S&P 500 Index: Bear Flag Hits Downside Target

Members, please refer to the Glossary of Trade Setups for details. This pattern is a core trade setup from The Ultimate Trading Course.

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In this podcast, we discussed the sound of fear last heard in early October as the Shanghai Composite breached 2,000. At this point, we believe price action has entered the Discouragement phase of The Investor Sentiment Cycle. Analysts are opening bearish, giving the market up for dead, confidently projecting large “next stop” percentage declines for the Dow Jones Industrial Average and crude oil [SEE VIDEO].

CHARTS DISCUSSED IN THE PODCAST

S&P 500 Index, 65-minute Intraday Chart

S&P 500 “Mr. Magoo”, Daily Chart

The daily chart could be a trap for sellers in that it can be seen as a textbook descending triangle that “should” be sold on a breakdown below the lower edge of the pattern, but ends up popping back up into the trading range above the October 10 low.

S&P 500 Index: Zero 52-week New Highs and 259 New Lows

NYSE Composite: One 52-week New Highs and 1,271 New Lows

For more information on our market barometers, please see What The Market Says.

ARTICLES MENTIONED IN THE POCAST

• Teck suspends dividend to save cash
  Teck Cominco Ltd. said Thursday it will suspend dividend payments in 2009 and slash capital expenditure next year among other moves designed to save some $2.4-billion and help pay down debt. . . . Teck’s debt-financed $14-billion takeover of Fording has saddled the miner with an estimated $10-billion in term and bridge loans that have to be repaid. There has been serious concern among analysts and investors that Teck is over-leveraged at a vulnerable time economically.
• Bernanke May Find Deflation Is Back as Fed Concern
  Government figures showed that consumer prices excluding food and fuel costs fell for the first time since 1982 last month. . . . Deflation, or prolonged declines in prices, hurts the economy by making debts harder to pay off and lenders more reluctant to extend credit. Japan is the only major economy to have suffered the phenomenon in modern times. “A lesson I take from the Japanese experience is not to let that get ahead of us, to be aggressive,” Bernanke’s deputy, Vice Chairman Donald Kohn, said in answering questions after a speech yesterday in Washington. “Whatever I thought that risk was four or five months ago, I think it is bigger now even if it is still small.”
• Treasury Yields Drop to Record Lows as Recession Concern Rises
  Yields on two- and five-year notes and 30-year bonds dropped to the least since the Treasury began regular issuance of the securities. Ten-year note yields touched the lowest since 2003 after yesterday’s release of the minutes of last month’s Federal Reserve meeting showed policy makers expect the economy to contract through the middle of 2009 and more interest-rate cuts may be needed to counter deflation.
• Bond Risk Soars to Record as Markets Return to ‘Crisis Mode’
  Credit-default swaps on the Markit CDX North America Investment-Grade index jumped 23 basis points to an all-time high 270, according to broker Phoenix Partners Group at 11:15 a.m. in New York. The Markit iTraxx Crossover Index of 50 European companies with mostly high-risk, high-yield credit ratings climbed 37 basis points to 927, having earlier traded at 933, according to JPMorgan Chase & Co. prices in London.
• Outrage of the Day: AIG’s Mystery Bailout Cash and Hey, How About Some Empathy?
  Cramer then aims his personal Outrage at the market “wizards” and know-it-alls — you know, the ones you see crowing about how they saw this financial crisis coming and got out and, oh yeah, made a ton of money and are doing absolutely great, thank you very much. To those smirking faces, this is what Cramer has to say: “Shut the heck up.”

We will update and review the rest of our market barometers tonight for members.

Daily Chart with InVivo Swing Trading Tools

There are a number of the reasons why the momentum players like ISRG;

1. High priced stock with lots of volatile up and down moves.
2. Lots of trading volume and liquidity.
3. Institutional players are involved because it is a member of the NDX 100 Index.
4. Has a unique business that people like talking about in the media, message boards and at cocktail parties.

An analyst from Lazard Capital recently said, “Intuitive Surgical Corp., are trading at low prices compared with their expected results, which may create a buying opportunity.” This is yet another example of someone giving us the old “the fundamentals look great at these stock prices” line.

ISRG is one of the rare stocks that remains above the $100 mark in this bear market. After trading as high as $359 a share, it has broken the $300 and $200 levels to the downside. These are big psychological levels, and as trading approaches the important “$100 Handle”, more analysts may come out to do their “fundamentals look great” dance for shareholders.

