The Bear; It’s Back

SPX – 1073.65

DJIA – 10,066

“The market represents everything everybody knows, hopes, believes, anticipates, with all the knowledge sifted down to…the bloodless verdict of the market place.”

-William P. Hamilton

The fat lady belted out a tragic tale last week, a libretto about an angry bear, back from hibernation, cigar lit, pondering how to best go about its task, just the opposite of the bull whose post requires going up with as few investors onboard as possible. Music to the bear’s ear is the talking heads, cautious but unnerved, declaring it’s only a shake out to scare the weak hands, just what the bull wants. Pleased these “experts” can’t read the tape, the bear’s job is sink the market with as few investors in lifeboats as possible.

The Bear is Back (Source: Misplaced)

There’s not much to add to Friday’s alert. Price and time overbalanced for the S&P 500 (SPX) and its 3-day swing chart carved out a pattern of lower highs and lower lows, indicating the primary trend is down. The SPX also closed below its 5% weekly exponential moving average and  a bear signal was recorded under Dow Theory when both the Dow Industrials and Transports closed below their respective May 7 lows on high volume.

I thought that Friday’s low might have ended the first section down but yesterday’s dead cat bounce said otherwise. Panic is in the air pre-opening and I think the SPX could slice under its February low (1044.50), confirming in yet another way that the primary trend is down. How far the stock market falls and how long the decline lasts are unknown, but I suspect the bottom of the first leg down is not far away in either price or time.

S&P 500 - Daily (Source: StockCharts.com)

The Market Trend Indicator (MTI) is signaling DOWNTREND, each key index below its respective 18% weekly exponential moving average. The SPX’s 18% average is 1143.28 and the DJIA’s is and 10,639. The New York Advance/Decline line is 3,821 net declines below its 18% average. Net volume hurdle rates that need to be overcome to signal a reversal are (70.9) for the NYSE and (71.3) for NASDAQ.

From a technical perspective, it’s negative that virtually all the bull market leaders are under pressure, no change in the “buy low-sell high” mentality in place through the advance. Most recently, Travel & Tourism fell into the bottom ten group performance list as measured by relative strength. It was in the top ten list at year-end 2009. Foreign stock markets are highly correlated.

MSCI World Index (ex-US) - Weekly (Source: StockCharts.com)

Other key markets continue to grapple with debt in Spain and political response to runaway debt, debt restructuring or currency debasement being the most likely options. Tension in Korea and a hint of China delusion add to concerns.

Barclays 20-yr+ Treasury ETF (TLT) - Weekly

Flight-to-safety buying is driving government bond prices higher. I think a short position makes sense once the stock market puts in an intermediate-term bottom. Gold sold off last week but held well relative to other commodities. I’m curious as to how it reacts today. I want to see new all-time highs for gold on any recovery in the stock market or I start to worry about long positions as it appears markets are beginning to discount potential deflation.

Euro - Weekly (Source: DecisionPoint.com)

Gold (continuous contract) - Daily (Source: StockCharts.com)

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 27            (Thursday)

June 2              (Wednesday)

Jun 11             (Friday)

June 14            (Monday)

June 25            (Friday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Conclusion:

I recommend lowering the stops for short positions to just above last Thursday’s intraday bounce high, 1029.24 for the SPX and down from just above its May 13 high at 1173.57. For the recovery rally, I would size positions (smaller) for a counter trend move. While small cap issues could still lead the advance, I plan to use ETFs tied to the SPX and NDX.

For investors, I think it’s a lot closer to the end that not for the first section down in the bear market. If you are the “buy low-sell high” sort and haven’t already implemented corrective action, I think it makes more sense to take defensive steps, not in a panic, but after first recovery rally, generally the largest in a bear market.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Primary Trend Down

SPX – 1087.69

DJIA – 10,193

“When coming events cast their shadows before, the shadow falls on the New York Stock Exchange.”

-William P. Hamilton

When price overbalanced but time hadn’t, I wrote the bull market deserved the benefit of doubt, the technical readings recorded on May 6 the sort that would hold for at least one last rally to a new high. The bull case lost that benefit in this week’s pounding. The penetration of May 6 lows this morning, however slight, emphasize we shouldn’t dismiss the technical warnings. Time overbalanced using weekly data and the 3-day swing chart pattern for the S&P 500 (SPX) is one of lower highs and lower lows. Price and time overbalance combined with a 3-day swing chart downtrend indicate the primary trend is down.

