Market Not Following Through, But Falling Through

June 2010
Stock Market Commentary:

Before we address the current market outlook, it is important to step back and put the recent action in proper context. Since the March 2009 bottom, the major averages have experienced explosive gains on the simple premise that the global economic recovery will be robust. That notion helped the benchmark S&P 500 Index rally +83% before reaching a near-term top of 1,219. Since then, notions of a robust recovery have come into question, especially due to the ominous debt levels in several European nations and Beijing’s various attempts to curb its red-hot economy. The euro, which has also enjoyed healthy gains since March 2009, topped out in December 2009 and has steadily fallen during the first half of 2010. Looking ahead, it is imperative to monitor the direction the euro is heading in order to better gauge investors’ world-wide collective appetite for risk.

Stocks Fall Hard During The Second Quarter of 2010:

It was a brutal quarter on Wall Street. The Nasdaq Composite and the benchmark S&P 500 Index both fell -12%, meanwhile, the Dow Jones Industrial Average and the small cap Russell 2000 Index skidded –10% to their worst quarterly performances since Q4 2008. It was the Nasdaq’s worst Q2 since 2002. For the year, the Nasdaq Composite is down -7%, the S&P 500 Index is -7.8%, and the Dow Jones Industrial Average is -6%. In addition, it was worrisome to see the S&P 500 Index close below the 1,040 which has served as formidable support for most of the year.
Bullish Case:
History shows us that most bull markets last between 18-36 months before they fail. Therefore, the fact that we are only beginning our 16th month bodes well for this somewhat “young” bull market. It is also somewhat encouraging to see nearly every government across the globe step up and unanimously infuse an unprecedented amount of capital into the global economy. This unified action saved the global economy from entering a deeper recession and laid the foundation for this massive bull run. On average, central banks around the world are still keeping rates near historic lows to help spur economic growth.
Bearish Case:
Sovereign debt woes continue to be the bane of this rally. At the end of April 2010, the S&P Rating Agency downgraded Greece’s debt to “junk” status, which accelerated the steep sell-off in the euro and sent it down to fresh 4-year lows! This sparked a world-wide panic sell-off which sent stocks plunging. In addition, Spain and Portugal’s debt was downgraded which put pressure on a host of capital markets. Italy, Hungary and Iceland are the three nations which analysts believe are also dealing with onerous debt levels. All of this helped the US dollar, gold, and bonds to be able to rally smartly as a so-called safety play. Since November, the greenback has rallied smartly and jumped above its 50-day moving average (DMA) and 200 DMA lines. As expected, the stronger dollar sent US stocks and a slew of commodities (i.e. dollar denominated assets) lower as investors continue to debate our economic future. 
The fact that all of the major averages, and a handful of leading stocks, sliced below both their 50 and 200 DMA lines (on heavy volume) over the past two months illustrates how weak this market actually is. The bears believe that the effects of the massive worldwide stimulus packages from 2008-2009 are beginning to wane and the future of the global economic recovery may not be as robust as initially expected. The bears also claim that technically this rally is done and overdue for a serious intermediate-term correction. Since the March ’09 lows, the major averages have retraced (rallied back) a little over +50% of their 2007-2009 bear market decline, which is a fairly typical bounce before a new down leg ensues. Only time will tell exactly how this plays out.
A 10-week rally first was technically confirmed by the March 1, 2010 follow-through day (FTD), and the strength went on to help the major averages reach new 2010 highs and new recovery highs. That rally, however, ended on May 5, 2010 when the major averages violated and closed below their respective 50-day moving average (DMA) lines. One day later (May 6th) will go down in history as the day of the “flash crash” which sent the Dow Jones Industrial Average plunging an unprecedented 1,000 points in 30 minutes. This type of violent sell-off illustrated how weak the market actually is, and it has led many to question the health of our markets today after an incredible 15-month bull move.
Market Action:  Price & Volume C-
As we know, the major averages topped out in October 2007 and then proceeded to precipitously plunge until they put in a near-term bottom in early March 2009. Since then, the market snapped back and enjoyed hefty gains which helped send the major averages to one of their strongest 15-month rallies in history. The small cap Russell 2000 Index was the standout winner, surging a whopping +117%. The tech-heavy Nasdaq Composite is a close second, having vaulted +100%, before reaching its interim high of 2,535 on April 26, 2010. The benchmark S&P 500 Index raced +83% higher before hitting its near term high of 1,219 on April 26, 2010, and the Dow Jones Industrial Average soared +74% before printing its near-term high of 11,258 on April 26, 2010.   This data indicates that Monday, April 26, 2010 appeared to be a very important day for the market because that is the day that most of the popular averages printed their near-term highs and negatively reversed by closing lower from new high territory. 
In addition, after such hefty moves, a 10-15% pullback, if the indices can prove resilient enough to hold their ground near current levels, would be quite normal before the bulls return and send this market higher. However, this sell off intensifies, then odds will favor that even lower prices will follow. Furthermore, the downward sloping 50 DMA line already undercut the longer term 200 DMA line in the NYSE composite and the benchmark S&P 500 which is not a healthy sign (and known as a death cross or dark cross). We are now waiting for a new follow-through day (FTD) to emerge before this market can move higher again. Remember that markets can fall much faster (and further) then most people think. That said, defense is king until the technical damage is repaired. Trade accordingly, never argue with the tape, and always keep your losses small.
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