Mixed Market Follows Fed

The SPY is currently set up exactly the same way the XLU was June 1. Take a quick look at the XLU chart to see what could happen to the S&P 500 next. The QQQQ, on the other hand, has been holding up nicely near its highs. This is quite a divergence.

Whether or not the S&P follows the XLU route lower or not depends on how the market decides to interpret the Fed minutes released yesterday afternoon. If the market concludes that a rate cut is imminent, then no doubt the S&P will shrug off the sell signal and march higher. The high level of put buying seems to indicate that this is what will happen.

Meanwhile, good long side set ups can be found in the Automotive, telecom, and semiconductor sectors if you are picky and choosy about what to buy.

Ballerina Springs to Life

The market rallied hard out of the extreme fear base built over the past few days. The pull back, rather than being technically damaging, was akin to a ballerina who dips before she springs. Now that fear has been released the tone is likely to be set by today's Fed minutes, which are released at 2:15 p.m. ET.

The semiconductors regained leadership yesterday, and this is precisely the type of action tech bulls want to see. Technically the charts look to be in fine shape, especially tech. Unless the Fed springs an unwanted surprise today, we should see this positive bias continue for a few more days.

Note that shorts need roughly 7 days to cover, so if the market moves higher here, we could see an explosive situation on short covering alone.

Fear Levels Spiking

Turnaround Tuesday started off with a gap up, but the market has experienced a change of character over the past few days where instead of buying dips, sellers are jumping on the rallies. The day was negative and the S&P has now firmly broken its trend and rolled over below its 50-day average.

Does that mean we should short here? VIX levels, the indicator which measures fear, are spiking at levels not seen since the market rallied strongly out of the late February sell off. You want to short when the market is complacent, and buy when the market is running scared.

We don't recommend buying just yet. We are near a bottom, but unless you have very deep pockets and can afford to see prices get chewed up a bit more before they bounce, it is best to hold off and be patient.

Meanwhile, we scanned every market sector today and found one reliable trend out of more than 100 sectors. Electric utilities are in a firm downtrend and sellers show no sign of letting up anytime soon. The XLU has tried to bounce from its two year uptrend, but over the past two days sellers have been aggressively chopping off the tops. It looks like there will be continued pressure on interest rates, which in turn will place pressure on the utilities.

Turaround Tuesday Watch, but be Careful

Yesterday’s whipsaw trading was extreme. The market dipped in the morning, recovered on heavy volume as prices pushed up into the green, but then they reversed hard again in the afternoon as buying momentum stalled and selling took over again.

Blame the Yen. The carry trade in the Yen has been driving the liquidity, and/or lack thereof for months now. Yesterday’s market reversals tracked the strength and weakness of the Yen throughout the day.

The big question here is are prices ready to accelerate to the downside, or are sellers running out of momentum. Data indicates the later.

The VIX is now back at the exact same level of fear that preceded the hard reversals higher we witnessed on June 8 and June 13. Put buyers are still investing in higher than 3-1 puts to calls. And, on top of all that, the QQQQ has not broken its trendline and the SPY, while back at its June lows, is exhibiting bullish divergences on several important indicators.

It is certainly possible that downside momentum could accelerate here, but it is historically unlikely. It would be a real coupe if historically unlucky options traders actually hit the jackpot for a change. Especially now that we are nearing the end of the month when mutual funds are flush with cash they need to put to work.

The bottom line here is that the market has failed to gain upside momentum when it had the chance after last Thursday’s goal line stand. This does not mean that the market has to now break down and start a larger correction. Unless and until we see the June lows breached, this market is in the neutral to bullish category. Moreover, with sentiment figures at ultra bearish levels and with indices at support and losing downside momentum, odds favor another turnaround Tuesday today.

One word of caution though, if buyers for some reason fail to move back into the market today and prices weaken beyond June lows, then it is best to quickly close out all long trades and get out of the way. Such a situation could cause a panic situation that leads to a better buying opportunity. Yesterday we mentioned this, if such a panic ensues, we will be looking to buy in hand over fist. But not until the panic has gained some steam.