There’s a clique that’s grown over the last 20 years equating bull and bear markets to percentages, recently proclaiming the market officially entered correction territory by being down 10% and they’ll announce a bear market when prices fall 20%. I’m not in that camp. The primary trend, typically lasting for years and labeled a bull or bear market, is governed by the business cycle and fundamental conditions, not percentage moves in the stock market. The primary trend swings between discounting the best that might occur (bull markets) and the worst that could happen (bear markets), often going to extremes in either direction due to emotional factors, but extremes were absent this time around at the April 26 high.

A bear market was signaled under Dow Theory on Thursday’s close, indicating the best for this cycle was discounted, particularly telling in face of steadily improving business data, albeit interwoven with systemic risk concern set off by weak hands (overleveraged countries) in Europe and the impact of dealing with the PIIGS’ debt on emerging market exports and developed nations living over their head, particularly the United States. The SPX also closed below its 5% weekly exponential average, the equivalent of a 200-day or 40-week moving average that I use to track longer-term trends.

The weight of evidence points to the cyclical bull market being over. How far the stock market falls and how long the decline lasts are unknown, but I’m not in the super cycle bear contingent. Following the March 2009 bear market low, my bias has been to expecting a series of cyclical bull and bear markets.

Under Dow Theory, the movements of the Industrials and Transportation indexes are considered jointly, using closing prices for both The action of one index must be confirmed by the other before reliable conclusions are drawn. It is bullish when rallies penetrate high points from preceding intermediate-term advances and declines terminate above the low points of preceding secondary corrections. Rallies in which either the Industrials or Transports fail to penetrate preceding intermediate-term high points that are followed by declines that slice below prior intermediate low points calls for a bearish interpretation. Note in the following chart of the Dow Industrials and Dow Transports following the secondary rally in mid-May how both closed below the May 7 lows.

Dow Jones Industrial Average (Source: StockCharts.com)

Dow Jones Transportation Average - Daily Close (Source: StockCharts.com)

The Dow Theory encompasses more than a mechanical reading of the averages, and incorporating an understanding of values, investor psychology and sometimes subjective calls to determine whether a rally or decline qualifies for a reading, it is not infallible. Nor is it is a system for beating the market because doesn’t make take tactical sense to wait for a confirmation to take action. For instance, the low today could have marked the end of the first section down (inconclusive and too early to call), or the bulls would say near the end of a brutal correction in a bull market not yet long in tooth. Slipping into the Elliott Wave world, I count a five-wave decline in the SPX hourly chart, which if it holds should be followed by an A-B-C rally, generally retracing one-third to two-thirds of the decline and followed by another five-wave decline at a minimum.

S&P 500 - Hourly (Source: Wailuku Capital Advisors)

The Market Trend Indicator (MTI) was NEUTRAL last Monday but quickly slipped back into DOWNTREND on Tuesday. It is my favorite tool to identify and follow intermediate-term trends lasting weeks to months. Each index is below its respective 18% weekly exponential moving average, 1143.28 next week for the SPX and 10,639 for the DJIA. The New York Advance/Decline line is 3,115 net declines below its 18% average.

As for volume, there have been six 90%-down days since April 16 compared to one 90%-up day on May 10. Following a +52.3 net volume reading for the NYSE and +53.2 for NASDAQ on the mid-May bounce, this week’s selling resulted in a (70.9) hurdle rate for the NYSE and (71.3) for NASDAQ that needs to be overcome to indicate a change in trend.

S&P 500 - Daily (Source: StockCharts.com)

From the high, the Energy, Materials, Financial and Technology sectors were down the most. It’s a negative that the bull market’s leaders are all under pressure. The other key markets I track continue to grapple with the problems of too much debt around the world and the political response to deal with the turmoil by going even further into debt. Policy options include debt restructuring or currency debasement.

Barclays 20-yr+ Treasury ETF (TLT) - Daily (Source: BigCharts.com)

Flight-to-safety buying drove government bond prices higher. I think a short position makes sense (with a stop above the May 6 high) once the SPX puts in an intermediate-term bottom. Gold sold off this week but held well relative to other commodities. I want to see new all-time highs on any recovery in the stock market or I start to worry about long positions that looked like it was beginning to discount potential deflation this week.

