Friday's strong move to the
upside caught a lot of traders on the wrong side of the market. Regardless of
whether financial pundits refer to it as a short-squeeze or simply panic
level buying is largely irrelevant. Time and price are always the final
arbiters of financial markets. Price on Friday was clearly telling us that
too many market participants were shorting equities and the Euro.
The news coming out of the European
Summit is what drove prices higher according to most media outlets. However,
few traders have actually taken the time to research the fact that Germany
has not technically agreed to the European Stability Mechanism legislation at
this point.
The German Constitutional
Court has delayed the passage of the ESM legislation on the grounds that this
court needs to affirm the agreement is constitutional. Several high profile
politicians in Germany have allegedly filed multiple law suits surrounding
the new ESM law.
Should the German
Constitutional Court determine the ESM legislation is unconstitutional a
referendum will go before the German people. The last thing the Eurocratic
blue bloods and their banking cartel minions want is regular people actually
having a say in the outcome of the Eurozone project.
Ultimately the German people
do not appear to be in favor of propping up the rest of Europe in exchange
for more empty promises of austerity. Furthermore, the German people
recognize that they are taking on a massive risk by loaning money to
insolvent banks and other Eurozone sovereigns who have not proven to be
prudent with managing their current fiscal conditions.
The decision made by the
German high court could have a far-reaching impact on the price action in
European financial markets as well as in U.S. domestic financial markets. The
outcome of the forthcoming decision will carry far more weight than Friday's
June unemployment report. Already I am reading that should the unemployment
number come in significantly weaker than expected Ben Bernanke may work to
convert Operation Twist into full blown QE III at the next FOMC Meeting.
The addiction to cheap money
by large institutional banks will not end until the Fed is no longer able or
willing to continue to print money. Should economic data continue to weaken
going into earnings season I am sure the banter regarding QE III will
increase at lightning pace and bad news for the economy will be good news for
stocks. Poor economic data will increase the likelihood for additional
liquidity being provided through a 3rd Quantitative Easing initiative.
Leaving the macroeconomic data
aside and focusing on market technicals, we find several unsettling
situations in a variety of underlying assets and indicators. The warnings are
largely falling on deaf ears as the equity bull parade continues. Before we
talk about the S&P 500 Index directly, perhaps we should examine some of
the indicators and underlying assets that are sending out bearish smoke
signals.
The first chart I would draw
your attention to is the McClellan Oscillator which is a widely followed and
focuses on market breadth as a possible market indicator for tops and
bottoms. Note the key high and low points of the Oscillator and how they
correspond with the S&P 500 Index.
Clearly the McClellan
Oscillator is worthy of considering when looking at the S&P 500 Index. As
can be seen above, when prices spike into the overbought and oversold zones a
major turning point generally is drawing near in the price action. Obviously
the current price action in the oscillator is reaching into the extreme
overbought zone and looks poised to challenge the highest high over the past
2 years potentially.
In addition to the McClellan
Oscillator, another indicator that I look at from time to time also helps to
identify key market bottoms. Essentially this indicator measures the NYSE
advancing volume versus declining volume. (Note: The opposite ratio will help
define key highs) What is important to point out in the chart below is that
we did not see major accumulation on Friday compared to data during the past
year.
What is absolutely obvious
about this chart is the divergence between the price action in the S&P
500 Index and the accumulation readings recently. This divergence could very
well mean that a top could form in the not-so-distant future.
Probability is presently
favoring that a top is near for the S&P 500 Index. However, there are two
key price levels that I have identified as likely targets for a possible top
in the near future. The key resistance levels are 1,375, and 1393
respectively.
If we were to get a weekly
close above 1,395 on the S&P 500 Index the bearish expectation will be
totally false and a new rally phase will be initiated. The daily chart of the
S&P 500 Index shown below illustrates the key price levels that I will be
monitoring carefully.
It is likely that we will see
prices move slightly higher during the next few trading sessions as I
anticipate light volume ahead of the Independence Day holiday. However, the
June unemployment report set to be released on Friday could produce some
volatility in either direction depending on the outcome of the report.
It is without question that we
have several warning signs that the S&P 500 Index could be closing in on
a top and a potential lower high which is exceedingly bearish. In addition,
the strength on Monday in both the 10 & 30 year Treasury bonds should not
be ignored.
The Treasury and bond market
in general know something that the equity market does not. Treasury bonds in
particular completely reversed almost all of the selling pressure they saw
during Friday's rally. The daily chart of the 10 Year Treasury Note is shown
below.
In closing, there is a
considerable amount of headline risk in Europe and in the Middle East. We
have major economic data being released on Friday which could also move
financial markets. Right now I am watching the 1,375 and 1,395 price levels
on the S&P 500 Index. As long as price is trading below those key price
levels, a bearish outcome should not be ruled out completely.
Happy Independence Day &
Happy Trading!
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