The Week Behind, The Week Ahead

You Know They Are Worried....

Wells Fargo (WFS) just issued confidential guidelines, effective October 18^th regarding repurchase demands by investors and mortgage insurers. Basically give them what they want, avoid a lawsuit due to title fraud on a nearly unimaginable scale. Wells Fargo, which was CAUGHT in the “robo-signing” scandal has refused to halt foreclosures as a way to avoid billions of dollars in impairments. So, come Monday, the avalanche of demands by investors and mortgage insurers will be considered; if it is found there is no way to explain their way out of this they are prepared to buy what may amount to hundreds of billions of dollars in loan repurchase and rescission demands. As I mentioned a few weeks ago, this is a scandal not to be taken lightly that has roots in far out places that we can't even imagine yet.

This would certainly explain why tech which has been coming in with some good numbers, was high flying on Friday while the banking sector was taken to the wood shed. Also why I said last week FAZ is a serious long trade contender.

Last week's data was mixed at best. The US Trade deficit was bigger then expected (knock down GDP for Q3), Initial Claims were higher then expected and as I predicted, the real jump would be seen in the red headed step child that is locked in the basement, better known as the U6 unemployment data which is really the best measure of unemployment-this number didn't just come in higher, it jumped substantially. Also the University of Michigan's Consumer Sentiment reading came in weaker then expected. On the other side of the coin, US Retail Sales and the Empire Survey both surprised to the upside. However it must be said in truth that this is the year of the revision. Revisions lower, a week or two after the data is out is happening far too often to be coincidental.

Speaking of surprises, the market did not act well to Ben Bernanke's speech. This was a day, (should the right phrases have been uttered) that could have moved the entire market 2.5% or higher, instead we saw a tech rally, but of the 10 important averages, 6 were down-4 were up. While the NASDAQ 100 put in an impressive performance due to the tech stocks coming in with better earnings, you have to remember that strange phenomena in the market of stocks coming in with great earnings and then being sold off, it doesn't always happen the same day. That's not a prediction, just a warning from my experience. 

The market is a discounting mechanism (that's why it's considered a leading economic indicator), it's forward looking so the phrase “what have you done for me lately” or the song rather, DOES NOT APPLY. The market's view is, “That's great, are you going to do better next quarter?” and that is why guidance is the most important part of the earnings report and whether the company has a good record of sticking to or upward revising guidance.

Back to the market's performance Friday... The 10 important averages still remained at a negligible +.37% gain. The dominant price volume relationship was Price Down/ Volume Up. Eighteen of the Dow 30 closed down, 16 with volume up. This is normally taken as panic selling and there are several big name banks in there that surely fall under that classification.

The FED...

Central Bankers have always been ambiguous about their intentions, no one was more ambiguous then the last Fed chairman Alan Greenspan, it was called “Greenspeak”. The man could talk for two hours and no one had an idea of what he was thinking. Bernake is subtle, but not that subtle. In his remarks it sounded an awful lot like QE2, which is yet to be determined in size, scope and trajectory, may be spread across a much wider group of assets, notably it may be back to where this all started with MBS. What amazes me about the whole notion of quantitative easing is the fact that one of the goals is to spur lending to small businesses and the like to get the economy moving again. The fact is, lending has collapsed and continues to decline more then a year (no comment) into the recovery. I'm assume during such a credit crisis, it would be extraordinarily difficult to stimulate demand by manipulating interest rates considering where they already are.

Two Separate Paths?

According to Dow Theory, the averages should confirm. So Friday and recently we have a runaway NASDAQ 100, but the DOW and the S&P refuse to make similar moves. Typically, although the averages used in original Dow Theory are not the same as we use today, it means there is not confirmation and either two are going to have to start putting on their running shoes or one may come crashing back down. If we look at the transports, otherwise known as the DOW -20 we see a ugly candle formation there recently- an inside day and two Haramis or at least two candles in a Harami reversal formation. Furthermore, it's bumping into April resistance and possibly forming a small double top.

The banks are in trouble, middle America is hot, just recently a family of 9 (I believe) took off the locks the bank put on their house after kicking them out, and MOVED RIGHT BACK IN. Lawsuits? Yes and a lot of them. No wonder Wells Fargo is trying to preempt that reality. However this time it's different, America had little tolerance for the first round of bank bailouts, but we did tolerate it as we were pummeled with the notion of "Too big to fail. Now with the banks playing the role as the villains who broke laws and look like the corporate bullies they have been acting like, they are not going to get such a luke warm reception and politically it will be difficult for the government to intervene on their behalf as we just saw with the President's recent pocket veto. This means banks WILL be raising capital reserves and some of that money will come directly out of risk assets like the stock market. What the Fed does, in it's coconut shell game will be harder for middle America to decipher, but once the worm turns, it will have really turned. Obama knew he was walking into a mess, but the depth of this mess must be taking his breath away (that's not a political statement-there's plenty of blame to go around). Think about it, this is only a month or so old really, but my personal belief (all the insider selling and what not) is Wall Street has been hip to this a lot longer then we have. This rally of 12% on the SP-500 since September, I believe was a strategic decision on the part of Wall Street, I said so BEFORE the rally even materialized when we first saw signs of accumulation in late August. The insider selling has been heavy and for all the reason insiders may have to sell, one reason they that would keep them from selling is “I expect shares of my company to be higher a month from now”. With the volume they are selling at, they need demand, which is what this rally has provided for them to exit. The selling from ORCL has been near astounding, although there have been many many more companies on that sell-side list. The buy side-less then half a dozen each reporting period.

This is a sign that investors were not “THRILLED” with Bernake's speech, but rather luke warm to disappointed.