Gold (continuous contract) - Weekly (Source: StockCharts.com)

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 27            (Thursday)

June 2              (Wednesday)

June 11             (Friday)

June 14            (Monday)

June 25            (Friday)

*We’ve had a streak of high-volume acceleration days that haven’t waited for these days to roll around. Mr. Market is a tricky devil.

Conclusion:

Tactics and discipline count more than predictions, a belief I overrode by covering most short positions prematurely and proving once again the wisdom of the observation. I promised my wife years ago that I wouldn’t make the same mistakes more than 1,200 times and I’m still well below 1,000. At least we were out of long positions early in the break but small profits on the short side versus letting profits run is not what planned, deliberate speculation is all about.

For remaining shorts, I recommend lowering the stop position to just above the May 13 high (SPX-1173.57). For the recovery rally, I would size positions (smaller) for a counter trend move. While small cap issues could still lead the advance, I plan to use ETFs tied to the SPX and NDX.

For investors, what’s your strategy for skinning the cat. Make sure you have one. If the first section of the bear market isn’t over, I think it’s a lot closer to the end that not. If you are the “buy low-sell high” sort and haven’t already implemented defensive steps, I think it makes more sense to take the most action after first recovery rally, generally the largest in a bear market.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Benefit of the Doubt Goes to the Bulls

SPX – 1136.94

DJIA – 10,625

“Greek civilization peaked about 2500 years ago and hasn’t been very important for the past two millennia. Today, when we think of Greece, we think of cruising theMediterranean. I can’t think of one significant product I own that is Greek. If Greece disappeared, I doubt it would make a difference to my economic life. Indeed, I doubt it would make much difference to the economic lives of almost anyone outside of Greece. Yes, there are banks in Europe that own some Greek debt but the recent Eurozone bailout package probably means those bonds won’t default for another year or two at a minimum.”

-James Meyer, CFA, Tower Bridge Advisors, May 17, 2009

Time did not overbalance for the S&P 500 (SPX), indicating the weakness from the April 26 high (1219.80) is a correction and higher prices likely lie ahead in coming weeks. Still, price overbalanced after a three or four section advance, often a clue that it’s late in the cycle and the next intermediate advance could be the last. Most recently, this phenomenon occurred in 2007 when price overbalanced after the high in July and the SPX rallied to a new all-time high in October unconfirmed by the Advance/Decline line and marking the bull market’s end.

Today’s cyclical bull market gets the benefit of the doubt until proven otherwise. I suspect the May 6 low (1069.65) marked the correction’s low and yesterday’s test was successful. With volume worse than breadth, there was enough weakness to force out a lot of the trend followers, zap investor sentiment and set up short sellers for more pain. Nevertheless, it’s a cut and chop sort of market, probably late in the cycle, a circumstance that causes me to trim position sizes, while attempting to buy as close to the low as possible.

The Market Trend Indicator (MTI) is in NEUTRAL territory. Both the SPX and DJIA are below their respective 18% weekly exponential average, 1155.48 for the SPX this week and 10,737 for the DJIA. The New York Advance/Decline line is 932 net advances above its 18% average.

S&P 500 - Daily (Source: StockCharts.com)

Peak net volume readings are (80.6) for the NYSE and (74.0) for NASDAQ. I mentioned a (71.1) figure last week for the Russell 2000 (RUT) but that should have been the S&P SmallCap 600. I don’t have volume data for the Russell 2000 but it must have been on my mind because I was short that index. I covered much of my short position yesterday and lowered the stop buy point on what’s left to just above last Thursday’s high to insure a profit on the trade. I know, I cut profits, basing my actions on technical evidence and bias, educated or not, but Mr. Market’s in a tricky, devilish mood.

Peak net volume readings on last week’s bounce were +53.3 for the NYSE and +53.2 for NASDAQ. Yesterday’s net volume readings on the test were (55.0) for the NYSE reconfirming downtrend while NASDAQ showed more strength with a (38.0) reading. for NASDAQ. Net volume readings above the test figure on both indices would confirm an MTI uptrend reading. Intermediate-term net volume readings also overbalanced to signal downtrend, (28.0) versus a +26.9 hurdle rate for the NYSE and (26.9) versus a +22.8 peak reading on its prior intermediate-term advance for NASDAQ. Peak reading for the cyclical bull market, +31.0 and +40.2 respectively for the NYSE and NASDAQ were not overbalanced, so the reading is applicable to the intermediate-term trend and not the primary trend. I use daily net volume signals to trade moves lasting weeks to late while intermediate-term signals often come too late to trade, as I suspect was the case last week. However, a rally to new highs, if unconfirmed by weekly net volume, would constitute a warning.

