Looming Negatives to Test Bull's Resolve

George Brooks |

Looming Negatives to Test Bull's ResolveInvestor’s first read      - Brooksie’s edge before the open

Monday, April 23, 2012        9:10 a.m. ET

DJIA: 13,029.26

S&P 500:   1,378.53

Nasdaq Comp.: 3,000.45

Russell 2000: 804.05

Two technical patterns are emerging,  both potentially harmful for the market- The “Best Six Months” for owning stocks (Nov.1 to May 1)*, and a Head & Shoulders Top.”

For years, there has been a strong tendency for stocks to put in their best performance between November and May.  A Head & Shoulders Top reflects the distribution of stocks from savvy investors to less savvy investors who are buying a market that has been rising without regard for the likelihood it has risen too far.

The breakdown from the latter could coincide with the end of the Best Six Months this time around adding credibility for the bear case.

I expect the financial press and  analysts to trumpet the dangers of both of these emerging phenomena in coming weeks, and for good reason – these patterns have a history of being right!

The current  bull market  is a bit long in the tooth, a little more than three years old. The  likelihood that  May to November will be a bummer is increased by negative political campaigning,  Europe (again), high fuel prices, and concern for our economic recovery.

BUT, no pattern  works all the time.

Zacks’ Steve Reitmeister’s Apr. 21 column argues that the “Best Six Months” pattern is not right all the time that the period between May and November has gone counter to the norm rising instead of falling.  To back his claim he cites the May/November stretch in 2003 and 2009 as examples,  pointing to the fact the market rose sharply in those years. He concluded that “Each year is different.”

He’s right, each year must be examined in its own context. However, a closer look at 2003 and 2009 reveals that the exception to the May/November poor performance  was due to the fact that an unstoppable  new bull market was underway in those years.

Indeed the market can rise between May and November, in fact, the DJIA posted gains in excess of 6% on nine occasions over the last 20 years.  It’s just that it generally posts bigger gains between November and May.

“Head & Shoulders Top”?

We already have a left shoulder and head and a right shoulder  may have started to form  April  11.  If it is a top, the initial downside risk would be between 600 and 700 Dow points from the H&S “neckline,” or DJIA 12,040 (S&P 500: 1280).

The more meaningful H&S tops form over a longer period of time. If this one plays out, it will serve more as a nasty correction rather than the beginning of a bear market.

Worth noting,  I have seen these patterns abort; instead of plunging, the market reverses and soars as it did in mid-2009 (Investor’s first read –“NOT a Head & Shoulders Top”)

CONCLUSION:

Ever see the movie “The Shining” ? Remember Jack Nicholson breaking through the door with an axe,  as he threatened his wife, screaming “Here’s Johnny!”

That scene reminds me of Europe with its series of crises. “Here’s Europe!”

This time it’s Spain on the ropes with subtle reference to Italy. Greece was double- A ball, this is the big leagues. A meltdown in either could sink the euro.

But European leaders may be prepared to head this one off just about the time most investors decide to cut and run.

TODAY: Ugly at the open, down some 110 in early trading. The two-day risk here is DJIA 12,855 (S&P 500: 1365).  It looks like volatility is picking up as the seriousness of negatives ranges between painful and tolerable.

Based on what I can see NOW, I expect the May to November period to have a slightly negative bias with a lot of volatility, best suited for nimble traders than investors with mediocre timing. As for the Head & Shoulders Top, I am suspicious of a cruel fake-out, a break down that looks like an imminent free-fall only to reverse to the upside when traders are shorting aggressively and investors selling their last shares.

ECONOMIC REPORTS

Again, the flow of economic reports will be important this week because the Street is concerned that the economy is slowing.

TUESDAY

Case Shiller Home Price Ix (9:00) – a 20-city house price index was unchanged in January following a 0.5% drop in December

New Home Sales (10 a.m.)Fell 1.6% in February to a 313,000 annual rate after increases of 5.4% in January and 4.3% in December.

Consumer Confidence (10 a.m.) - dropped to 70.2 in March from 71.6 in February.

FHFA House Price Ix (10 a.m.) – unchanged in January after a 0.1% increase in December.

WEDNESDAY

Durable Goods (8:30) - February orders rebounded 2.4% after a 3.5% decline in January and 3.3% increase in December.

FOMC Meeting Announcement (12:30) -  is expected to leave policy rates unchanged, but the Street will be focused on comments by Fed officials after the meeting for any clues about a change in policy going forward.

THURSDAY

Jobless Claims (8:30) – declined 2,000 to 386,000 in the April 14 week, after a sharp jump of 26,000 (revised up by 8,000) the prior week.  The four-week average is now 374,750.

Pending Home Sales (10 a.m.) – dropped 0.5% in February after a 2.0% rise in January.

FRIDAY

GDP (8:30) – Q4’s GDP’s last estimate was a plus 3%.  Q3 was 1.8%.

Employment Cost Ix (8:30) – a measure of the total employee compensation costs, including wages, salaries and benefits. It rose 0.4% in Q4 vs, a rise of 0.3% in Q3.

Consumer Sentiment (9:55) – The index slid to 75.7 in mid-April from 76.2 in March

George  Brooks

*Stock Trader’s Almanac.  You should not be without this statistical  gem and reservoir of investing savvy. Got my first issue in 1968 and every one since.

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The writer of  Investor’s first read, George Brooks,  is not registered as an investment advisor.  Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. Readers are expected to assume full responsibility for conducting their own research pursuant to investment decisions in keeping with their tolerance for risk.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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