Market Tops Don't Look Like This

Friday's weak day was a disappointing lack of follow through from Thursday's strong buy signal mentioned in our last report. Nevertheless, the weak, choppy trading seems to have had more to do with the restructuring of the Russell 2000 index than it had to do with supply and demand.

The bullish case is building in the near term. On Friday put buying spiked to 2:1 on the QQQQ and more than 7:1 on the SPY. Moreover, the news for the day focused on sub prime, which we have all gotten an earful about lately. Market tops just don't look like this. The market just doesn't work that way. Market tops occur when there is too much enthusiasm, which indicates that all the good news is already priced in and prices have no where else to go but down.

Market tops do not occur when dumb money has loaded the boat with puts and when commentators focus only on doom and gloom scenarios. The market is perverse. Remember that. Those who control the largest blocks of money need sellers to give them shares when they are buying and as such, the news that gets filtered down to the retail market is designed to create fear. In other words, it’s a game of hard ball.

On Friday major indices closed back at their uptrend support levels. If these support levels break this week, we may see a panic occur, but we submit that that panic will be an opportunity to get in and buy stocks hand over fist.

On the other hand, buying was taking place late Friday and with prices back at support, we may just see prices reverse higher again today. Whichever scenario unfolds, this is not the time to be panicky with your holdings.

A Wild Accumulation Day

Market indices did indeed quickly find support after Wednesday's sell off. Yesterday's report explains why.

After all the distribution days lately, it's interesting to note that yesterday was one of the strongest accumulation days of the year. In fact, it was the strongest accumulation day of the year for the QQQQ, which left a buying tail at its trend line; strong, strong confirmation of the uptrend. And it was one of the top 3 accumulation days for the SPY, which left a similar buying signal at its trend.

It looks like we could get a summer rally.

A Very Important Lesson

Yesterday we saw yet another steep decline following expiration week. We have been bearish on the market for a while now due to the distribution days that have been adding up. Nevertheless, it is important to remain objective here and not let your market bias skew reality.

Reality is that while the market is technically not in very good shape here, there has been an underlying propensity toward dip buying that is not easily seen in the daily charts. Every time the market takes a dive, no matter how shallow, dip buyers have been right there putting a floor under the move keeping prices elevated.

If this were occurring in an environment of exuberance then we would discount the dip buyers as hopeful, yet gullible traders. The truth is though, that this has been one of the most hated market rallies on record. Nobody trusts it and this has been reflected by the fact that the options market has seen a put:call ratio near 2:1 for months now. In other words, everyone is afraid of a decline, so they are hedging against it.

So how to interpret the dip buying in this situation? If the majority of market participants hate the rally and distrust it so much that they are shorting it, then it must mean that dip buyers represent smart money, not hopeful retail traders. And like the old Dean Witter commercial, when smart money talks, the market listens.

Robert Carver explained how this works very nicely. This is a keen observation about how the market works, so pay careful attention. This can earn you a lot of money over the years if you understand it and act on this information (highlights are ours):

As the market falls, more investors get nervous and buy more puts, causing more short-selling of the futures to hedge the new puts and it becomes a waterfall. But, the effect is only temporary. As prices move lower and lower, put holders, who have seen their puts rise in value while their stocks decline, sell their puts and then "return to the scene of the crime" to buy more stocks, which are now on sale. This causes the market to immediately rally back, often to new highs, and leads to short covering in the same derivatives which caused the decline in the first place. Short covering pushes the market higher, creating an equal effect on the upside. Hapless bears who took the initial decline as a sign that the "big crash" had started are then forced by rising prices to buy back their losing positions, pushing the market to new highs. And so it goes .... As long as stockholders are afraid that the market will go down, it can't go down for long. The puts create an "ocean of liquidity" which floats the market. And, as long as investors are buying puts, this self-fulfilling prophecy insures the market against a meltdown.

But, you might say, "What happens when investors stop fearing a decline and forego buying puts?" Ah, grasshopper, therein lies the ultimate top in stocks and the beginning of the next crash.

So what is the lesson for today? Since options traders bought puts at a 2-1 margin yesterday it means that healthy investor fear persists and that this decline is likely to be short lived. When the day comes that options traders start to buy calls on the dips instead of puts, that's when we need to look out below.

