Repair Work At Equity Markets

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June 8th, 2004

                                                    Repair Work At Equity Markets

ANALYSIS

The old saying of good news is good, can sometimes in reality mean that good news is also bad news when market participants are too narrow minded, or focused on short-term solutions. Part of this state of mind relates to the current bad equation of aggressive rise in interest rates while limited value is being put on the underlying strength and prospects of improved labor demand, record corporate cash flows, (largest excess over investment spending in a half century), and the strongest four quarter GDP growth in decades.

DIRECTIONAL TREND

Nonetheless, the bad equation may now stand a chance to reverse itself. With respect to the Fed and the much anticipated rate hike later this month, history of the last fourteen rate hikes shows that the market has advanced 64% of the time over the course of two months. The largest gain being 7.3%, and the largest loss at 5.8% - the latter occurring at the top of the bubble in May 2000. Moreover, presidential election years have shown a distinct tendency to boost market action during summer months, specifically July and August. As illustrated by the charts in fig 1 & 2, the fourth year of the cycle shows that buyers historically have stepped up to the plate sometime in June, or soon thereafter.

The one thing that characterized the month of May, besides being the worst month during election years, was the clear drop off in volume. From May 10th and on, this can be observed in spider markets such as SP 500, 400, 600, DIA, and QQQ - See fig 3 & 4 - Though significant volume is not always necessary for prices to breakdown, since they can fall on their own weight, but it does however seem to imply that "would be" sellers are not as aggressive as before ? the potential for quick snapback as well as favorable support (200DMA) can be explained. A certain reluctance to sell can also be supported by the unusual high volume in equity put options early June.

For additional clues on directional trend, several momentum measures have gained notable strength in almost all ten industry groups, implying that current market dynamics are showing real investor desire for upside rather than downside - 8 out of 10 groups have had their MACD line cross the zero line, while 9 out of 10 (except telecom) show their relative strength index (14 days) crossing the 50 midpoint line - This is important ? Midpoint lines usually serve as resistance in strong market down trends after being breached to the downside. However, as of late, the current lack of volume on up-days also seems to suggest that the market is bent on taking one step at the time, and ?may? stay within trading-range before a significant breakout occurs. Sector groups showing pockets of strength are defense Index (DFI), Steel index (DJUSST), Internet Service index (GIN), Manufacturing / Tools-Accessories. Weak groups are Cosmetics (DJUCSM) after a phenomenal run since late April, Energy, and Restaurants (DJUSRU).

INTERNAL CHARTING

Recall the NYSE breadth chart (fig 6) exhibited on April 19th (Ref: ?Continued Theme Of Rotations?) That chart specifically gave weight to the 60% level as major support for the percent number of stocks above their 200 DMA. It was stated that a violation below 60% would signal a downturn in full force once breached ? the initial test survived, but the second punch did indeed trigger an avalanche of supply by dropping straight down to 51% and then 44% on Monday of May 10th - Decliners crushed advancers by a wide margin of 12-to-1, the worst decline since late October of 1997.

But in a broader sense, the central theme of rotations as argued, has kept the bullish bias intact despite short-term volatility. Up to date charts (See fig 5 & 6) shows a much better picture where NYSE has formed a classic reversed head & shoulder at 65%, while Nasdaq is almost there, but at weaker level of 44%. SP 100 (large caps) paints a near perfect bullish cup?n handle completion (71%). So, if we are to believe in these classic bullish patterns, it should not come as a surprise that the market "could" be setting itself up for additional upside and challenge the highs of March. A sustained move should ?ideally? be accompanied by higher than average volume, preferably above 1.8 billion on Nasdaq and 1.5 on NYSE.

MONEY FLOWS

Important firepower is always the blood of money flow that moves the market. April equity net inflows to mutual funds as recently reported by ICI was surprisingly strong at 23.3 billion - This number is once again (YTD) hitting the average monthly top end range between 25 to minus 1 billion - Average monthly net inflow since 1993 has been about 13 billion, while the monthly average for 2003 was 18 billion -- YTD net inflows per month is 27 billion, excluding January (40B), and we still have an impressive inflow of 23 billion. The chart in fig 7 shows the consistent inflow since the bottom of 2003. Money flow tends to follow price action as investor confidence rises and falls in proportion to the market. But given the recent upswing in labor demand, money flows may continue to experience a steady inflow for a while, thus add more fuel to this market.

Fig 1: SP 500 total return on monthly basis covering 18 presidential cycles 1928-2000. Blue square highlights the 4th year in all presidential cycles ? cumulative, SP 500 tends to advance higher during the month of June and the following two months.

Prepared By I.V

Inlägget är redigerat av författaren.