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Uncertainty Still Abounds

(September 6, 2007)

Dear Subscribers and Readers,

What a difference a day makes.  While the disagreements between the bulls and bears were still many going into yesterday morning, there was at least thing which they could agree on – that yesterday was a crucial trading day – as 1) the S&P 500 was bumping against its simple 50-day moving average, and 2) heading into yesterday morning, the market was substantially overbought in the very short-run.

The significance of 1) was obvious – as a close by the S&P 500 above its 50-day moving average would have substantially improved its attractiveness to both technical traders and trend followers alike.  While this would not have been very significant 20 years ago (portfolio insurance aside, trading in the S&P 500 futures was not as market-moving as it is today) – today, it is definitely important.

The S&P 500 got rejected at the S&P 500 – my guess is that it will continue to vacillate between its 50 and 200 DMA for the rest of this week before breaking out either on the downside or the upside sometime next week...

As for 2), the fact that the market was immensely overbought in the short-run suggested that a correction was coming.  In a strong or a bull market, the stock market typically just “work off” its overbought condition by trading in a narrow range for a sustained period of time, before embarking to new all-time highs.  At the very least, any consequent/subsequent decline from an overbought condition is typically only narrow in nature – and also typically accompanied by relatively low volume.

While volume was a little on the low side during the decline yesterday, it should not be taken lightly, as the percentage of declining issues reached 70%, while downside volume was 81% of total volume on the NYSE.  In addition, all ten sectors of the S&P 500 ended in negative territory, including the energy sector, even as crude oil prices continued its ascent to near all-time highs.  The decline was also evident across the entire market cap spectrum was well, as the S&P 400 Mid Cap and the Russell 2000 Small Cap Indices declined 0.9% and 1.3%, respectively, for the day.

In other words, the substantial decline in the stock market yesterday was discouraging for the bulls, and as such, this author would continue to hold off in going long – and will most probably continue to do so until we get more signs of capitulation.

Interestingly, a similar situation is unfolding in the UK stock market – with the FTSE 100 also meeting heavy resistance at its 50-day moving average.  More ominously, yesterday's decline in the FTSE 100 completely retraced its rise on both Monday and Tuesday – and in addition, the 50-day moving average is now about to cross below its 200-day moving average – something that hasn't occurred since late July/early August of 2004:

The FTSE 100 is now meeting heavy resistance at its 50 DMA.  More ominously: 1) the FTSE 100 retraced all of its gains on Monday and Tuesday, and 2) the 50 DMA is about to cross below its 200 DMA, something which has not occurred since over three years ago.

While a crossing of the 50 DMA below its 200 DMA is not without precedent (it did so briefly in from late July and throughout August 2004), the fact that it is now occurring in a mature stage of the current bull market suggests a more serious breakdown than most folks have been expecting – and is probably something that should not be shrugged off.

As for Japan, the Nikkei has been trading below both its 50-day and 200-day moving averages since the last two trading days in July, and has continued to remain weak since that time.  Moreover, its 50-day moving average has already broken below its 200 DMA – for the second time in as many years:

NIKK (Tokyo Nikkei Average) INDX

As for the German stock market – just like the U.S. stock market – is more or less indecisive, as it also just got rejected at the 50-day moving average.  At the same time, however, it is still trading above its 200 DMA.  Just like the S&P 500, I expect the DAX to vacillate between its 50 and 200 DMAs for the rest of this week (and possibly into early parts of this week) before it “decides” to break out on either the downside or the upside:

DAX (German DAX Composite) INDX

Interestingly, the German stock market has actually been acting relative strongly within the major markets in Western Europe.  This is evident from the following daily chart (again, courtesy of www.stockcharts.com) of the French stock market, which is actually trading below both its 50 and 200 DMAs, with the former above to cross below the latter:

CAC (French CAC 40 Index) INDX

Interestingly, despite the relative strength of hard commodities in the most recent correction, the Toronto stock market is, nonetheless, not doing as well as it should:

TSE (S&P/TSX Composite Index) INDX

By far, the strongest major market index is Hong Kong's Hang Seng Index, as liquidity continues to run high in this market (note that the HK Monetary Authority – given the region's currency peg to the U.S. Dollar – will be forced to follow suit and cut rates should the Federal Reserve cut its Fed Funds rate on September 18th, despite the fact that the HK economy is still booming):

HSI (Hong Kong Hang Seng) INDX

The $64 billion question remains: Which way will the major market indices resolve over the next few weeks?  While the bulls and the bears can argue about this all day, we now all know about one thing: the breadth of the global stock market has been getting narrower and should continue to get narrower as time goes by.  More specifically, it is now clear that the major countries in Western Europe (not to mention Japan) is now getting progressively weaker – and that going forward, the global equity markets that will be “picking up the slack” going forward will be the U.S. (by virtue of her size), Chinese, Hong Kong, Australian, and South Korean equity markets going forward.

For now, I am still not convinced that the stock market has made a sustainable bottom yet, and that the window for a further decline is still open during the September to October timeframe.  As demonstrated by the “Citigroup news” yesterday, there are still too many potential skeletons in the closet in both the hedge fund and the investment banking system, and chances are that we will not get a clear idea of how bad things are until at least after the release of the latest round of quarterly earnings reports from Goldman Sachs and the like, or even after September 30th, once the latest round of hedge redemptions are over and done with.  For now, we will just sit tight and wait.

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