Goldman Sachs Industrial Metals Index - Daily (Source: StockCharts.com)

I think the Nasdaq 100 (NDX) and small cap indices fell more and bounced back more than the SPX and I think are likely outperform the SPX on the next rally. Dollar strength, fears of a double dip in Europe and its impact on a slowdown in China appear to be behind the weakness in oil, copper and other commodities. Gold bucked the trend, up against every currency, including the dollar. While the dollar most likely backs off if I’m right about the stock market, I wouldn’t be surprised to eventually see it rally above it 2009 high.

U.S. Dollar Index - Weekly (Source: DecisionPoint.com)

I don’t expect Basic Materials to maintain leadership beyond the initial bounce. As for gold, I think its advance has the potential to accelerate if the dollar backs off. Gold and Gold Mining climbed back into the top ten group relative strength list. Last weekend’s Financial Times reported that frantic over the eurozone bailout, Germans lead gold rush frenzy.

Gold (continuous contract) - Weekly (Source: StockCharts.com)

I plan to re-establish a short position in long-term bonds, with an initial stop against via inverse exchange traded funds (ETFs) such as TBF (ProShares Short Barclays 20-yr+ Treasuries), SHV (iShares Short Barclays Treasuries) and for more leverage, TBT (ProShares UltraShort Lehman 20-yr. Treasury). I’ll start with stops against the May 6 high with plans to tighten them as soon as possible.

Barclays 20-yr+ Treasury ETF (TLT) - Daily (Source: StockCharts.com)

FORTUNE magazine interviewed Oaktree Capital’s Howard Marks. He explained, “John Kenneth Galbraith said there are two kind of forecasters: the ones who don’t know and the one who don’t know they don’t know. I put myself in the former category. We don’t have an economic forecast. But we’re not counting on a high degree of prosperity in the years that lie immediately ahead.”  I seem to share Marks’ worries which follow.

“No. 1, that the economy is highly reliant on the government stimulus program. What happens when they’re withdrawn?

No. 2, the economy is reliant on artificially low interest rates. What happens when they rise to normal levels?

No. 3, there are still a lot of problems to be worked out in commercial real estate, and a lot of banks still hold a lot of commercial mortgages.

No. 4, the main source of energy in the economy over the prior 20-yers has been the consumer, who did his part by spending more money than he made. Where does growth come in the next five                       years if the consumer doesn’t go back to doing so?”

Just when you thought we were free from global warming, last month was the warmest worldwide April on record since records were started in 1880. At least U.S. and credit card delinquencies and charge-offs continued to decline for the same month. From the big number file, the Bank for International Settlements (BIS) reported the gross value of derivative trades declined 33% in 2009 to $21.6 trillion from $32.4 trillion and down 15% from $25.4 trillion at mid-year.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 27            (Thursday)

June 2              (Wednesday)

Jun 11             (Friday)

June 14            (Monday)

June 25            (Friday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Conclusion:

Time did not overbalance, an indication higher prices lie ahead in coming weeks. A SPX close above 1155.48 and DJIA close above 10.737 would signal uptrend and confirm another quick shake is past. I expect small cap stocks and the NDX to lead the SPX on the next intermediate advance and recommend ETFs tied to those indices. My recommended stop point for remaining shorts is just above the SPX’s May 13 high (1173.57).

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Awaiting Mr. Market’s Tell

S&P 500 – 1159.73

DJIA – 10,785

May 11, 2010

“Is this a buy signal- or is it more like a bank run morphing into a run on debt laden countries?”

-Andy Kessler, The Wall Street Journal, May 8, 2009

I thought the stage was set for a correction, missing a catalyst amid resigned investor reception to better business news and positive earnings in an extended market. Thought to be known and tucked away, the catalyst reared its ugly head when fears of a systemic meltdown were triggered by potential derivative counterparty risk tied to sovereign debt. The U.S. banks reportedly hold only $16.5 billion or so of Greek debt but about ten times that for the other PIIGS.