Sellers Miss an Opportunity

The market has been correcting in time instead of price. Prior to options expiration, we were not sure we trusted this action as the market could have potentially been held artificially higher in order to put a hurt to the put buyers. Over the past few days, however, we have been seeing expired put contracts being rolled over into next month as sentiment levels refuse to budge from an overly bearish posture.

Overly bearish sentiment creates a paradox in that prices can be held afloat by protective measures the crowd takes to hedge their positions. In other words, all those puts that buyers continue to actively accumulate have the effect of keeping a floor under the market. This allows the market to correct in time (sideways) instead of price (down).

This is a bullish development if it continues.

Even so, the broader market offers few advantages here. Dip buyers who are looking for stocks to move straight up are very likely to be disappointed. Flipping has been the name of the game lately and it looks to remain so for at least another week if we have measured the trend lines correctly.

This does not mean that opportunities don't exist however. The lack of selling pressure has given some more speculative, under-the-radar-screen, small cap stocks a boost. In other words, when the cat is away, the mice will play. So right now, when selling and buying remain muted in the broader market, those stocks not so closely watched are seeing some play.

Expecting the Unexpected

The tech sector is poised to extend its recent break out to new highs. However, the broad market is diverging. Yesterday, TheStreet.com's Dynamic Trading System issued a sell signal and the VIX shows that fear that we saw in the market last week has dissipated and that complacency levels have returned. The mixed message the market is sending here raises risk, which has already been very high.

The immediate term path of least resistance in this situation seems to be the downside. At the very least, the market is much more vulnerable for a sharp correction than it is for a sharp upturn. Until the market does something though, it is best to just manage open positions and even perhaps lighten up on some of your positions.

One potential here would be to see the market pull back near recent lows setting up another dip buying opportunity for perhaps a significant run higher. If the QQQQ can break out and close above $48, however, we may instead see the market being pulled higher instead of tech being pulled down. Again, the message is very mixed here.

In any case, today is turnaround Tuesday, so expect the unexpected.

S&P Holds Back Bulls

Last week the market whipsawed bears and put a squeeze to their positions as options expiration games, a focus on inflation numbers, and overly bearish sentiment gave bulls a boost. On Friday the QQQQ broke out to a new high giving bulls another boost.

It's pretty hard to trust the market here, however. While calling a top is a very difficult endeavor, it's not so difficult to see that buying in at these levels is very risky indeed. While the tech heavy QQQQ broke out Friday, it wasn't able to do much more than close unchanged on the day. Moreover, volume was at its weakest levels in three days and certainly not indicative of the type of volume you would want to see as an index breaks out to a fresh high.

Adding insult to injury, the SPY not only did not make a new high, but turned around and reversed hard mid day carving out what is now very likely a lower high, or at least something very close to one.

Traditionally options expiration strength tends to unravel on the following Monday. So, we will be looking for the market to put on a bearish trend either today or tomorrow.

Volitile Week Punctuated by Options Expiration

The market does a good job at frustrating the most people most of the time. Lately, this includes everyone who has longer than a trading strategy with a time frame longer than one day.

This week has seen the market make a hard whip saw, which is fine, the market sometimes does lean hard one way only to reverse and stop out traders. Oftentimes these types of turn around events are good buy signals.

The trouble here, is that this current buy signal is just so hard to trust. The market seems to get rocked by one piece of data one day, only to react equally as violently to a seemingly contradictory piece of data the next day. It's a market that can't make up its mind. Moreover, it's very hard to overlook the fact that indices are very extended and the heavy distribution days we have experienced of late.

In fact, the rally over the past two days looks to us to be a selling opportunity for smart money, or a distribution rally. And, since today is options expiration day, it's possible that the rally over the past two days served merely as a chance for options sellers to collect their fees on all the put contracts they sold last week when the market was in a panic slide.

We continue to believe that the short side offers the path of least resistance in the intermediate term. Near term, however, things are just not very clear. Timing is everything and it's difficult to say when sellers will take control of the market again. The best thing to do when the picture is so unclear is to lighten up the load and raise some cash. To be sure, we will be happy to put this options week behind us.

Whipsaws and Chop

Over the past week stocks have been falling in response to the bond market. Just as the major indices were about to follow through out of a lower high, however, the Beige Book release yesterday sparked a rally as it indicated that the Fed has indeed engineered a goldilocks scenario. One trader noted, however:

Since the Beige Book was prepared there has been worsening news on the housing and real estate fronts. The Beige Book was based upon information collected before June 4, so it does not include data since then, and does not include the observations made by Bernanke in his June 5 speech. So, in other words, the market rallied under a premise that is not backed up in fact.

Today the PPI report comes out, so the market has even more data to digest. Right now the market is getting tossed around like a rag doll as it tries to find its way.

We have a difficult time believing that the serious weakness we witnessed last week and all those distribution days (including yesterday's) can so easily be shaken off. Bonds are still the main driver of stocks in this market and right now bonds are consolidating within an established downtrend.

It looks like the chop is going to stay nasty until the bond trend reasserts itself though.

Market Correction Probabilities Increase

There has been a lot of chatter this week about the similarities between the current market set up and the technical conditions that existed back in 1987 before the crash. Before we look at the similarities, we would point out that there are now measures of protection in place that should keep the market from suffering a similar fate. One reason the market crashed so hard in 1987 was due to the fact that the NASDAQ system was still in its developing stages and could not handle the order flow. Once the sell orders started to hit, they jammed up the system and panic ensued.

That said, similarities are eerie. The set up back in 1987 was a sharp market rally, followed by a steep pullback, that then recovered weakly only to make a nominal new high. Once the weak recovery played out, there was a huge air pocket below that did not lend support during the sell off.



Now take a look at the current NASDAQ chart. It to rallied sharply, suffered a hard correction, and has since moved up weakly only to make a nominal new high.



Note that this last leg higher where the nominal new high was achieved also occurred as money flow was negatively diverging against the uptrend. This indicates that smart money has been selling into the rally.

We have complained recently about how long positions have been stuck in the mud and that they have been prone to stop out failure due to the underlying distribution taking place. In fact, we have taken measures in recent weeks to close out all long positions and to start opening short positions as the market has stalled out.

Clearly the set up is the same now as it was in 1987. This does not mean that the market is doomed to suffer a similar crash. It is interesting to note though, we went back over the index charts over the years and every single time the market has set up like this, it has corrected. Most corrections just took more time to play out than the 1987 correction.

An important point to focus on: One last point to keep in mind, each one of these corrections led to an excellent buying opportunity. Most of which were followed by multi year runs higher. As such, we embrace the opportunities this set up seems to present.

Dead Cat Bounce Pattern

Yesterday we noted the similarities between the way the XLU traded late last month and the way the major market is trading now. Indeed, yesterday the market bounce started Friday stalled as volume decreased. This classic dead cat bounce pattern increases the probabilities of a fresh leg lower.

Will it turn into a waterfall decline? We have no crystal ball to answer that question with. It should turn into a decline, but what type of decline it turns into is anyone's best guess. If the decline back to last week's lows attracts more buyers, then we may reassess our bearish posture. If last week's lows give way to further selling though, then prices will likely decline significantly further.

Lower High Watch Begins

Market corrections tend to play out in phases, frustrating buyers as they drip lower. Last week started out as a waterfall decline, but buyers stepped back in on Friday. This may be the start of the drip lower that will frustrate dip buyers who have been up until now successfully buying dips.

Technical damage was done last week and major indices have seen significant distribution take place. Because of this we will be watching for a lower high to develop this week, which will provide a second chance shorting opportunity.

The XLU, Utilities Spider, offers us a potential road map for the broader market. Note the original slide, similar to that which occurred last week in the broader market, followed by a lower high, which led to a larger sell off last week.



This week we will be watching to see if the broader market follows this XLU pattern. If so, the QQQQ should find resistance at $47.30 and the SPY should find resistance at roughly $152.50. A failure to create a lower high would negate this hypothesis.

A Lot of Fresh Shorting Opportunities Here

We were wrong about the weak bounce occurring. Nevertheless, there are a large number of shorting opportunities still available here. In order to participate, more aggressive entry is necessary.

