Disappointing data continue to weigh on market

Good day! For the second week in a row the market logged strong losses. The indices broke lower on Tuesday after a two-day congestion and despite hitting support on Thursday, the momentum remained bearish into the last trading day of the week. A slower uptrend move off Thursday's lows continued into early Friday morning. The 8:30 a.m. ET jobs data was disappointing, but the initial reaction was mixed. The index futures popped, dropped, recovered into the open, and then turned lower once again at 9:36 a.m. ET. The recovery into that level was slower than the drop, shifting the pace within the reaction to the news to show continued favor for the bears. The remainder of the morning and the first part of the afternoon were spent giving into this bias.

Dow Jones Industrial Average

The morning's employment report on Friday followed a bevy of bad data for the week, indicating that nonfarm payrolls for June fell by 125,000, which was higher than the 100,000 decline that had been anticipated. Private payrolls, however, were up by 83,000, although last month's private payrolls were revised downwardly to show an increase of 33,000. A large portion of the losses came from the drop of employees hired for the 2010 census. The official unemployment rate now stands at 9.5%. 9.8% had been anticipated. The previous reading was 9.7%. Average weekly hours worked, however, slipped from 34.2 to 34.1, while average hourly earnings were down 0.1% month-over-month. An increase of 0.1% had been expected.

The disappointing data continued at 10:00 a.m. ET when the Commerce Department reported a 1.4% drop in factory orders in May after eight straight monthly increases. A drop of 0.8% was anticipated. The largest decline was felt in transportation equipment orders.

Friday's data followed a string of disappointing reports that began on Tuesday morning. The Conference Board kicked it off by offering up a downwardly revised index of leading economic indicators for China, following up in the U.S. with its consumer confidence index. It was lower by nearly 10 points from 62.7 in May to 52.9 in June. Three days of depressing jobs data followed, along with a huge drop in pending home sales and manufacturing. All-in-all, there was little cause to cheer in regard to the state of the overall economy.

S&P 500

Friday was a decent trading day though. Price action was smooth, with a number clear-cut technical setups on the 5 minute time frame in the overall market. As expected, volume dropped off following morning trade as market participation dried up into the three-day holiday weekend, but this can actually be helpful on follow through, since it can amplify price moves intraday.

The downside in the markets continued into the 13:00 ET correction period, but the final descent on the 5 minute time frame slid down the 5 minute 20 period simple moving average. This created the start of a reversal pattern that coincided with the 13:00 ET correction period. The indices rallied back to the zone of the previous 5 minute highs, breaking the 5 minute 20 sma, and then fell into a trading range along the moving average. Volume dropped off even further and the indices created a nearly textbook Phoenix(TM) buy setup that triggered at 14:54 ET. This setup was also part of a reverse Head and Shoulders pattern on the 5 minute time frame and helped the indices trim their losses going into the final hour of trade. They weren't able to hold onto those gains, however. Profit-taking hit in the final 15 minutes of trade.

Nasdaq Composite

The Dow Jones Industrial Average ($DJI) ended the session on Friday at 9,686.48 with a loss of 46.05 points, or 0.47%. Only Microsoft (MSFT) (+-.47%), Coca-Cola (KO) (+0.04%), and Johnson & Johnson (JNJ) (+0.02%) ended with gains... albeit barely. The biggest loser was Verizon (VZ), down 4.69%. General Electric (GE) followed with a loss of 1.70%, while Caterpillar (CAT) fell 1.32%, and Bank of America (BAC) dropped 1.28%. The Dow ended the week lower by 4.51%.

The S&P 500 ($SPX) fell 4.79 points, or 0.47%, and closed at 1,022.58. Allergan Inc. (AGN) was the biggest gainer in the S&P 500, up 7.21% on take-over speculation. Genzyme Corp. (GENZ) rose 5.90%, while Biogen (BIIB) rose 5.76% on the same speculation following a report by Bloomberg. The report suggested that French drug maker Sanofi-Aventis was preparing for a U.S. acquisition worth $20 billion or more. At the opposite end of the S&P spectrum were Intercontinental Exchange (ICE) (-5.68%), Prologis (PLD) (-5.20%), Verizon (VZ) (-4.69%), and Zion Bancorporation (ZION) (-4.51%). The S&P 500 ended the week lower by 5.03%.

The Nasdaq Composite ($COMPX) ended the session lower by 9.57 points, or 0.46%, and it closed at 2,091.79 on Friday. Logitech Int. (LOGI) followed GENZ and BIIB on the gainer's list for the Nasdaq-100 with a gain of 4.12%. Expedia (EXPD) (-3.42%) was the biggest loser, followed by Apollo (APOL) (-3.41%), Sears Holdings (SHLD) (-3.26%), and Priceline (PCLN) (-3.09%). The Nasdaq Composite ended the week lower by 5.92%.

