Evening Update (The Bullish Momentum is Shifting)

The Bullish Momentum Is Shifting
(Long, so take your time reading...but I took the time to lay out the details because I believe they are important)

As I have a limited amount of time each morning to formulate and express my thoughts on the market I like to write supplemental updates when I have commentary that extends beyond the scope of the morning newsletter. As you may have gathered from this morning's letter, I have become concerned with the macro trend higher as red warning flags seem to continually pop up. After dissecting the market action over the last month, week, and today as a punctuation mark, I believe that the Bullish trend is shifting and may soon turn Bearish.

Over the last several weeks, and especially since The FOMC meeting last month, I have promoted a Bullish trading stance for the supportive markets. Buying the Nasdaq, buying Crude Oil, buying the Australian Dollar and selling the Dollar Index are trades that continually made the Buy or Sell recommendation lists over this time while the Quantitative Easing story has dominated market direction. However, the macro relationships are beginning to shift; painting a Bearish picture for the market going forward. I wanted to take some time to break down the red flags that I am seeing in greater depth and provide some new suggestions to keep on your radar.

The Euro is Near Key Technical Levels

My objective for the Euro over the last several weeks has been 1.4050 on its 2nd leg higher. Looking at the weekly chart closer though I think that the market may have difficulty reaching this level. From the high in late November of '09 to the low in early June of this year the .618 Fibonacci Retracement level sits roughly at 1.3925. As the market encountered this level today it ran into a wall that stalled gains. There are a number of analysts that have similar objectives to my own, ranging from 1.39 - 1.4050. I believe that as the Euro reaches this critical technical and psychological barrier that there will be significant selling pressure that will temper further gains and lead a decline in prices. I recommend taking profits and liquidating Long Euro positions for the time being until the market gives fresh signals that a move higher is imminent. The same goes for Short Dollar Index positions as the inverse of the Euro.

The fundamental story that drove the Euro lower over the first half of the year is all but forgotten now with the weaker Dollar stealing the headlines lately. I am still hearing accounts though that the original bailout packages for the PIIGS were insufficient and have only delayed the European debt issue. Technically many large declines are followed by a 2 leg advance and if the Euro stalls out now then this would be action consistent with another large leg lower. I can still draw a visual path of a Euro move back to .95, which is still my long term objective for the market. I believe that the next direction for the Euro will be lower and possibly much lower throughout the 4th Quarter with a potential target of 1.10 on the next leg lower.

Crude Oil Has Reached Its Pattern Objective

The $84.14 Bullish cup and handle objective was reached today for all intensive purposes as the market climbed to a high of $84.09. While I have had my eye on the possible initiation of a larger Bullish pattern I now am highly skeptical of this pattern's advance. Two consecutive closes for the November contract above the $83.91 high trade from August 4th would project a move to roughly $95. The case for Bullish continuation is troubling because the market has now recovered back into the proverbial "box" from Crude's steep decline in early May. Measuring from the high of $93.14 May 3rd to the low of $70.96 from May 25th you receive a .500 value of $82.05 and a .618 value of $84.66 on the Fibonacci Retracement. Between these values is the same zone that Crude failed in early August. Unless the market is able to initiate the large Bullish pattern above $83.91 then it is likely that Crude will also encounter substantial selling pressure. I recommend taking profits and liquidating Long Crude positions (including longer term), if you have not already, until fresh Bullish signals emerge.

In addition, I began making note in early September of the substantial divergence between the advance in open interest for Crude versus the outright market price. This divergence is nearly identical to the action that we saw in the Crude market from late March into early May that preceded the massive sell off throughout May. When too many longs pile into a market without the price advancing you have the setup for a liquidation trap if too many of these positions become net losses. My prediction is that (just like in May) much of this open interest in the Crude market is "dumb money", in that it is longer term investments that are resistant to small price fluctuations. When the price of Crude drops the open interest will likely remain at a stagnant level and setting up a fast liquidation run if the price falls below $75. My original 2nd leg lower objective for the market was $62.50 based on the August 4th highs, so this would again be the next target for the Crude Oil market if it fails to advance further

Industrial Metals Have Reached Their Bullish 2nd leg, 3rd leg, or Pattern Objectives

Copper, Palladium, and Platinum have now all reached their individual market targets on the recent Bullish advance. All remain in deeply overbought territory without a Bullish objective prior to a pullback in prices. My belief is that the optimism for Gold and Silver has spilled over into the rest of the Metal complex creating such strong rallies. Each of these markets is now ripe for a pullback in price, meaning the next direction is likely lower.