As you can see, the SPY has been hesitant the last several days as well, putting in bearish candles like a star and two bearish hammers. Volume during this time has gone up and the percentage net change over the last 3 sessions is slightly down. One of the notable indicators on this chart is the MACD Histogram which is now in a negative divergence with price. This shows a loss of momentum. Of the standard technical analysis indicators, MACD is one of my favorites. It's ability to show divergences that actually work, rather then stay stuck in overbought or oversold conditions is what makes it an indicator that I trust and I've based a few custom indicators on the mechanics of MACD.

Now check the Dow 30 for MACD similarities....

Again, a long wick candle (the long wick is a rejection of higher prices) followed by a Doji (loss of momentum) and a Star (loss of momentum). Note the last MACD Histogram negative divergence in August and how much more pronounced this one is. Also note the heavy volume the last 3 days with a net percentage change of -.30. While the change in price seems nearly meaningless, the lost art of volume indications shows what can be described as churning, the exchanging of shares which typically happens near the end of a rally from strong hands or smart money to weak hands or retail money.

As I've stated many times, the NASDAQ is the leader, whether it be to the upside or downside. The actual NASDAQ composite, while putting in impressive performance on a percentage change basis, did so on lighter volume with an ominous “Hanging Man” Candle

This is one of several common reversal candlestick formations and can be considered the opposite of the bullish hammer found at the bottom of a decline before an upside reversal.

For those looking for the “Holy Grail”, get back to the basics. What we are looking for in a trend is a change of character. Try out ROC (Rate of Change) on price, but instead of using it in conventional ways, use it as a divergence detector. Look at this chart of the SP-500

Note the red arrows and the white arrows are showing nearly every reversal on the chart through divergences. We're in a nasty one now.

Here's the DOW's ROC.

And the NASDAQ 100...

It's not a perfect indicator (none are), but with all the “fancy” and “hip-in fashion” indicators, the usefulness of ROC has been severely overlooked. I'm using a setting of 5 to show more detail but you can us 14 for the general trend, an investor may wish to use 20, the shorter the timeframe though, the more detail you'll see. Don't be afraid to apply it to indicators as well, you'll find a “so-so” indicator can really show you some amazing things with ROC applied to it.

One of the very frustrating things for talented technical analysts has been the flat out, complete correlation between the dollar and equities. True, there has always been a correlation, a stronger dollar typically is not good for equities, but now it's nearly a complete correlation. Around last week, 3C was showing some weakness in the Euro which means strength for the dollar vs the euro, and we did in fact get a distinct change of character and for the first time since September 10^th, we saw the 3 moving averages make a bearish cross, it looked like we'd see further weakness but the Euro recovered. Tonight as I write, we are again VERY close, as you will see to that same bearish crossover of the 3 moving averages. Tonight's is in blue and the red arrow shows just how close the crossover is.

As you can see, as of the open of FX trading we've seen quite a nasty downtrend on this hourly chart, of course this would suggest some weakness in the stock market but we still have 9 hours to go as of now.

Looking forward to next week, we have more POMO, it'll be interesting to see where the money hits, if it hits and it it has the same effect. Investors will be watching that and listening to anything coming from the Fed in an effort to try to divine QE2. I have a feeling that since we are facing a whole different set of challenges (before we were trying to get the economy back on track-now we may be facing shoe #2 of the banking crisis) we'll see money spent on different assets and clearly Janet Yellen and I believe even Bernanke made reference to cooling off or in her words, “Taking away the punch bowl” in markets they have deemed to have become too speculative.

On our proprietary 50 Equities....

Over the weekend I asked if anyone had stocks they liked that they'd like to be covered in the 50 or so equities we'll have continual coverage of representing different industry groups. One was sent in that I want to share with you tonight because it's a great looking chart. The stock's ticker is LLNW.

As you can see Limelight Network has put in an extensive base, this leads me to believe that it will see a long term term move, there will be ups and downs, but it has left stage 1 (base) and is entering stage 2 (mark-up). The volume on the breakout was excellent and the base looks great, it is what I'd call a rounding base and the volume for such a base is there just as it should be.

Look at the 3C daily accumulation into this base, it was in a leading divergence long before it even broke out.

The 10 min 3C chart

It pulled back as they usually do after a breakout like this chart below and 10 min 3C shows it looks like it's getting ready to make its next leg higher. This has an excellent chance of becoming a trending stock.

This is a screen I use to weed out false moving average breakouts by adding a custom indicator condition and a provision that RSI be over 50. As you can see, the short moving average of 10 days (yellow) crossed over the long of 22 days (blue), in the middle window is the custom indicator (yellow) which MUST be above its moving average and finally RSI 22 is above 50. After a breakout, there's a lot of momentum and the first pullback is usually to the 10-day moving average. Subsequent pullbacks will eventually come back to the 22 day moving average. So this is an ideal place to buy, the pullback that is expected has occurred, MACD is solidly rising with the trend, RSI is in good shape and its broken out of the base on good volume. I like this stock a lot RIGHT HERE. You can put a stop below the breakout level around $5.80 or below the 22 day moving average at the $5.50 area-just not AT $5.50 as it's too obvious. Or use my Trend Channel which I prefer which will move up nearly everyday locking in gains. Right now it's around $5.25 but it'll move up quickly.

The initial target here calculated from the base measuring implications, should be at least $9-$10.

I'll be adding some of your stock suggestions along with some I have picked out to the back tested system, but this is one that I wanted to bring you now as it looks ripe.

Monday we have US Industrial Production out.

Have a great week and I'll keep you updated on our select list and the back testing. If you enter the trade above let me know so I can post the current Trend Channel stop.

Have a great week.