MANUFACTURING SLOWDOWN CAUSES PROFIT-TAKING IN STOCKS -- SHORT-TERM INDICATORS STILL SUGGEST MARKET IS IN NEED OF A BREATHER -- NBR INTERVIEW THIS EVENING
NBR INTERVIEW TONIGHT ... I'm scheduled to be the Friday night Market Monitor guest on the Nightly Business Report with Paul Kangas this evening. The TV show airs on Channel 13 (PBS) and runs from 6:30 to 7:00 pm NYT. The guest usually appears midway through the show. We'll be talking about all the things you've been reading about here. Tune in if you can.
US MANUFACTURING CONTRACTS WHILE EUROPE EXPANDS... It always amazes me how the financial markets are able to sniff out economic trends. Over the last week, U.S. bond yields have been tumbling which has hinted at economic weakness in the U.S. At the same time, the U.S. Dollar has tumbled with most of the losses coming against European currencies. A falling dollar -- and a rising Euro -- suggest that Europe's economy is growing faster than the U.S. Today we get a report that U.S. manufacturing has fallen below 50 (which signals contraction) for the first time in more than three years. [Strangely, the financial press labeled the U.S. contraction as "unexpected"]. At the same time, Europe reported the seventeenth consecutive month of expansion in its manufacturing sector. That's exactly what the plunge in bond yields and the dollar have been telling us. That report has caused more profit-taking in the stock market. That shouldn't come as too much of a surprise, nor should it be too disturbing. Earlier in the week I suggested that the stock market was overextended and in need of a pullback. One of the reasons had to do with the fact that the S&P 600 Small Cap Index had reached resistance at its May peak (see circles). Given the overbought status of the market, that's a logical spot to expect some profit-taking to appear.
Chart 1
WHY THE S&P 500 IS DUE FOR A PULLBACK ... The next chart shows that the S&P 500 has risen over 180 points (+15%) since July in an almost uninterrupted fashion. That's a little unusual. While there are no signs of a major top, there are signs that it's in need of a pullback or a consolidation which may have already begun. On Monday, I showed that the daily MACD lines were on a "short-term" sell signal after having failed to confirm the recent price move to new highs. That hasn't changed. Along the bottom of the chart, the ADX (black) line has turned down from overbought territory near 40. That usually suggests that the market is in need of a pullback or a consolidation. How far down could it correct? The first level of support is Tuesday's intra-day low near 1380. I suggested on Monday that the S&P appeared headed for a test of its 50-day average. That (blue) line is currently at 1370. If the 50-day line doesn't hold, the next level of support is the early November low near 1360. Even that would represent only a -3% pullback from the recent high and would be relatively modest.
Chart 2
Chart 3
FIBONACCI RETRACMENT LINES ... The worst case scenario I can see at this point would be a drop back toward the spring high at 1326. That would be a correction of approximately 5%. The horizontal lines on Chart 3 are Fibonacci retracement levels. The top line, which is a 38% retracement of the July-November rally, sits just above the May peak. A correction of 38% is pretty normal in an uptrend. So is a pullback to a previous peak. I kind of doubt that a pullback of 5% is in the offing. But even if it is, it's nothing to be too concerned about. It's also possible that the market may trend sideways for a week or two between its November high and low to work off its overbought condition.
Chart 4
WEEKLY BOLLINGER BANDS CONTRACT ... Another sign that the market rally may be pausing comes from the weekly Bollinger bands. Chart 4 gives three different ways to view the bands. The %B indicator on the top of Chart 4 uses the bands as an oscillator. In that version, the upper band is 1.00 and the lower band is 0.00. Readings of 1.00 often coincide with short-term peaks. The chart shows the %B starting to weaken from that overbought level. The middle line (.50) is the equivalent of the 20-week average. [The 20-week average is now at 1332 which is just above the May peak]. A pullback to that support line is possible and wouldn't upset the market's uptrend. The line on the bottom of Chart 4 is BB Width which measures the distance between the two bands. I explained recently that widening bands were indicative of a continuing uptrend. A contraction in the weekly bands often signals a market pullback. The chart shows that the Band width is contracting for the first time in several months (see arrow).
Chart 5
WHAT TO DO ... As I suggested earlier in the week, it might be a good time to lock up some "short-term" trading profits, or postpone new purchases until the market has worked off its overbought condition. The biggest driving market force right now is the collapsing U.S. Dollar. The ProFunds Falling Dollar Fund is the best way to profit from that trend. As I've been suggesting recently, precious metal assets (and commodities in general) should benefit from the falling dollar as well. So should foreign stocks. My favorite foreign market at the moment is Japan for reasons that I wrote about yesterday. Although it's been a weak performer, it may start playing catch-up to the rest of Asia. I also believe that bonds are undervalued relative to stocks at this point in the economic cycle. Chart 5 shows the 7-10 Year Treasury Bond ETF (IEF) on the verge of a new three-year high. Some nervous money has already started rotating from stocks to bonds.
