Until yesterday, stocks (NYSEArca: VTI) were moving higher amidst a flurry of bad news. It has finally sunk in that Europe is a bigger sinkhole than expected. It's ironic that it took an avalanche of bad news for stocks to spring higher.
The question is whether this recent spike (before today's decline) is a bullish "wall of worry climb" or one of those hopeful and short-lived gasps higher, before the wheels come off? As you will see in a moment, the market seems to be at a crucial fork in the road.
Technicals confirm this assessment. Yesterday the S&P was able to close above the 200-day moving average but failed to move above important Fibonacci resistance. Yesterday's ETF Profit Strategy update warned of complacency and pointed out that the market has arrived at a short-term "make it or break it point" (see below for more details).
In other words, it’s crunch time and simply coasting on autopilot could result in missed opportunities or larger than desired losses. Periods like this require a focus on the only data that really counts.
Europe in a (Sinking) Nutshell
For over two years, Europe (and Greece) has doubled as a scapegoat for falling prices and catalyst for higher prices. It’s time to abandon the media’s short-term yo-yo approach to investing dictated by Europe and take a look at the long-term inevitabilities.
Greece is toast even though no one wanted to admit it a year or even a month ago. Next in line is Italy, even though no one wanted to admit it a year ago.
The yield of 10-year Italian bonds is above 7%. Psychologically 7% has become a beacon due to the fact that Greece, Portugal, and Ireland each sought bailouts soon after their debt reached these levels.
Faith in the euro-zone, in the European Financial Stability Facility (EFSF) is dwindling. The EFSF had to offer investors premium interest rates (1% above its benchmark compared to 0.06% in January) for a $4.5 billion bond offering on Monday.
Sovereign debt is not the only problem in Europe. The Wall Street Journal reports that: “European banks are sitting on heaps of exotic mortgage products and other risky assets that predate the financial crisis. Sixteen top European banks are holding a total of about $532 billion of potentially suspect credit-market and real-estate assets, according to a recent report by Credit Suisse analysts. That’s more than the $467 billion of Greek, Irish, Italian, Portuguese and Spanish government debt that those same banks were holding at the end of last year, according to European stress test data.”
Europe can’t admit its problems, so the only thing it can do is extend and pretend. If you hear good news out of Europe (such as the ‘comprehensive’ fix announced two weeks ago), keep in mind that it’s economic winter in Europe and one day of sun doesn’t make it summer.
Time to Turn Off Autopilot
The chart below shows a whole set of parallels between the 2007/08 topping process and today. Most important for right now is the re-test of the red trend line (dashed red circle on the very right).
When the S&P tested the trend line in 2008, it coincided with the 200-day moving average. Today too, it coincides with the 200-day moving average (currently at 1,273).
Previously, the parallels (I call it “the script”) suggested new lows in October followed by a powerful rally. Based on the script, confirmed by various other research, the ETF Profit Strategy Newsletter outlined the bottom as follows in the October 2 update:
“The ideal market bottom would see the S&P dip below 1,088 intraday followed by a strong recovery and a close above 1,088.” The price target of this rally, also based on the script, was around S&P 1,275.
Yesterday’s ETF Profit Strategy update stated that: “For the short-term we are at a make it or break it point. The S&P pushed up to the 78.6% Fibonacci retracement level at 1,276 (measured from the Oct. 27 high). This is pretty much the maximum retracement we allowed.”
There’s never been a currency crisis the size of Europe. This crisis could overshadow any bullish biases, like seasonality, and send stocks spiraling.
Considering all, U.S. stocks have held up very well. Despite the scope of the problems we’re dealing with, the S&P (SNP: ^GSPC) is down only 7% from its May high, the Nasdaq (Nasdaq: ^IXIC) 5.5% and the Dow (DJI: ^DJI) only 4.8% (as of yesterday’s close).
The Dow, S&P and Nasdaq are all up for the year, which is quite amazing considering all. However, the more economically sensitive Russell 2000 (Chicago Options: ^RUT) is down, as are financials (NYSEArca: XLF) and banks (NYSEArca: KBE).
Looking at the script and the lofty levels of the major U.S. indexes, the risk to the down side is huge, especially once the bullish seasonality goes into hibernation. The higher stocks trade, the further they can fall.
The Only Thing that Matters
The market doesn’t care what I or anyone else says. The market is the final authority of profits or losses. That’s why it’s smart to listen closely to what the market has to say.
Things like low-volume rallies, weakness around resistance levels or, most importantly, failure to remain above support, are strong indications that various domestic and international problems are about to send prices lower.
To illustrate the validity of support/resistance levels, picture the following illustration: A car is driving on a long road with a few traffic lights. If the car is going to stop, accelerate, or make a U-turn anywhere on the road, it will most likely be at a traffic light. If the S&P is going to reverse, it will likely be at support/resistance.
One of those important resistance levels was 1,369. Way before Wall Street became aware of the huge down side potential, the April 3 ETF Profit Strategy update warned that: “There is strong Fibonacci projection resistance at 1,369. In terms of resistance levels, the 1,369 – 1,382 range is a strong candidate for a reversal of potentially historic proportions.”
Following a brief squirt to 1,371 on May 2, the S&P tumbled nearly 300 points or 21%.
An example for a crucial support level was 1,088. The October 2 ETF Profit Strategy update pointed out that: “The ideal target range for a bottom is around S&P 1,088 – 1,040. However, since 1,088 is strong support, I’d prefer not to see a close below 1,088 (intraday move below 1,088 followed by a close above would be OK).”
From its October 4 intraday low at 1,075 (the S&P never closed below 1,088), the S&P soared over 200 points in less than a month.
Are support/resistance levels important?
The ETF Profit Strategy Newsletter follows various indicators to provide a well-rounded short, mid and long-term forecast and identify support/resistance levels that act like “traffic lights for stocks.” Updates with actionable trading strategies are provided at least twice a week.