According to my Market ID (internal dynamics) data, last week’s damage was in a class with the seven worst weeks in the 2007-2009 bear market, and worse than all but two. The panic encouraged extraordinary action by the European Union and International Monetary Fund, stepping in quickly with a big-time emergency loan package, nearly one trillion dollars and aided by the Federal Reserve slipping in dollars via a currency exchange program to Europe’s Central Banks in Europe while the Bank of Japan kicks in another $21.6 billion.

That was some open yesterday, capturing all the day’s gains and more in the first half hour. I don’t remember another quite like it. A week ago, my headline read Bipolar Swings. Perhaps today’s should have been Bipolar Swings on Steroids. Following four 90%-down days since April 16, yesterday was a 90%-up day, the sort of action sometimes seen at intermediate turning points.

S&P 500 - Weekly (Source: StockCharts.com

Healthy Stock Pause, Or Start of a Slide? asked a headline in The Wall Street Journal’s Money & Investing section yesterday. It’s an open question, one that could be answered soon, but noise levels are elevated. It didn’t take long for the bears to craw out; they’ve had trouble sleeping, hibernation out of the question. More mainstream mouthpieces, tertiary and otherwise, were quick to defend the correction camp, blithely blaming the quants while huddled to stay warm and comfortable in the middle of the herd. They’ve had quite a run from the low but the truth is no one really knows. I operate under the premise, regularly confirmed over three decades, that the stock market has the best track record in answering the sort of question asked by the Journal. The key is understanding the market’s language.

Price and time overbalance is an important technical tool in that regard, often the first to detect a change in the primary trend. The overbalance rule says to expect a change in the primary trend when price and time overbalance after a three section or more advance. I count four sections from the low but it could be three. Price overbalances when an active market falls further than it has on any decline from the low and vice versa on rallies from the high. Time works the same way; it is more important than price but indications by both are necessary to determine a change in trend. Few follow this principle and I’ve never seen anyone measure in the manner I do, a method discerned from W.D. Gann.

Price overbalanced for the S&P 500 (SPX) but not time although the count is still active.  To overbalance, the SPX would have to fall below last Thursday’s low (1069.65) without first trading above a nearby level (1167.58). With just a little follow through, the SPX signals the weakness was just a correction and perhaps that was it. Even if that is the case, I suspect there’s a test of last Thursday’s low before a sustained advance but that’s bias.

S&P 500 - Daily (Source: StockCharts.com)

As for trend, the 21-day rule signaled downtrend last Tuesday and the Market Trend Indicator (MTI) shifted to neutral on that day’s close. Strength in the Advance/Decline line into the high was behind the slower signal by the MTI. The MTI went to downtrend after Friday’s close but one day later is NEUTRAL, just a little away from an uptrend reading, the SPX only a fraction below its 18% weekly exponential average (1159.82). The DJIA leapt back above its 18% average (10,763) and the NY Advance/Decline line is 2,556 net advances above its 18% average.

Net volume overbalanced earlier but including two 90%-down days, recorded peak readings Thursday, (80.6) for the NYSE and (74.0) for NASDAQ. SPX net volume recorded a (82.5) peak and the Russell 2000 (RUT) reached (71.1). I’ve never seen an advance end on a peak reading but declines sometimes do.

Eurodollar Index - Daily Close (Source: StockCharts.com

Leading sectors and groups were hit the hardest last week. That’s no surprise. There hasn’t been much change in the best or worst-performing group list as measured by relative strength weighted towards nine months. Small cap indexes fell more than large and by sector, Basic Materials and Oil & Gas, neither of which bettered prior recovery highs in April, were down the most, followed by Technology and Financials. The worst performing groups included Paper, Travel & Tourism, Coal, Automobiles, Aluminum, Recreational Products, Recreational Services and Gambling. Virtually everything bounced yesterday. Note Gold Mining is moving up the relative strength table rapidly, climbing into the top ten for performance over the past month.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 13            (Thursday)

May 27            (Thursday)

June 2              (Wednesday)

Jun 11             (Friday)

June 14            (Monday)

June 25            (Friday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Barclays 20-yr+ Treasury ETF (TLT) - Daily (Source: StockCharts.com)

That may have been it for the rally in long-term government bonds, a heck of a spike with flight-to-safety buying. I’ll look for an opportunity to reestablish short positions once the stock market’s picture clears up. Gold’s advance is beginning to accelerate with gold mining stocks leading the metal and gold rising despite strength in the dollar, both signals that further gains likely lie ahead as deficit time bombs tick around the world.

