The “green shoots” of “bullish optimism” were squashed today after the Federal Reserve Chairman’s testimony this afternoon.  As we have indicated repeatedly over the past weeks, we maintain our short-term and intermediate-term “bearish” outlook within the U.S. equity markets.  Price action and momentum continue to be decisively negative along with extremely light volume and “bearish” money flow.  In addition, we have been closely monitoring the bond markets (which continues to signal trouble ahead for equities) and various volatility indexes.  Based on our analysis, volatility indexes (for example, the VIX) have been signaling another market move to the downside. 

The VIX broke below its 200-Day SMA back during the March 2009 market bottom (typically a bullish sign).  The VIX continued to trend lower and remained below its 200-Day SMA throughout the massive move higher within the equity markets…until April 2010.  During April 2010, the VIX once again “spiked” and traded above its 200-Day SMA (and has remained above the 200-Day ever since).  Since April 2010, the VIX has subsided and traded down to its 200-Day (and usually touched) on a number of occasions – this occurred on May 25^th, June 18^th, July 13^th ….and again July 20^th (yesterday).  Each time, however, the equity markets sold off (often suddenly and violently) within a day of the VIX retracing back to its 200-Day SMA.

Also, our stochastic oscillators have once again entered “overbought” territory, particularity the SPX and Nasdaq.  Again, stochastics are often leading indictors to price action.   However, “overbought” and “oversold” conditions do not necessary mean an immediate, or impending, reversal.  However, “overbought” conditions within our stochastic oscillators which occur within a longer-term “down trend” (especially if the index is below key resistance levels) are typically very “bearish” and a very good indication of another short-term market top.   The bottom line – we see significant resistance to any upside market move and anticipate a further continuation of this market down trend.

Market Close –> Wednesday – May 12, 2010

2/8/2010 – Monday

 The equity markets continued their slide today.  The Dow Jones Industrial Average closed below 10,000 for the first time since November 4, 2009.   After last Friday’s apparent “short covering rally”, the market tried to stay in the green today, however, selling pressure accelerating throughout the afternoon and into the close (most major averages closed at their lows of the day).

 As we have stated repeatedly over the past weeks and months, we felt that the 2009 market move was NOT due to sound economic fundamentals.  On the contrary, we felt the massive advance from the March 2009 lows was rather a technical “bound” off from extremely “oversold” conditions with “performance chasing” institutional money “pumping up” the equity markets.  In a sense, it was an institutional “pump and dump” scheme of monumental proportions.

 As we forecasted, the fragile and exhausted equity markets are now sliding precipitously and indicating big trouble ahead.  Often investors are told that bull markets develop over time and continue to increase by “climbing the mountain of worry”.  This is true.  However, in this case, we feel the “mountain of worry” is truly substantiated and genuine.  Surveying the global economic and political landscape paints a gloomy, if not menacing picture.  From a fundamental perspective, the equity markets are indeed “stretched” and priced for robust future growth (now that is optimistic!).  From a technical basis, most market averages are exhibiting “ugly” chart patterns and extreme weakness.

 At this point, price action is “ugly” across the board. Relative Strength (RSI) is certainly confirming bearish sentiment and is approaching “oversold” levels on most the major indexes.  Again, simply being “oversold” does not necessary mean the markets reverse and enter into a sustainable rally.  We may see periods of “relief” or bargain buying (such as last Friday), however, these periods are more often temporary reprieves within a “bearish” trend and not evidence of a “bullish” reversal.  

 More importantly, we are seeing significant “bearish” price action patterns developing across most of the major indexes.  Major support levels have been violated and significant trendlines have been broken.  Heavy volume has finally arrived (selling volume) and this complete breakdown in price action has produced what is otherwise known as the ominous “Death Cross”.  A “Death Cross” is a technical event in which a shorter-term moving average crosses over a longer-term moving average.   At Option Empire, we typically use the 20-Day SMA and the 50-Day SMA.  At this point, the DJI, SPX, Nasdaq and Russell 2000 are all exhibiting the “Death Cross”.  Besides a brief two week crossover in mid-July 2009, the S&P 500 and Dow Jones Industrials have not had this type of “Death Cross” bearish pattern since April 2009 (shortly after the market bottom in March 2009). 

 These latest price action trends only confirm our earlier analysis and indicators.  As we stated in mid-January…..“We have been monitoring a strong moving average divergence within the Russell 2000 (over the past two weeks) and now within the S&P 500 (over the past week).  This type of divergence is very indicative of an impending market “downturn” on the near-term horizon.”  That “downturn” in the equity markets appears to have arrived. 

