The Market Rally Is Getting Tired – Here Are Some Warning Signs.

May 16, 2008
Author: Peter Stolcers, Founder of OneOption

This has been a great week for the market. It has been able to overcome the decline from last week and it has broken through minor resistance in the face of many obstacles. Early in the week, the CPI came in lower than expected. The market rallied on the news and lower oil prices helped to boost the rally. That move eventually gave back most of its gains, but the path had been cleared for a rally later in the week. Thursday, the market staged its most impressive rally and it broke through the SPY 142 level. What made this move special was that higher oil prices and weak economic data did little to dampen sprits. Industrial production decreased by .7%. That was higher than expected and it's the biggest drop in nearly 3 years. Initial jobless claims increased by 6,000 and that was in line with expectations. However, continuing claims stayed above 3 million and that means that people are staying unemployed. The Philly Fed came in at -15.6 and while it was better than expected, a number below zero still represents contraction. The Fed Chairman encouraged banks to continue raising capital during his speech. I believe that he is telling them to get their act together now because the Fed is preparing to pull back its outstretched hand. Inflation is on the rise globally and they cannot continue to keep rates at this level. The better-than-expected CPI was a joke. Gasoline prices showed a seasonally adjusted decrease of 2% when in reality prices at the pump rose 11% in April. Its frustrating to hear that inflation is in check when we all know it's not. As I mentioned earlier, the market has been able to shrug off a surge in oil prices. Many traders rationalize that as long as oil prices stay high, global expansion is robust and that will bode well for international companies. The energy sector comprises a large part of the S&P 500 and these stocks are certainly helping the rally. I have been mentioning that tech stocks have to lead this rally for a sustained move to materialize. They have done exactly that and Thursday, the QQQQ exploded to its highest level in 2008. I am still a bit skeptical of this rally. Financial stocks are not participating and retail earnings have been dismal. For instance, JC Penney reported a 5% decline in revenue and a 50% drop in net income. They also lowered guidance for the next quarter. Earlier in the week, Wal-mart hit its number, but lowered guidance. As the market reaches for SPY 145, strong headwinds will blow. That level represents a five-year up trend line that was broken in January, the 200 day moving average and a horizontal resistance level from April 2007. A move through this level will be hard fought and it will take time. As I look back over the last year, big declines that have come on relative highs have been a warning sign. I am a bit surprised that the market has been able to recover so quickly. In June and July another big round of mortgage resets will hit the market and the old adage "sell in May and go away" could prove to be prudent. This week, the market was at a one month high and that would normally induce option expiration buy programs. Once the daily momentum is established, the move continues. That was not the case Wednesday and prices reversed. After a nice grind higher all day Thursday, it looked like the same might transpire Friday. After an initial rally, the market reversed and stocks headed lower. The table was set for expiration bullishness to carry the market higher. It failed to materialize and I interpret this as a sign of weakness. Next week, the economic news front is fairly light. The LEI, PPI, FOMC minutes, initial jobless claims and existing home sales round out the releases. I expect the PPI to come in hot, but the market has been able to shoulder inflation news the last two months. The Fed has been very vocal and I'm not expecting anything new from the FOMC minutes. New home sales were surprisingly good on Friday, but I believe that is an aberration. Any improvement in existing home sales could go a long way, but I'm not expecting it. The earnings next week are largely dominated by retailers. I like shipping stocks and a number of them are also announcing next week. Here are the few symbols to watch: EXM, DRYS, AZO, HD, HPQ, BJ, CRM, BCSI, FRO, GME, PDCO, SAFM, STP, ZLC, GPS, ZUMZ. I have been searching for stocks that have hit a brick wall during this recent rally. They represent a safe trading opportunity as this market struggles to move higher. These stocks have proven that they won't move higher and that helps me trade against a market rally that is long in the tooth. If the market pulls back, these stocks will resume their long term down trends. Remember, a little more than a month ago we feared a full-blown financial crisis. There is a little too much optimism at its early stage of the recovery. Pre-holiday trading is usually quiet and it has a bullish bias. I plan to keep my positions small and I will start to build bearish positions in a few key sectors. image

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