Gold (continuous contract) - Weekly (Source: StockCharts.com)

As for Thursday’s exaggerated meltdown, buy orders disappearing as the decline accelerated, highlighting the danger of fragmented liquidity with no common rules across alternative trading systems, the old ways didn’t work too well in panics either.

Conclusion:

If you followed my lead and initiated short sales when the 21-day rule signaled downtrend, I recommend maintaining those positions with stops above the April 26 high. The plan is to make adjustments once the stock market signals its intentions about the primary trend. If time were to overbalance, it makes sense after the first secondary reaction, to build short positions to a size more commiserate with trading in accordance with the primary trend. That would also be the logical point for long-term investors to reduce exposure. It’s too early to make that call.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Bipolar Swings

SPX – 1202.26

DJIA – 11,151

“There exists in nature a strong propensity to depreciate the advantages and to magnify the evils of the present times.”

-Edward Gibbon

Generally subject to mood swings, Mr. Market’s behavior changed over the last three weeks, cycling rapidly between manic buying and depressive selling, the buying elevated by positive earnings and frenzied short covering, with selling triggered by distress over Europe’s PIIGS, delusional or not. Based on swing chart patterns and six distribution days for the S&P 500 (SPX), I think the trend is about to change but it hasn’t reversed yet. A distribution day is recorded when the market closes lower on higher volume and five or six distribution days over a few weeks or so warns an uptrend is at risk. The streak in this stretch includes two 90%-down days.

A SPX trade below last week’s low (1181.62) indicates a correction is likely underway. The 21-day low for the SPX is 1175.12 and if violated, likely provides the first confirmation, beating the MTI, my favorite trend following tool, to the punch. The Market Trend Indicator (MTI) remains in an UPTREND because each index is above its respective 18% weekly exponential moving average, 1170.57 for the SPX this week, and 10,847 for the DJIA. The New York Advance/Decline line is 7,955 advances above its 18% average.

S&P 500 - Daily (Source: StockCharts.com)

NYSE net volume overbalanced a week ago with a (33.5) reading overbalancing its +22.1 hurdle rate. NASDAQ net volume is positive, its +44.5 peak reading is still in force, a peak recorded on March 10 while last week’s selling produced a peak reading of only (24.5) so it wouldn’t take much buying to reconfirm uptrend for both NASDAQ and the NYSE. Look out if neither can.

Small cap stocks fell more than blue chips last week and by sector, Financials, Basic Materials and Technology fell the most last week while Utilities, Telecom and Health Care fell the least, indicating the sectors that led the advance are likely to fall the most in a correction while money shifts at the margin to more defensive sectors. Mortgage REITs were among the worst performers for three months, probably reflecting the Fed’s exit from buying mortgages. A broader question is has the stock market begun to discount the end of quantitative easing, leaving the economy to stand on its own. Nonferrous Metals slipped into the bottom ten list, burdened by a month long slide in copper prices and perhaps suspicious of a slowing in China. The World Expo opened in Shanghai last week but note how the Shanghai Stock Exchange Composite Index is trending lower after failing to surpass its 2009 highs.

Shanghai Financial District Skyline (Source: Boson Globe, http://www.boston.com/bigpicture

Shanghai Stock Exchange Composite - Weekly (Source: StockCharts.com)

The Wall Street Journal had a good article over the weekend on the strength in small cap stocks. Small cap stocks typically outperform when interest rates are low with leadership faltering when interest rates are rising. Small cap has outperformed large cap since the top in 2000, just over ten years and reportedly the longest streak on record, besting the 1974-1983 run. These cycles usually last about seven years and I thought it was ending at the 2007 bull market high. The Russell 2000 fell 60% and the S&P SmallCap 600 59% during the bear market compared to 58% for the SPX and 54% for the DJIA. But even after the first surge off the low, small cap stocks led the bull market charge with the S&P SmallCap 600 index up nearly 119% and Russell 2000 up 118% through last week’s high compared to nearly 90% for the SPX and 74% for the DJIA. As a rule of thumb, I generally start looking for a change with the P/E ratio on SML is two times the SPX. From the Journal’s article, here’s a table showing various ratios today.

