nicely.

After that, the market shows us if this is the longer term bottom or just a way station before a deeper correction that foretells this bump upside in economic data was just a way station as well. The coincident indicators are not where they should be (e.g. VIX) after last week's test, but with the financials basing and the small caps still hanging tough along with the retailers, they could get there as well.

Looking at the patterns trying to form up this is definitely part of the process, but there is still work to do. A hold at the July lows or in that general area would be huge. For now we look nearer to home and try to ride a sharp rebound higher with some stocks that can fly when they rebound and then see if we can play a move back down to test the lows. That is the market we have right now, but we also are still watching the basing stocks in the background that are still holding well and still setting up for a break higher to lead the market if it bottoms. If they breakout as the market posts another test and a real reversal, we move into those with more vigor.

Support and Resistance

NASDAQ: Closed at 2255.88
2261 is a March 2008 interim low
2286 is the first April 2008 gap up point.
2340 from the March 2007 low
The 10 day EMA is 2344
2355 is the trendline from the summer 2004/July 2006 lows, Q4 2005 consolidation
The 50 day EMA at 2359
2370 from the April 2006 peak
2378 is the mid-February peak; 2379 from the October 2006 peak
2386 is the August 2007 intraday low
2388 is the June 2008 low
The 90 day SMA at 2389
2392 is the April 2008 peak
The 200 day SMA at 2406
2419 is the January 2008 peak and the early February peak
2451 is the August closing low
2474 is the July 2008 peak
2483 is the mid-June interim peak
2500 from interim August 2007 lows and early May 2008 interim peak
2551.50 is the May peak; 2550 is the June peak
2603 is the early January gap down point

2202 is the January 2008 low
2167 is the July 2008 low
2155 is the March 2008 low

S&P 500: Closed at 1242.31
1244 is an August 2005 peak
1257 is the March low
The 10 day EMA at 1267
1270 is the January low
1285 is the recent July peak
The 50 day EMA at 1285
1313.15 is the August 2008 peak
1317 from the February low
The 90 day SMA at 1318
1320 is a 50% retracement of the May to July selloff
1324 is the April low
1331 is the June low
1354 is an ancient trendline
The 200 day SMA at 1355
1370 is the August 2007 intraday low
1374 is the March 2007 closing low
1387 is the April 2008 intraday high
1396 is the February 2008 peak
1406 is the August and November 2007 closing low

1240 to 1221 are September 2005 peaks1234 is the July 2006 low
1234 is the late July low
1224 is the June 2006 low
1215 is the July 2008 closing low
1200 is the July 2008 intraday low
1176 from the Q4 2005 lows
1167 is the January 2005 low
1154 from the May 2005 lows
1142 is the 2005 closing low

Dow: Closed at 11,220.96
11,317 from March 2006
11,388 is the prior August low
11,615 is the up trendline off the July low
The 50 day EMA at 11,579
11,634 is the January intraday low
11,665 is the 2004/2005 up trendline
11,670 is the May 2006 intraday high; 11,642 closing
11,731 is the March 2008 low
11,867 is the August 2008 peak
The 90 day SMA at 11,908
11,982 is a 50% retracement of the May to July selloff
12,050 from the March 2007
12,070 from the early February 2008 lows
12,250 from late March 2007 lows
The 200 day SMA at 12,328
12,518 is the August intraday low
12,573 is the mid-February high
12,743 is the November low
12,750 to 12,768 is the February 2008 peak and a series of lows and highs from August 2007
12,786 is the February 2007 peak
12,845 is the August closing low
13,092 is the December 2007 intraday low
13,133 is the May 2008 high

11,131 is the late July 2008 low
11,061 from February 2006
10,962 is the July closing low
10,912 peak from March 2005
10,854 from December 2004
10,827 is the July 2008 intraday low
10,701-10,705 from July 2006, July 2005

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.

September 8 - Monday
Consumer Credit, July (3:00): $8.5B expected, $14.3B prior

September 9 - Tuesday
Pending home sales, July (10:00): -1.0% expected, 5.3% prior
Wholesale inventories, July (10:00): 0.7% expected, 1.1% prior

September 10 - Wednesday
Crude oil inventories (10:35): -1.89M prior

September 11 - Thursday
Export prices, August (8:30): 0.8% prior
Import prices, August (8:30): 0.9% prior
Initial jobless claims (8:30): 444K prior
Trade balance, July (8:30): -$58.0B expected, -$56.8B prior
Treasury Budget, August (2:00): -$105.0B expected

September 12 - Friday
PPI, August (8:30): -0.3% expected, 1.2% prior
Core PPI (8:30): 0.2% expected, 0.7% prior
Retail sales, August (8:30): 0.1% expected, -0.1% prior
Retail sales ex-Autos, August (8:30): -0.2% expected, 0.4% prior
Business inventories, July (10:00): 0.5% expected, 0.7% prior
Michigan sentiment, September preliminary (10:00): 63.9 expected, 63.0 prior

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

Jon Johnson is the Editor of The Daily at

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