Day 1 Of A New Rally Attempt

Friday, May 21, 2010
Stock Market Commentary:

Stocks got clobbered this week sending all of the major averages below their respective 200-day moving average (DMA) lines as contagion and economic woes dominated the headlines. A series of options expired on Friday which caused a spike in volume compared to Thursday’s levels on both major exchanges. All week, volume expanded as the major averages declined which was a clear sign that institutional investors were aggressively dumping stocks. In addition, breadth was decisevly negative on both major exchanges. New 52-week lows steadily outnumbered new 52-week highs which is not an encouraging sign.

Monday & Tuesday’s Action- The Selling Begins:

On Monday, the major averages closed with modest gains after spending most of the session in the red. Crude oil slid below the psychologically important $70 a barrel level and New York’s manufacturing slowed. It is important to note that crude oil is used as a good proxy for the strength of the overall economy. Therefore, the fact that crude has sliced and closed below its longer-term 200-day moving average (DMA) line bodes poorly for the economic recovery. It is also disconcerting to see copper, another proxy for the global recovery, drop and close below its respective 200 DMA line which also bodes poorly for the pro-growth story. On Tuesday, stocks negatively reversed (opened higher but closed lower) as the Euro plunged to a fresh 4-year low against the US dollar.  In a surprise move, Germany’s SEC, BaFin, placed a temporary ban on naked short selling of euro bonds, banks and insurers in an attempt to curb the month long decline and ease contagion woes.

Wednesday-Friday’s Action- The Selling Intensifies:

On Wednesday, all the major averages undercut their recent lows which effectively ended the latest rally attempt. Economic news was mixed, US consumer prices fell short of expectations which helped allay inflation woes. Elsewhere, the Mortgage Bankers Association (MBA) said foreclosures surged to a new record in the first quarter as uncomfortably high unemployment rates caused homeowners to fall behind on monthly payments. The report also showed that residential foreclosures jumped to +4.63% from +4.58% in the fourth quarter of 2009. Shortly after 2:00PM EST, the minutes of the Federal Reserve’s latest meeting were released. Fed officials said they were not in a rush to sell $1.1 trillion of mortgage-backed securities, with a majority of policy makers wanting to wait until they begin raising interest rates before unloading their positions. 

Market Action- In A Correction:

Stocks took a heavy beating on Thursday, sending all the major averages below their respective 200 DMA lines on heavy volume. Stocks ended higher on Friday after the S&P 500, Russell 2000 and Nasdaq Composite all shook out below their May 6, 2010 (flash crash) low. For the week, all the major averages suffered tremendous losses and fell over -10% from their late April highs, which is the first time a pullback of that magnitude has occurred since the March 2009 low. The fact that the market rallied on Friday technically marked Day 1 of a new rally attempt which means the earliest a proper follow-through day (FTD) could occur would be Wednesday, providing Friday’s lows are not breached. However, if at anytime, Friday’s lows are breached, then the day count will be reset. What does all of this mean for investors? Simple, the market remains in a correction which reiterates the importance of adopting a strong defense stance until a new rally is confirmed. Trade accordingly.