 Volatility, although well above the January lows, is still modest.  Modest volatility suggests that the selling pressure is still somewhat “orderly” as investors continue to divest themselves out of equities (just not panicking).  Given the orderly selling pressure, the selling is likely to continue.  At some point, however, we may indeed see a significant spike in volatility (investor fear gauge) if the orderly selling is interrupted by extreme fear and sellers “capitulate” (massive selling, on high volume, across all sectors and averages).  Interesting to note – although volatility is still relatively modest, most “volatility trading bands” have expanded dramatically (Dow Jones Industrials, S&P 500, Nasdaq, Russell 2000, etc).  This suggests potential “snap back” rallies in the near future as the bands “stretch” and the markets develop into extremely “oversold” conditions.  Again, these sharp market reversals could very well be “head fake rallies” and we would suggest extreme caution for “long” equity investors at this point.

 The bottom line, we feel the markets are technically “broken” at this time with few fundamental, or economic, catalysts to propel the U.S. equity markets significantly higher.  For now, our short-term and intermediate-term outlooks are “bearish”.

On Friday, the unemployment report “appeared” better than expected when initially reported.  However, further analysis revealed a number of questionable or misleading variables that indeed skewed the results.  At present, the “unemployment rate” is just over 10%.  However, “real” unemployment is closer to 18% -20% when we consider 1) “under” employed workers 2) workers that have “given up” and fallen off the unemployment rolls and 3) small business owners who may never show up on the unemployment radar.  Beware – listening to the “simplistic” analysis often espoused on the “unemployment numbers” is, in our opinion, very misleading and erroneous.  Maybe someone should explain basic statistical analysis to these “economists” and prognosticators.  Yes, the number and rate of unemployed workers is slowing – it must!!  To assume that the rate and number would not decline would be to assume we are regressing to 100% unemployment. At the pace of job losses realized over the past year, every American would be out of work and unemployed with 5- 6 years!!  Of course the rate of job loss is slowing!  No country has or has EVER had 100% unemployment!  The “unemployment rate” will regress to a means, or average rate, over time for any economy (even for a very weak country with terrible economic conditions).  EVERY society has a baseline, or mean, level of employment (just for survival).  It’s not about the rate slowing (that should be obvious to the average 5^th grade student), it’s about job GROWTH and CREATION.  A “slowing” unemployment rate increase and “slowing” job losses will do absolutely NOTHING for helping this economy regain growth and prosperity.  Perhaps “job creation” would be a more suitable goal for attaining economic growth and prosperity, not simple a slight “reduction” in job losses month over month.  All the “spin” in the world can not changes facts and basic truths.

As we anticipated, the tide has appeared to have changed for the U.S. equity markets. 

Our short-term Advance/Decline and Volume indicators and oscillators reversed direction today and are now moving downward (a bearish trend).  Although these are initial reversals and these indicators can reverse course at any time (in this case, once again turn positive or bullish), generally a reversing trend remains in place for a matter of days to weeks.  As such, we would anticipate the U.S. markets to trend lower (market pullback) or at least trade in a sideways consolidation period.

Is this market finally beginning to price in a “double dip” recession?  Has the market advance too far and too fast, overshooting the most optimistic recovery expectations?  Perhaps…however, it is simply too early to read too much into these early warning signs.   For now, we are anticipating a “pause” and likely “pullback” from current levels.  The strength, magnitude and duration of any pullback have yet to be determined.

Is there enough momentum and strength to propel this market even higher?  We shall have to wait and see how much bullish momentum is left in this market.  In our opinion, we would suggest extreme caution to the “faint of heart” investors thinking of getting into or staying long this market.  In our view, the U.S. equity markets are approaching an ominous crossroads.  If the major indexes (such as the S&P 500) can not advance to new highs over the coming weeks, the probability of another market reversal (perhaps correction) is very probable.  This menacing outlook could very well set the stage for a classic “double top” scenario.   Option Empire subscribers – login to more detail.

The Street was feasting on positive economic news today! Many retailers posted solid gains for the second straight month and were stronger than expected. Is the consumer spending binge back in vogue now? Not to be a “downer”, but an increase from “terrible” levels should not be mistaken for a sustainable “recovery”. Elsewhere, the Labor Department reported that first-time jobless claims fell to a 10-month low of 512,000 last week, declining by a wider margin than economists expected. Again, decreasing job losses is indeed better than losing more jobs than previous months, however, at some point we actually need to “create” or add jobs and not simply just “lose less” each month. Regardless, the bulls found the “positive” in the weekly unemployment data ahead of the government’s highly anticipated payrolls report due out tomorrow.