Consumption strong, business investment weak

click on charts to enlarge

The GDP release on Friday revealed an interesting dynamic. Consumption is strengthening (illustrated in the first chart by the ratio of personal consumption of durable goods to GDP - a good gauge of consumer vigor), while business investment is weakening (in the second chart I plotted the ratio of private nonresidential fixed investment to GDP).

Indeed, we know that, recently, employment reports have been good and, taking into consideration the dynamic I mentioned above, it means that businesses have started to invest in human capital more than in software, machines and structures.


Is this good or is it bad?

I noticed from the second chart that previous recession entries took place with the ratio starting to drop as it does now. Still, during the expansion before 2000 one downtick in the ratio could happen without the economy peaking. But two downticks in a row represented a top, so the next GDP release is pivotal.

Still weak

The chart above is that of a 3 day ema of TRIN. I call it short term TRIN.

Notice the fact that this indicator did not spike beyond 1 as it previously did on rallies. I take this as a sign of weakness.

Meanwhile, the total put/call ratio is acting like the market is not ready to fall - yesterday it spiked towards oversold despite the strength in the market.

Maybe there are some bears that have not capitulated yet (as I did yesterday) but who are ready to exit on a pull back at the open.

This is just a conjecture. It might be something else but the effect is the same - the market shows some strength first when the ratio acts this way.

Out at 1396.25

Changed my mind about waiting any longer.

The market will eventually pull-back but it might be from even higher levels.

Trade update

The market is surging in the afternoon, which represents a sign of strength.

Thus, I am waiting for the market to pull-back so I can exit my short, although, as I am writing this, it looks like it will never happen.

The price am I willing to cover at is 1394.5, just above the 1394.25 support on the daily chart. If the market does not come there until the close, I will leave a limit order in.

Short at 1388.25

Weak, overbought and at resistance

I think the market is about to turn lower again and this time break to at least 1340. Yesterday's rally provides a nice entry point for a short.

Indeed, despite the big gap up and close at the highs, yesterday was not a 90 % up volume day. I take this as a sign of weakness. I do not know if this observation has statistical value but I noticed that during previous intermediate term corrections big rallies are not 90 % up volume days.

Also, as Tony noticed, the total put/call ratio spiked to overbought yesterday, after a few weeks of staying too bearish.

Weak and overbought is a great combination by itself if you wanted to sell. 

When the market is also against resistance the opportunity could not be better because a possible loss is greatly minimized.

Sometimes the best opportunities come during the European morning, but I think the market will come to the US sellers too. 

Strength above the upper trend line of the bear flag can be a trigger to take losses in case of a short.

Bear flag break-out and head & shoulders

The market is set for a short term bounce but the overall picture looks bearish. For now, by my measures, this is still just an intermediate term correction (7-10%) in a bull market.

The analogy continues

I posted recently about the analogy with the 2011 February-March correction. Click here to go to that post.

Here is an update in which I highlighted the day that corresponds to yesterday. They look a lot alike.

So, next up would be a rally today and it is already starting to take shape as I am writing this.

Generally, analogies represent good "intuition pumps" but it is good to remember that they work until they don't.

Out at 1378.5

The market is reluctant to fall.

I also got the worst entry ever so there is not too much room for error.

It could go down without me but I am more worried about not taking a loss now. The time to make money was on the way up from January.

Short at 1379.25

A little too low for my taste but the market looks weak.

The 1380.5 resistance should protect me.

Patience is key

"Have patience and trade as the market breaks at least an important level against your bias."

If I were to remember only one thing about trading the above would be it. It is the best method to minimize risk I know of.

It is not always easy to apply, though. The fear of missing out interferes quite often


It is my expectation that the market will start falling soon to new lows for the correction. I took yesterday's short in this context. Things didn't look right after I entered the trade and I decided to wait patiently.

Today, the market has already broken above the important 1388.5 level. This is a great opportunity to attempt another short entry if conditions seem right at the open.

Out at 1383.5

Changed my mind. The intraday reading on the CPC shows a depressed ratio.

Short at 1383.75

Short term trade for a fall to 1360

Yesterday's rally - strike 4

Yesterday was not a 90% up volume day despite the big rally. That's an important sign of weakness.

Another sign of weakness is the fact that the market came to the sellers after 1 p.m. and it got sold into the close.

So I think the last days represent just consolidation before the market starts falling again.

Here is what could happen.

> Today:

> February - March 2011:

Retail sales - good, therefore peak performance

Someone once said that anyone who has traded at least half seriously knows to associate strong  economic performance with tops rather than bottoms.

The latest retails sales report can be interpreted in the same vein:

All this in the context of short term peaks in employment and consumption of durable goods.

The dollar - the "more monetary stimulus" hysteria

I previously commented on the dollar here. I was expecting a drop to the first important support level (lower blue line in the chart below). This expectation was formulated in the context of an extension of the market rally to 1450 SPX.

Weekly chart of the June contract for the US Dollar index. 

Since then, however, the SPX seems to have put in an intermediate term top and the dollar is forming a diamond chart pattern.

A diamond is a reversal pattern but I do not rely too much on the predictive value of chart patterns. I only take them seriously when the market is breaking out.


A break out may happen when the market realizes how foolish it is to already expect more monetary stimulus from the Fed. The deceiving employment report  has inflamed some impatient spirits.

The Fed does not change course from day to day. It can break the dollar rally but it would have to hint at it first. For now, all the hints where in the direction of no more stimulus.

Bounce

The intermediate term correction is underway. The divergence on the 13 day ema of TRIN has given a nice and timely warning (red segment).

Although, generally, a correction ends when the 1.4 level is reached, this time it is too small to have ended.

That is why I think we will only see a bounce before the market starts falling again.

I expect the market to drop below 1350 first and then start rising for a few days.

Employment confirming the economic slowdown

Here is a chart of what I call an average pace of monthly change in private payrolls. The series has started falling.

 I am talking about a short term slowdown. 

As for the long term, while a recession cannot be ruled out, for now, there is no compelling sign of it.

Reluctance to break down

Although things are nicely set up for a bigger correction, the market is not breaking down yet. There were some attempts since end-March but they all failed by the time the market closed. Yesterday was no different.


Here is a chart of a 13 day ema of TRIN.

This indicator has been weak for some time but it does not yet show a bigger spike towards oversold that would lock in the divergence and mark the beginning of the correction.

Maybe it happens today but I doubt it given the good expectations for tomorrow's NFP report.

This is why I think that, after reaching weekly support at 1380 today, the market may start rising towards the recent highs again.

Economic slowdown in the near future

The FOMC minutes informed us yesterday that the economy has behaved a little better than expected lately. However, for the stock market that is not so great news because it has already happened.

Here is a chart of the average pace of monthly change in real personal consumption expenditures for Durable Goods.

The chart shows that the series has already risen and that, after carving out a pattern that is not occurring for the first time (red circles), it is ready to start falling. 

Looking back, in the case of the previous two occurrences the market has seen two important tops: spring 2010 and spring 2011. 

I don't think spring 2012 will be any different.

Out at 1410.25

The market is acting weak after a very weak close yesterday.

This exit might be too early but I need to reassess.

Long at 1406.25

The market looks headed to new highs.

Still, I would not be surprised to still see some fast short term sell-offs.

Oil at monthly support

The May contract for oil has reached monthly support at 102.8.

Will it find reasons to bounce, or even continue the uptrend?

I think it will. Here is a chart of the Chinese PMI with the latest release highlighted.

Thus, buyers can speculate again the low risk entry offered by the shake-out on the daily chart: