Here’s Why Watching Market Internals Will Be The Key

• July 26, 2004
• Chris Curran

The sell-off that started on the first day of July
continued in full force last week and there was little in the way of places to
hide as far as stocks went.  Initially, the selling was largely centered again
around the beleaguered Tech sector.  However, in the past several days, many of
the shares that are considered to be safe blue chips began to break down as
well.  There were signs up of an intermediate term bottom being put in mid-week,
but those hopes faded away as the week ended in an ugly fashion. The weakness
was just not focused on equities, as bonds and commodities were also under
pressure.  The only area of strength was in the U.S. Dollar, with the greenback
helped along by Mr. Greenspan’s hawkish comments on Tuesday and posting one of
its largest weekly gains in months. 

The
September SP 500 futures closed Friday’s session with a loss of —21.50 points
and finished the week with a loss of  ,while the Dow futures tumbled 96 points
and   points respectively.  On a weekly basis, the ES posted its 4th down week
in a row to settle right above the week’s low on its 200-week MA.  Looking at
the daily chart, the ES crossed the support line on a bullish Gartley to negate
Thursday’s sorry excuse for a bounce, and looks ready to test its May low.  The
YM also crossed the support line on a daily bullish Gartley to close lower for
the 5th week in a row.  In the small caps, the Russell E-mini (ER2) has formed a
daily bullish Gartley at its 78.6% Fib retracement of the May-June up move,
giving a 1st target of 556.

               

September
bonds (ZB) ended the winning streak to post a weekly hanging man just below the
62% Fib retracement of the year’s decline. The Semiconductor Index (SOX) closed
at the low of the week and the low end of its weekly channel, and has entered
the reversal area on the AB=CD pattern.

           

The recent
market activity has simply been classic bear market action.  Whether we are in a
bear market is still up for debate, but we can’t ignore the negative price
action that is taking place with deterioration in market internals.  It has long
been my view that the bear market that ended in October of 2002, and the
recession that preceded it, did not do their job in restoring enough health to
achieve a fresh secular advance.  The reason I say this is that valuations never
reached levels that often signal major bottoms or which would indicate
widespread selling of equities as an asset class.  Meanwhile, as far as the
economy goes, consumers and the government added more debt during the downturn.
This didn’t allow the normal cleansing process which recessions historically
achieve.  The housing sector also provided a means of liquidity, thanks to the
Fed’s excessively easy monetary policy.  That liquidity helped the consumer
continue to spend, during what should have normally been a period of
retrenchment.

So here we
are in mid-2004, with the monetary stimulus behind the stock market gains and
the economic rebound largely behind us.  With the stimulus gone, we have already
seen the Retail sector experience some problems, as consumers have started to
curb their spending habits.  Meanwhile, many equities have taken a turn for the
worst, despite valuations appearing much more favorable than anytime in the past
5 years.  The problem is that most companies may have already experienced peak
earnings growth for the current cycle.  Also, if the economy were to contract
significantly, it’s quite possible that earnings could experience negative
growth.  This could very well be one of the main reasons stocks continue to sell
off in the face of what most pundits label a sound fundamental environment. 
Because of all the imbalances that remain in the U.S. economy, the risk of
another recession in the not-too-distant future is still higher than what it
would normally be this soon after the prior economic trough.  And with the Fed
Funds Rate already near historical lows, there is not much the Fed would be able
to do should the economy start
rolling over again. 
Currently, the key indexes are
in a very deep oversold conditions, which should lead to some sort of bounce in
the near-term.  Watching market internals during an oversold bounce could be the
key in answering the question
posed above about whether a
new bear market is underway. 

 

 

Please feel free to email me with any questions
you might have, and have a great trading week!

Chris
Curran