Technicals suggest stocks could break down

The equity markets are in trouble. They are in trouble of breaking down for the first time since the April peak of a 2010. Last week we alerted you to the shift in psychology on the other side of the world. As you know by now there is a feeling that China won’t have a hard landing. Compare and contrast that to the rhetoric you heard first after the top in 2007 and bottom in 2009. We have nothing against reaching highs in the market. As a matter of fact, we don’t believe the market has to top out simply because it reached old resistance levels. Certainly, there will be a certain amount of institutional profit taking at those levels. That is to be expected. However, nothing stops these same individuals from getting back in at a certain point, does it?

So here’s the concern. The psychology of the market is shifting. Let’s take the past week for example. I’ve been looking for signs of happiness or euphoria and haven’t found it in this market, until the other day. With the LinkedIn IPO the media announced they were going to ‘party like its 1999.’ Folks, that kind of talk makes me very nervous. They spent the rest of the day asking guests if they thought we were in some kind of IPO bubble. If they have to ask, it’s not a bubble. How could we be in a bubble mere weeks after the nuclear meltdown? That’s not reality. What is reality is that for the first time, we are seeing some real excitement in this market. With apologies to McDonalds, the public isn’t really involved so we don’t see the end of the long bull market, but we do see an intermediate term market in trouble.

Why does it always have to be black or white with some people? If it isn’t a bubble the market is going to crash and it’s the end of the world. Guess what, I’m writing this on Sunday morning and you are reading this on Monday morning. The world is still here. I suspect it will still be here in January 2013 as well. But the NDX is now testing an uptrend line from the July/August lows of last year. This is the 3rd test since March and right now it’s as close to breaking down as it can without actually breaking down. The fat lady is in sight; all she has to do is start singing.

On Monday, the BKX staged a comeback and put in a low right on the mid line. It was 90 calendar days off the top back in February along with a good Gann square of 9 reading. But thus far all it has been able to muster is a move up to first resistance. Friday was a bad day for banks and we can ill afford to see banks start leading to the downside. But as you can see from the chart, even if they do flop out here, they are in the upper portion of a downward sloping median channel. As long as they never drop into the lower portion which is the real path of least resistance down they will eventually set up for a rally. The significance to any banking selloff from this point forward is to what degree they get hit. If they stay out of the serious path of least resistance down, chances are whatever is coming down the pike is not long term bear in nature.

So why is it that markets are shifting? The first problem is psychology is getting overheated. The next problem is the fact we hear a lot of talk about a ‘soft patch’ in the economy. Excuse me, but I’m not certain what a soft patch is. It’s that classic sentiment that comes after a really good run in the stock market. See, first they are telling us it’s a weak recovery. By virtue of the fact so many non-teenagers have been chasing burger flipping jobs you can believe it. But a soft patch in a weak recovery? Pardon me for complaining, but I never heard of such a thing. But that’s not the point. The point is psychology is really tricky. After the 2007 top, there was no doubt business had slowed down. It appears business is slowing down again. But in 2007 we were told the economy was coming in for a ‘soft landing.’ Now we don’t have soft landings, we have soft patches. It means the same thing. The bottom line is we’ve transitioned from worriment of a double dip recession which was the wall of worry that allowed the markets to climb to a slope of hope where we hope it’s a soft patch. See the difference? There’s been a shift and it could be we are in the early stages of a new pattern in the stock market.

It was a neutral week for China which attempted to bottom out, did but couldn’t get any lift. That affects everything in commodity land. All of which brings us to the oil market. There are 2 key events materializing in oil that is very instructive for gauging the mood of the crowd. First of all, remember back in 2005 during the Katrina sequence where the market was driven by fear that one day of production or even a single rig is lost. Just the thought of a hurricane was enough to send prices through the roof. Now the threat of flooding in Louisiana and the potential of opening up the spillway did nothing to spike the price of oil. Then they actually opened the spillway and that did little to change anything. Then a lesser publicized event up in Canada, near Calgary actually shut down some production (forest fires) and it did nothing to change the price of oil. Oil is driven by 2 fears; there will either be too much oil or not enough oil. Right now, traders believe in the soft patch theory and all of the demand destruction it will cause. Right now, fires and floods mean nothing. For goodness sakes, did you see where the President threatened sanctions against Syria, of all nations? How much did that move the needle?

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