This market is oversold and will bounce at some point, but the momentum is heavily down here so we may not get a decent bounce for a few more days. Even then, the bounce is likely to be of the dead cat variety. When we do get a dead cat bounce, we can add on to our growing short position.

And the Roller Over has Begun

We have been bearish on the market for a little over 3 weeks now. Three weeks back we closed out all our long positions and took short positions on market indices. Since market tops are generally drawn out processes, it's been tough maintaining our bearish posture at times; especially when the QQQQ index experienced a false breakout last week.

We stuck to our guns though since last week's breakout occurred on low volume and was accompanied by bearish divergences in many of the leading indicators. More importantly, however, the fact that reliable trade set ups had dried up was a huge warning sign that something was just not right.

After yesterday's trading, we are tempted to yell "Vindication!" but it's probably still too early to declare victory just yet. Indeed, yesterday marked yet another important high volume distribution day. More importantly, breadth was extremely negative, with 75% of all stocks in the market in decline.

What this means is, we should now see stocks running into more and more resistance on the bounces that are sure to follow yesterday's decline. A waterfall type move lower is unlikely here, so if that is what you are expecting, you should probably adjust your expectations a bit. Sentiment is highly negative right now, so at a minimum, we are likely to see some of yesterday's short gains being given back.

Summary: Look for the market to drift lower following weak bounces.

Muddy Waters

Rather than clarify things, yesterday's market served to muddy the already murky waters.

As the Yen-carry trade, which has been creating so much liquidity in the market hiccupped at the open, prices sold off on heavy distribution-like volume. This was in fact the type of behavior we have been looking for and had actually predicted would happen in yesterday's report where we called for a turnaround Tuesday.

But then in came the angels to the rescue and the first dip buyers were bolstered by more buying, especially in the Nasdaq 100, and distribution gave way to accumulation. There is no denying that liquidity remains in this market and that someone or some group with a lot of firepower is willing to step in and buy the dips in a significant way.

Technically the day was a distribution day, especially in the S&P and the Dow. All three major indices exhibit hangman patterns, which theoretically represent reversal signals.

However, all hangmen are not the same. Had the market dipped on high volume, but recovered late in the day on weak volume, we would be looking for an extension of declines this week. Instead, heavy selling in the morning was answered with heavy buying in the afternoon.

This overbought market can go either way here. Any prediction bolder than that is not grounded in reality.

Will this Time Really be different?

Market volume was light yesterday, and breadth was flat. Bullish sentiment remains on individual stocks, but overly bearish on the indices. This is the same type of mixed sentiment we have seen for weeks now, so it's not a very good indicator of what to look for today.

After six positive days in a row now, the likelihood of a pullback or a turnaround Tuesday is high today. The question is, will the pullback attract more dip buyers as pullbacks have been doing for months and months now, or will it turn into something more?

We don't know the answer to this question, but signs of a significant market top remain. Will this time really be different? Again, we don't know, but we have our doubts.

Poor Set Ups Support Our Distrust

We continue to find reasons to hate this rally. Primarily the lack of decent set ups despite the fact that indices continue to squeeze short positions. If this market is really going to break higher, we would hope to start seeing good stock set ups. They are few and far between right now, which has in the past been a warning sign that has been very painful to those who ignored it.

It's a Craps Shoot

Earlier this week, Rev Shark of The Street, commented that this rally is the most hated stock rally by traders he has seen in his career. We can certainly understand and agree with his point. Unlike most rallies, this rally has produced very little to trade off. Indices have been inching higher, frustrating shorts and longs alike.

Buying set ups have just not been reliable the way they normally are when indices are on the march. At the same time, those who put on shorts end up getting squeezed after being enticed in by poor performance.

The market has undergone serious high volume distribution in recent weeks, yet prices continue to find dip buyers who have been moving prices back up on light volume. Distribution days favor the bearish case, yet bearish sentiment favors the bullish case.

The difference between the two this week that has caused prices to squeeze short positions can probably be attributed to end of the month mark ups. Next week reality is likely to settle in and either the market will show us that it really is determined to move higher in this "wall of worry" environment, or the distribution top forming will finally take hold.

Right now we continue to find risk on both sides of the trade as high as we have seen.