A name on many lips this past week has been that of of the highly publicized "Death Cross", which is about to take place in the S&P 500. The Death Cross occurs when a short-term moving average breaks below a long-term one. The crossover most commonly given this moniker is the 50-day moving average crossing below the 200-day moving average. It is hailed as a decidedly bearish signal for the market and it's one that has been making headlines time and time again over this past week.

This rare 50-200 Death Cross phenomenon has occurred 6 times in the past 12 years. Interestingly, it only marked the beginning of a new downtrend in two of these six cases. The first took place coming out of the uptrend into 2000. The second one followed coming off the highs of 2007. It is true that each of these was followed by extreme moves moves lower, however, they also followed multi-year uptrends. When the Death Cross followed only a year or two of upside, such as the four that failed to lead to a reversal, the outcome was the start of another swing to the upside within the larger uptrends. This was the case in 1998, 1999, 2004 and 2006. I have shown where each of these took place in blue in Figure 1 on a monthly chart.

Figure 1 - Monthly SPY

Why might the Death Cross currently under development be different this time around and be followed by a larger trend reversal? Well, I am not yet entirely convinced that it will be, but there are a few things to be aware of. The first is the pace of the selloff going into this impending crossover. It was substantially stronger than what you will typically see on a shorter-term correction in the market. The second thing to focus on is that the uptrend was clearly extended heading into April's highs. The S&P 500 had established three waves of upside since holding support in March 2009. This is shown in Figure 2. It is typical for a larger correction to follow that breaks the uptrend channel. Each of those three waves of upside also kicked off with diminishing pace or momentum compared to the prior one, further supporting the position of the bears.

Figure 2 - Daily SPY

These factors alone, however, are not necessarily enough to trigger a strong downtrend. In fact, there are a few cons for this reversal scenario as well, whereby the current action could merely be a portion of a longer corrective phase in a larger uptrend in the market compared to previous corrections. First, a sharp decline can still be followed by a continuation on the upside. We saw this occur in January. When this happens, it is usually the beginning of the corrective move that has the strongest selling. This is followed by new lows, but with less volume and momentum. This is actually how the weekly chart of the S&P looks.

Even if the market shapes up in favor of further downside, I am also not convinced that the market has had enough time to recover from the selloff in May to allow it to offer up another strong move lower just yet. Ideally, the trading range would have held for another month. This means that in order for the market to continue strongly to the downside, we may easily see a bounce back into the middle of the range from the past two months (and even into that 50 day sma) before the selling resumes. A more gradual correction compared to the descent of the past two weeks would be preferred for this scenario.

Crossovers themselves are also a bit suspect. In my experience, it is the convergence of two moving averages that is the most useful for helping to confirm a larger trend reversal bias, and the crossover itself is a lagging indicator. We can see this in Figure 3 in May when the 20 day moving average crossed under the 100 day moving averages several days after the May 13th high (A). Even the crossover of the 50 day under the 100 day lagged the reversal off highs on the 21st by three days (B).

Figure 3 - Daily SPY

My bias for the market in coming months actually falls in between the bulls and the bears and is tied more closely to my concern that the market has not rested enough compared to the drop in May to sustain another strong selloff quite yet. Although a correction in the market in the form of a trading range is evident on a daily time frame since May, the monthly charts still look like a major drop with very little corrective activity off support when this move is compared to previous drops of similar magnitude. I think that the result will be more back and forth action within the congestion itself as the summer continues.

Assuming this ends up being the case and the market does hold this larger trading range, then it is the price action of the smaller trends within that congestion that will increase my bias one way or other in favor of either a bullish or bearish move. For example, another pull higher into the range of the 50 day sma with slower momentum would help favor the bears. Whereas a more rapid rally, followed by congestion along the 50 day sma, would offer a bullish setup. This initial bullish setup, however, could merely be enough to pull the indices back into the upper half of the move since April's highs, and be followed by shifting momentum again within a larger weekly to monthly trading range. It is simply too early to tell just how deadly the longer-term aftermath of the current Death Cross will be. One thing I am certain of, however, is that it won't be the crossover itself that dictates the upcoming trend development.

Note: Unless otherwise stated, the index action described in this article relates to the E-mini futures contracts for the respective indices. Actual index action may differ slightly in terms of pattern formation, although the market bias will remain the same.

Toni Hansen is president and co-founder of the Bastiat Group, Inc., DBA Trading From Main Street. Toni is one of the most respected technical analysts and traders in the industry. She has been trading and educating new traders, money managers, professional market analysts and traders throughout the boom and bust of the last decade. She has worked in conjunction with some of the world's top financial exchanges. Learn more about Toni Hansen and the educational services she provides through her website at http://www.tonihansen.com.

About the Author
Toni Hansen

Toni Hansen is president and co-founder of the Bastiat Group, Inc., DBA Trading From Main Street. Toni is one of the most respected technical analysts and traders in the industry. She has been trading and educating new traders, money managers, professional market analysts and traders throughout the boom and bust of the last decade. She has worked in conjunction with some of the world's top financial exchanges. Learn more about Toni Hansen and the educational services she provides through her website at http://www.tonihansen.com.

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