Relief Bounce Starts But it is Less Than Convincing

SUMMARY:

- Market makes the expected bounce but it looks to be simply going through the motions
- Jobless claims continue to hold in above 400K.
- Trade Deficit shrinks unexpectedly as exports hit a record and imports shrink. That will raise GDP but again, that is illusory.
- Corn inventories revised sharply lower as a shortage looms.
- If the bounce does not show more spunk, be ready to exit upside positions and put some more downside positions to work.

MARKET SUMMARY

Relief bounce starts but it is less than convincing.

We anticipated a relief bounce in the market. Thursday the market did give a long-awaited bounce. It was six days in the making, but it did nothing to prove it was anything but a relief bounce. Indeed, the action was rather disappointing. The market seemed to be going through the motions of bouncing. There was not the flushout selling that I was hoping would start the day. TXN disappointed with its mid-quarter guidance. It was down, but then it said that just one supplier (NOK) was the problem and it recovered. As it recovered, the market got an early move on the relief bounce.

Futures were up premarket, and they held up all morning despite some equivocal economic data. We did not get the jump to the downside that would have acted as a good flushout. Instead the market gapped to the upside. It managed to hold the gains on the day. I cannot complain about the fact that it did not hang onto the move, but it let the move go in a key respect. That is, the SP500 moved up to the bottom of its trading range at 1294, and it faded back from that level. It was unable to make the move through. Moreover, volume was very weak and breadth was pathetic. Not like the big downside breadth we have seen of late when the market sold off with this big turnover. Both of these are indicia of a relief bounce and nothing more.

Industrials, materials, and commodities all rallied on the export data. Those stocks performed while the growth areas NASDAQ, small caps, semiconductors lagged. Again, that is not the indicia of a strong rally that is founded in good economic growth that would lead to a sustained move. Stocks such as CAT and DE moved higher, and made impressive gains. They were all the talk of the financial stations, but their patterns are terrible. They are not ready to lead the market higher. Indeed, DE looks ready to turn back over after this bounce and would be a short candidate. There were some good, solid stocks that moved higher, and they were from a variety of sectors across the market. HLF in drugs posted a nice gain. In retail, FOSL moved up over 3%. EXAS posted a 3% move. It is in biotechnology. HUM posted a 3% move. LAVA, in business software, jumped up 7.5%. MON is in the agriculture business, and it was doing quite well off the food shortage. It was up 3%. POT was up 4% with a solid bounce in volume as well.

Many good, strong stocks moved up well, but a lot of the move was in the industrials and metals that have been hammered (no pun intended). The patterns are ugly, and they do not look ready to lead the market higher. The leaders that I just cited could lead the market higher, but as you have noticed over the last few weeks, the list of leaders has grown thinner. They are just not that many leaders out there in good patterns and moving higher. There are still some great stocks in good position to move higher. The market has not totally collapsed, of course, and you will have some very good stocks that can lead the market higher. The question is whether they will do it.

Again, the move on Thursday did nothing to suggest to me that this was anything more than a relief bounce. My initial premise is still in place: This bounce is to be treated as a relief bounce. It can be used to make some quick-hitting upside plays and let current upside positions rally. If they are struggling and the rally starts to falter, sell them and then use the bounce after it peters out to take some downside positions for another move lower. All of this can change if it improves in strength and leadership, but it will have to prove it. We are in a “show me” kind of market. It has to show that it will be strong enough to warrant us putting a lot of our money to the upside.

FRIDAY

May export and import prices will be out on Friday. Import prices may be lower because the oil prices are down somewhat or at least they were a bit lower. They are bouncing back up, but that is June data and not May. The market itself is very technically driven. Obviously everyone is looking at technical positions now. They are looking at how the SP500 tapped the bottom of that range on the Thursday high and faded back from it. As noted earlier, it does not mean the rally is dead. That is the first day, and it did not get the best start. We wanted it to sell off, and then it would have reversed and had a much better running jump at the reversal and been much stronger. As it was, it had to gap higher and try to hold it. It was a tough assignment in this kind of market, but it did hold that 0.75% gain. It did not totally choke up and die. That means we will continue to see if it can make the break.

Everyone will be focused on that 1294-1295 level. Frankly, it could break that level, but if the rally does not show much more spunk, then we know it will be a relief bounce. In other words, it has to show more volume, better breadth, and maybe a smidge of leadership outside of the exporters. Maybe it can move more into the growth areas that really mean something for our economy. We know it may move up to a resistance level near 1317 or so and then roll down. It may not make it back to the top of the range. I am not anticipating the DIA we are playing to go to the top of the range; I am anticipating it to move back to that early-April peak. That is what we could look at for SP500 as well bouncing up to that early-April peak or some of these lows. This is just a range in the upper part of its trading range, and it could slow it down if it does not get more internal strength.

If it continues to bounce, that is great. We will let it happen and use it. We will let our upside plays run. We have some SSO, some DIA, some QLD and others that we picked up. We can then let our current upside positions rally back up. If they do not rally, that is a problem; as long as they are holding up it is great. If they are still struggling after they bounced to the upside and do not look strong, use the rally to close them out. Then when the thing does fizzle out (which I think it would if it does not improve its internals), then we exit more upside positions and flip it to the downside. We will put some more downside positions to work. Nothing wrong with playing the range or playing the inability to make it back up to the top of the range. It would be beautiful if it would just go like clockwork, bouncing up and down between these two white lines. Of course the market never works that way. You just have to watch how it reacts.

Again, the key is how it reacts to this line, not whether it finishes above it on any one particular day. It came through, it tried it once, failed immediately, and came down a bit further. It has tried it twice and it backed off. It has not failed yet; it has just backed off from making that move. Will it hit it and roll over? Or will it hit it and bounce up in this level, making a decent showing of the bounce before it rolls over maybe up to the 20 day EMA and then flipping? Or it could be to the 50 day EMA and then flipping. Or maybe it will continue up and find new strength. The soft patch could turn out to be just that, and all of a sudden there could be strength anew in the economy in the market.

If that is the case, it will go higher. But I will give you another hint about what could cause this to move higher. Look back to August 2010. The market had rallied through April of 2010, and then it fell off into this base. Late August 2010 is when the economy was slowing down again, but the Fed stepped in and injected QE II, another massive liquidity run. Look what it did to the market: two big runs, and now there is a question as to whether QE II will be extended. They say it will not, so the market is having a problem. There is worry that the economy has slowed since the start of the year, and it took until August before the Fed said it had to do something.

It could be doing the same thing here. The Fed does not want to do anything else. It could be forced to do something else if the market continues to falter and the economic data continues to soften as it has. That would be the next game changer. Then we would start seeing runs such as this again. What has this entire move been? The economy has not been great. It has not ripped off of great economic data, GDP or otherwise. It stinks. Everything off of the March low of 2009 has been based upon liquidity flooding the market. They are threatening to withdraw the liquidity, and the market is stumbling.

The economy is fading at a most inopportune time for the Fed. The last thing it needs is for the economic numbers to start fading as they have over the past six months, just when it wants to start withdrawing its stimulus. It may be forced to go to another Quantitative Easing route whether it wants to or not. That would help the market. If it does not come, I think this bounce ultimately will run out of gas, it will turn over, and we will get some more serious selling. Thus we will stick to the game plan. When we see our opportunity to move back in downside, we will do that.

Jon Johnson

Stock Splits & IH Alerts, Editor

InvestmentHouse.com