Equities Slow Above Resistance...Index Relationships Predicting a Bearish Move

Depending on where you choose to define the original bottom on the the S&P 500 break from late April, to either late May or early July of this year, you can produce a value range for the .618 Fibonacci retracement value from 1128 - 1151. It is clear from the pressure at this 1150 level over the last 2 weeks that there are many that are paying attention to this higher value on the range. During the S&P 500 rallies over the summer we have seen the market reach several key technical levels, but this time appears to be different than the others. In most cases when the Equities have stalled out and later advanced through technical resistance we have seen momentum re-emerge with strong follow through. Since the market has reached the 1120 upper end of the summer range though the gains have been labored at best. Although the market is sitting above 1150 for the time being I do not take much solace from the price action over the last several weeks.

Even more concerning is the relationships between the Equity Indices over the last week. Throughout nearly all of the recovery over the last 18 months the Nasdaq has been the leader on the rallies. Because of this I have taken to looking at the relationships between the Indices in the same manner as the spreads on an individual market are used to predict future Bullish or Bearish outright price action. While the Equity markets have generally moved higher over the last 5 sessions, the Nasdaq has now clearly become the laggard of the sector (check out the Nasdaq/S&P 500 ratio to see). This leader/laggard shift was clearly on display today as the S&P 500 settled unchanged from Tuesday's close while the Nasdaq settled over 14 points lower. This has been a fairly accurate predictor of future direction for the Sector and must be looked at as a Bearish indicator. Would you hold a Long July Soybean outright position as the market advanced slightly, but the July - November spread collapsed significantly for 5 straight days during this time frame? This is a Bearish signal for outright Bean positions and I know I definitely would not!

Bullish Reaction to Both Bullish and Bearish Economic Data Can Only Last So Long

The market has taken the assumption over the last month that both Bullish and Bearish economic data is Bullish for Equity and Commodity prices that day. The thinking is that while Bullish data is clearly a sign of strength, if the data is bad it will force The Fed into Quantitative Easing that will positively effect these markets. While it has been easy to ride this thinking's success there comes a time when one end of this reasoning has to fail. The swings over the summer have been fueled by over-optimism and over-pessimism permeating the market. Once one side becomes dominate we tend to see a sharp swing the other way to correct the alignment. Since late August when Bernacke first suggested The Fed would be open to QE this Bullish thinking has ruled the trade. However, the market is again giving warning signs over the last 2 weeks that burning the Bullish wick at both ends is waning. The immediate snap higher regardless of the number is proving less effective and sometimes creates a sell off after the initial reaction (Last Thursday, Monday, Today). I believe the market has now become over-optimistic and a correction in this thinking is near on the horizon.

Conclusion & What To Do Going Forward

I had more that I wanted to cover on why Quantitative Easing is not necessarily Bullish for Equities and Commodities and what I see as a possible reaction to the Unemployment Report Friday, but these will have to wait till tomorrow (a guy needs a little sleep at some point). Bottom line, there are so many red flags among these supportive markets right now that I did not even have time to describe some of the other moderate signals that I have listed on my notepad. I think that the main take away I have after preparing the analysis and extrapolating it into words is that one market can trick you into a Bullish or Bearish opinion, but by looking at the total package you get a much clearer picture. While it is possible that one of these markets or sectors could remain Bullish while the others turn Bearish (or the other way around), they share a tight correlation that you can derive the macro direction from. Right now the preponderance of evidence says that a shift is occurring from Bullish to Bearish price action going forward for the supportive markets.

While many of these markets I discussed still have well defined Bull trends I am only preaching a word of skepticism and knowledge for the time being. Just because a market has reached its objective does not mean that it will immediately reverse. I have a feeling that we still may see new runs at stops above the recent highs to induce short covering rallies. The key is patience for the technical setup prior to jumping into larger Bearish positions. I highly recommend laying off new long entry on the supportive markets for now and taking profits/liquidating positions in the markets of concern.