Wednesday, May 21, 2008

State of the Market - 5/21/08

A good start today for the market, but that quickly turned into a bad start due to more record high oil prices. This pressure on the market was exacerbated as soon as the oil inventories were released, causing oil to spike even higher to another new record, which sent the market down to further losses. Around 10:50, the Nasdaq and S&P 500 found some support near yesterday’s lows, and were able to rally higher for a little bit. That rally continued into the lunch hour and allowed the Nasdaq and S&P to briefly get positive on the day, but that bounce couldn’t stick and things quickly got ugly. The short-term support levels were taken out mid-afternoon on the Nasdaq and S&P 500, and the longer-term support on 12,750 on the Dow was sliced through rather easily around the same time. A bounce in the last hour of trading failed, and the market finished near its lows for the day. Volume was pretty heavy and all indices logged another distribution day. This gives the Dow and S&P 500 a total of six in recent weeks, and I would not be surprised if IBD doesn’t put the “rally under pressure” label on this rally tonight.

The selling really seemed to intensify around 2:00 today, which coincided with the release of the most recent Fed minutes. These minutes forecast lower GDP growth estimates, a higher then expected unemployment rate, and higher than expected inflation expectations. The Fed raised their inflation estimates for the rest of the year a full percentage point - a pretty big deal. That is kind of surprising since for the past year we have heard that inflation was expected to "moderate". Perhaps the problems are becoming so obvious that the Fed doesn't think it can really try and hide things anymore. The report also indicated that it was a very close call as to lowering interest rates at the last meeting, and that they do not expect to lower for the foreseeable future. Let's see if they stick with that - hopefully they will. I still believe inflation is the biggest problem the country is facing here, and raising rates would help things in that regard. How about focusing on the consumers in this country for once instead of the big bankers who made the mess they're in anyway? We all know that won't happen. Bottom line - there was basically nothing positive coming out of the report, and the market reacted accordingly.

Technically, things are officially now a mess. I was shocked that the Dow couldn’t even get support at its 50 day moving average today. This index looks like it is definitely headed lower. The S&P 500 cut through its 20 day moving average but did settle right above the neckline of the inverted head and shoulders pattern. The 1386-1390 is the line in the sand now for this index – if it breaks lower than this, it will also be done. The Nasdaq, which has led for the past few weeks, is also now below its 20 day moving average and fell below the bearish wedge pattern it has been forming. The 2417 area needs to hold or this index will likely be headed down to at least the 50 day moving average. The market is probably getting oversold on a very short-term basis so I wouldn’t be surprised of a small bounce soon but I don’t know if it will amount to more than that based on what happened today.

Dow, S&P 500
Nasdaq, Russell 2000
Charts from Telechart2007, Courtesy of Worden Brothers, Inc.

As for my trading, RICK didn’t work too well today and I was stopped out early in the session with a 2.1% loss. It wasn’t a very big position, so it’s not a big deal to me. I did set my stop loss pretty tight which is something I have really been wrestling with for the past few weeks – managing my stop losses. I was also stopped out of DGLY today at $9.75 for only a 3.6% gain, which is disappointing, no doubt. At its peak, I had a 20% gain, but I really thought this could be a big-time mover and wanted to give it a chance to move. It may still be a great stock, due to its great fundamentals and low-profile, but it did not hold a triad of support levels today, so I had to get out. If I bought earlier, then I might hold on longer, and I will still keep it on the watchlist. It did not close well at all. I also took profits on OFI (14% gain) and tightened my stops of FSYS. Those stops were hit in the afternoon and I exited with a 29% gain on the position. I will keep this on a watchlist for some consolidation but with the overall market looking like it is rolling over here, why risk losing more? Right now, I am up over 30% for the year in my main account, and I don’t want to give any of that back.

I did not add any shorts today besides a starting position in DUG. The tricky part about shorting is the timing, and now is not the best time to start shorting individual stocks in my opinion. If stocks have been down for four or five days in a row and you short them, you are just asking for trouble, and those are the type of shorts I am seeing right now – ones I would have to chase. Oil and metals are the only really overbought sector in the market right now, and if you feel you have to short, I would focus here. The problem with that is it is always difficult to time a top in a sector, especially when there is a lot of momentum behind it, so you are setting yourself for trouble there as well. That is why I am just playing the ETF and limiting the risk a bit. I also have a stop below today’s low for DUG so I am not risking very much on this trade. I still continue to believe that this sector is due for a major pullback so I will take a chance here. Overall, I would probably wait for the first weak-volume bounce before putting on any short positions.

I found two articles discussing the current situation in oil and found them both interesting. I encourage you to read it and draw your own conclusions. It is always hard to know what to believe when you read things online, but in my opinion, I don’t think oil is being driven this much higher for fundamental reasons. The weak dollar and speculators trying to find places to get returns on their cash is in my opinion the main reason prices are reaching such astronomical levels. I realize there are some fundamental issues, but it’s the rapid ascent that tells me fundamentals are not the driving force here. For instance, today was the first time in the last five weeks the oil inventories actually fell. What happened to the price of oil over those four weeks of increases? Obviously it went up, quite precipitously. I don’t think demand is increasing for gasoline at $4.00 – maybe I’m wrong.

The really sad thing about this whole oil “crisis” is that we have no one in Washington who wants to do anything to solve it. Oh, they talk a good game and throw stupid ideas out about suspending the federal gas tax and no longer filling the strategic reserves with oil. But when it comes to actually doing anything that might actually make a difference, like drilling in ANWAR or off the coasts or building more refineries, it is shot down quickly. Why should they really care anyway? They’re not the ones paying to fill up their tanks – they get to fly around on publicly-funded jets or caravans. As November approaches, I get more and more depressed as I think about the choices we as Americans have before us to lead the next four years. Neither candidate has any ideas on how to solve our energy crisis, and because of that, the middle class will continue to suffer the consequences.

Today was certainly not a good day for the bulls, and after today's action, it does appear we are headed for a more severe pullback. For the past week, I have said that the key for the continuation of this rally will be the volume on any pullback. Well, we have had two higher-volume days of selling in a row, and that is not good. I have not gone through my scans so I do not know how much damage was done to individual charts. When I do go through them, I will have a better idea of how bad things really are. I do know there were over 300 stocks down over 4% on higher volume, so today was definitely worse than yesterday. Right now, I would certainly not look to buy this pullback, not with the higher volume selling, but I would be careful entering shorts as well. We're down three straight days now, and many charts are down more than three days straight. A bounce here is a possibility. Based on the recent action, however, any bounces may be just chances to get shorts on in better positions. Cash looks like a good option right now. I'll be back later with some charts. Best of luck.

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