The following article was extracted from the June 7th
2011 Market update
Long term break down
Money continues to move into defensive stocks and this
usually takes place when the market is plagued with
uncertainty. In addition it is the energy sector that
carries the market up during its last leg and thatís exactly
what took place; the energy sector was the driving force
behind the highs the Dow set this year and it is what could
potentially push the Dow to test its highs one more time.
A healthy financial sector is one of the necessary
ingredients for a bull market. In 2009 shortly after our
smart money indicator generated a buy financials exploded
upwards. In 2010 their rate of ascension was mediocre to non
existent in comparison to 2009; coincidently this was around
the same time we turned neutral on the market. At present
this sector is underperforming. This underperformance can
clearly be seen in the 1 and 3 year charts of XLF (the
In the 1 year chart of XLF, the up trend has been violated
and it is now testing important short term support at 14.75.
XLF topped out in Feb, while the Dow rallied until May
before putting in a top. If the financial sector was
healthy then it should have rallied in Unison with the Dow.
Historically for a market to move higher the financial
sector or the housing sector has to be in good shape. The
housing sector is in the doldrums and the financial sector
is far from healthy.
The 3 year chart clearly reveals how bad things really are.
XLF topped about roughly the same time the buy signal issued
from our smart money indicator turned neutral. As of April
2010 XLF has done nothing but trend sideways. A weekly break
below 13 will be a very strong warning signal that the
market is close to breaking down.
If you look at the chart of JPM the pattern is actually
worse. It topped out towards the end of 2009 and since then
it has been trading in a very tight range. This is telling
because JPM is the nationís second largest bank and this
chart clearly illustrates that the market does not think JPM
is out of the woods yet. The chart of Bank of America the
largest bank in the nation looks even worse.
Last week we had a 9-1 down volume day; the down volume was
9 times that of the up volume. If the market has
experienced a strong correction this is a bullish
development as it is a sign that the last players are
panicking. As the market is far from oversold and trading
relatively close to 2 year highs this has to be viewed as a
bearish development. The only way it can be neutralized is
if we have a 9-1 up volume day; here the up volume leads the
down volume by a factor of 9.
Finally for the first time in many, many months, our V Index
has experienced a small drop; V readings dropped from 2140
to 2135. It is too early to tell if this is a trend change
but until they drop to or below 2000 the markets are going
to remain very volatile.
The Dow is at a precarious point; it needs to turn around
shortly or risk breaking down. There are a few factors that
indicate the Dow is getting ready to mount a rally from
these levels. If the SP 500 and the Dow are unable to
stabilise at current levels, then they could test their
march lows, 1250 and 11500. If this takes place it will
confirm that the market has already topped and that any
rally from these levels is going to lead to a lower high.
Dumb money has started to become increasingly negative, the
premiums of puts are rising, and the market has still not
closed down on a very high volume day. For example the
market closed in the red on volume of only 4.02 billion
shares. Volume continues to rise slowly on down days but
there has been no spectacular surge in volume yet.
Finally, the dollar could potentially test its lows, and if
this takes place it would provide the fuel the Dow needs to
Traders who opened up long positions and are getting nervous
can close all the positions that are showing a profit. We
would like to stress that we have not changed our long term
views on the markets; we are still bearish. We are only
somewhat bullish on the intermediate time frames because
price action suggests that the market could surge higher. A
full confirmation comes only when both price action and
volume confirm, but this has not been the case.
From a long term perspective, the Dow has hit all its
targets and long term traders should be out of the markets;
they should be only getting into Strangle plays, short
positions and maybe selling put options.
If the economy is on the mend the news that is pouring out
certainly does not indicate this. This so called economic
recovery has been completely illusory in nature; QE 1 and QE
2 provided the illusion that everything was getting better.
Unemployment remains at very lofty levels and only looks
like it is falling because they do not count individuals
that have simply given up looking for a job. The housing
market is still in a free fall and will remain unattractive
as long as jobs remain illusive. Government at the state
and federal levels are aggressively cutting back services;
all this does not take place if the economic outlook is
Getting a government Job was considered one of the safest
bets before but roughly 20,000-30,000 government jobs will
continue to be slashed until 2012. If revenues drop, more
cuts will be made. There are already talking about cutting
the Federal work force significantly; some are proposing a
10% cut. All this does not occur when an economy is
performing well. The US has been repeatedly threatened with
a debt downgrade if things are not put in order soon.
Sooner or later even harsher austerity measures will need to
be implemented. We cannot go on printing money forever and
living beyond our means; Greece is a perfect example of what
happens when you live on a hope and a prayer.
The financial sector is one of the main drivers of the
market and economy looks far from healthy; the financial
sector is indicating/ suggesting that it is just a matter of
time before it experiences a complete breakdown.
Until a full sell signal is generated, we believe the best
strategy is to open up strangle positions. When a sell is
generated, we can start to scale into put options only. So
far, we have 5 strangle positions and are actively scouring
the markets for more plays. Remember that these plays will
start to bear fruit after the market experiences a huge
move; the direction is not important. As we have over 1
year of time on these options it seems highly unlikely that
the market is going to trend sideways for over 12 months.
With such high V readings, a strong move is bound to occur
sooner or later.
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