Oct. 30, 2006 - Just like the Liberty Bell, The Philadelphia Semiconductor Index (SOX) finally cracked. We have discussed the lingering weakness in the SOX for the past month but it was likely a lone voice in the dark when other indices are setting all time highs. The simple truth is not only did the SOX not confirm 2006 highs in the Dow/S&P500/Nasdaq, it couldn't even make it to the 61% retracement of its own high. Friday's break sets up another interesting intermarket bearish divergence. The Nasdaq finally broke through its 2375 spring high as we told you it would last week. We also expected the divergence it created when the NDX did not take out it's own January 2006 high at 1761.
It seems that sellers only feel comfortable when these divergences do appear. Friday was the first real sign since early September that bears could be developing their growl again. The week ended with all of the major indices putting in a textbook bearish engulfing candlestick reversal pattern. In all cases except the SOX, buyers took prices to new highs for this cycle. By Friday afternoon, prices closed lower than Thursday's opening tick. The SOX put in a secondary pivot 8 days removed from it's cycle high on Oct. 16 which was exactly on the 60-62 day window off it's summer low.
Turning to the Dow, it has been battling Fibonacci resistance at the 12160 level all week. From last Tuesday morning until Thursday's close, the Dow stayed in a tight range from 12079-12166. This is a smaller degree internal resistance point with the larger one being at 12360. For weeks I have been suggesting I could not see the Dow getting that high without some form of correction. In the S&P500, I was watching impatiently for it to tag a resistance target zone of 1372-1384. It finally hit 1389 before succumbing to it's own bearish engulfing bar.
Frankly, I was looking for the kind of day we had Friday upon completion of the Fed's interest rate announcement for Thursday. I was a day early. Now that the candles have spoken, what does this really mean?
Bearish engulfing bars are high probability reversal points. We must analyze them in the context of the two bars. They are made up of a white candle where buyers take prices to a new extreme for the cycle and completely cover that territory going the other way the next day. What is the second or reversing candle's relationship to the first? In the case of the S&P500, NDX, SOX and Dow Friday's close was lower than Thursday's low. We were lower and in most cases closed near the lows for the day. Bottom fishers came in late in the day to create a bounce attempt but the best they could do was take the charts sideways. It is now questionable how much conviction buyers can bring to the party here in light of this bearish looking formation.
The only real factor sitting in the bulls favor is the put/call ratio, which elevated .27 to close at 1.03. While the p/c is a secondary indicator, it is excellent for interpreting intraday market behavior. What Friday's score implies is that a certain degree of fear is coming into the market and options bulls are not attempting to buy the dip. When options buyers attempt to buy the dip it almost guarantees lower prices.
Right now, I am looking for a follow through day, which is the higher probability outcome at this time. Watch Monday's candle. If we get another bearish candle to match Friday, we could have a larger selling event. I am looking for a smaller follow through event. Putting all of the pieces together, we still have higher price targets that have not been achieved. This usually leads to a choppy corrective environment as opposed to a pure selling event. If options bulls attempt to buy dips that could change.