Ratio                                          S&P SmallCap 600               S&P 500

Forward P/E                                             22x                                  15x

Earnings growth estimate                   130%                                42%

P/E to growth rate (PEG)                      0.17                                 0.38

Price/Sales                                                0.98                                 1.21

Price/Book Value                                     2.6x                                 1.2x

Dividend Yield                                         0.95%                              1.21%

In other markets, long-term government bond prices rallied enough to stop me out of a short position. I suspect the rally could carry further if stock prices correct but I’m not interested in a long trade, preferring to stand aside and reinitiate a short position via inverse exchange traded funds (ETFs) such the ProShares Short Barclay’s 20-year+ Treasury (TBF) and ProShares UltraShort Lehman 20-yr. Treasury (TBT).

TLT (Barclays 20-yr+ Treasury ETF) - Weekly (Source: StockCharts.com)

Further down the quality spectrum, Dealogic reported that new junk bond sales totaled $36.7 billion in March and April, the largest issuance on record for a two month period. A headline in yesterday’s Financial Times pointed out Rally has junk debt trading at close to face value while The Wall Street Journal last Saturday read ‘Junk’ Draws a Crowd, High-Yield Bond Market Booming Despite a Bulging Supply. What neither publication pointed out is that yield spreads moved towards higher quality bonds over the past four weeks, a trend that picked up speed last week. I suspect a more contrarian defensive stance is in order.

As for currencies, the U.S. Dollar index trended higher, producing a 7^th swing in its 3-day swing chart as Euro competition waned amid sovereign debt issues. Federal Reserve policy in the U.S. was unchanged but comments on the economy were more positive, reflection improvements in labor markets versus stabilization a month earlier. I still liken the competition between currencies as the “best horse in the glue factory” sort. Warren Buffet explained at the Berkshire Hathaway annual meeting, “Based on what I see happening around the world, currencies are a poorer bet than they have been for some time. If inflation ever really gets in the saddle, it gets very unpredictable. Faith in institutions can break down.”

Gold, which typically moves contrary to the greenback, is trading higher despite strength in the dollar. It’s outperforming virtually all currencies, a trend I expect to continue in and possibly picking up speed in coming months. Gold is well past the “buy low” category; in fact I think the speculative phase of the bull market is already underway, much like Internet in 1999 with a final rush at some point culminating in front page headlines and magazine covers in the general press. That’s when it’s time to sell. In the interim, I’m maintaining recommended stop sell positions just under the February 5 low ($1058 2^nd London fix) for traders and under last September’s low ($989.50) for long time investors.

Gold (continuous contract) - Weekly (Source: StockCharts.com)

Harmonic Preview:

(High Probability SPX Turning Point or Acceleration Days)

May 7                    (Friday)

May 13                 (Thursday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

New ETFs are started weekly but it’s a challenge for most to attain critical mass. ProShares started trading four new international ETFs with double leverage- Ultra MSCI Europe (UPV), Ultra MSCI Pacific Ex-Japan (UXJ), Ultra MSCI Brazil (UBR) and Ultra MSCI Mexico (UBM). Rydex closed 12 of is 14 leveraged ETFs, ceding the market to ProShares.

Conclusion:

My recommend stops for ETFs ties to the SPX and Nasdaq (100) were hit last week. Rightly or wrongly, they were set particularly tight. If the SPX were to regain its trendline connecting its February 5 and April 9 lows, I’ll be muttering to myself, “way to go Gibson, cutting profits,” but it would be minor trading positions only on the long side if that were to happen.

I favor short candidates tied to the strongest areas not the weakest as I expect institutions to shift at the margin to defensive groups. Size positions for a counter trend move. Appropriate inverse ETFs include SBB (ProShares Short S&P SmallCap 600) and RWM (ProShares Short Russell 2000) and for double leverage, SDD (ProShares UltraShort SmallCap 600), TWM (ProShares UltraShort Russell 2000) and SMN (ProShares UltraShort Basic Materials).

For investors, the SPX is a long way from any sort of signal that would say to run for cover but it’s a good time to clean up portfolios in accordance with your strategy. From Ned Davis Research, its data shows that since 1952, the average six month gain for the SPX is 1.58% for the May through October period versus a 6.36% gain for the November through April period.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.