Intuitive Surgical (ISRG)
What is the price action telling us?

Daily Chart with 50- and 200-day Moving Average

I have marked off the psychological $300 and $200 levels. We can also see that investors are going through Overt Warning to Panic phase of The Investor Sentiment Cycle:

Overt Warning to Panic
The area of sustained directional trending price action to the downside takes place is between the Overt Warning and Panic phases.There will be some sort of catalyst. Perhaps it is an earnings warning or some point of economic data that leads the crowd to finally clue in that the nagging negative price action they have been watching is the beginning of something big and bad.

The 200-day moving average is broken, and CNBC alerts investors. Everyone knows that the ship is sinking. Those who bought in the churning top realize they are holding the bag and stop buying the dips. Smart money shorts each failing bounce. Stop losses are hit, and margin calls force liquidation. Supply simply overwhelms demand and price action becomes a one-way street.

In mid October ISRG came out with earnings that confused bulls:

• Intuitive Surgical stock dives despite 3Q growth
  Intuitive Surgical Inc.’s stock sank 12 percent Friday, a day after the maker of surgical robots reported third-quarter results that easily surpassed Wall Street expectations. Intuitive shares fell $25.67 to $189.13, a “bizarre” movement, according to a research note from Lazard Capital Markets analyst Dr. Sean Lavin. Lavin said hospitals will continue buying the systems even if spending and credit tighten, and the stock will rise strongly “when investors look at the cash this company generates and assign a higher multiple.”

Once again, we see that the analyst is giving bullish fundamental reasons while the price action is telling us something else. Let’s see what happens next with ISRG. Will the ‘$100 Handle’ hold?

1. America’s Car-Mart, Inc. (NASD:CRMT)

CMRT is in the used car retail industry. Talk about a ‘double whammy’ for CMRT. They run two subsidiaries businesses:

1. Sells older used vehicles via America’s Car-Mart.
2. Provides financing for substantially all of its customers via Colonial Auto Finance, Inc.

Daily Chart with InVivo Swing Trading Tools

Right now, the company is not one, but TWO really tough businesses that are feeling lots of pain. Automakers begging for a hand out and the credit crisis have frozen financing for everything including cars. Let’s see what they say in their earnings in early December.

America’s Car-Mart (CRMT)

Daily Chart with 50- and 200-day Moving Average

The 50/200 “Cross”
The thesis goes something like this: the up or “golden” cross (50-day MA moves above 200-day MA) is supposed to be bullish while the down or “death” cross (50-day MA moves below 200-day MA) portends to weakness.

A Word About Stock Picking
What you should do with these ideas are up to you. We believe individual investors should make speculative trades in individual stocks only with mad money after fully funding retirement accounts according to a balanced portfolio strategy. Use a well-defined process to evaluate buy and sell signals. You may wish to investigate these ideas further with the following questions in mind:

• Which phase of the Investor Sentiment Cycle is this stock in?
• Is there a valid reason for entering this trade? Is there a technical trade setup on this chart?
• Is it smart to follow the dumb money? Read the landmark research paper by Mullainathan & Thaler.
• Is this a classic behavioral finance trap?
• Do I have a position sizing strategy? Are all of my eggs in one basket?
• What’s a good spot to place a stop loss?

The information found in this article is designed to be educational. For additional information, please read Putting It Together.

If you enjoy reading our blog and trading ideas, why not buy us a cup of coffee to show your support? Membership is only 53 cents per day! Treat yourself to 24/7/365 access to professional insight, daily market barometer readings, weekly ETF rankings, portfolio strategy, trading tools, comment privileges and the occasional stock pick. You’re only a click away from viewing this article...

Auto executives were grilled on Capitol Hill while England’s Woolworths entered talks to sell the 800-store chain — for £1. Cash flow of German giants BASF (to idle 80 factories) and VEM Vermoegensverwaltung is being squeezed by both canceled orders and debt service from acquisitions and takeovers done in better times. Downgrades, here we come.

A Change in Sentiment: Dow 6,000
I mentioned last week that market participants seemed disturbingly sanguine on the test of low. Member Dan gave us heads up that Dow 6,000 was bandied about on Fast Money. Louise Yamada also talked of Dow 6,000 as the next stop (along with the 1937 scenario which members were alerted to on October 14.)

These articles are from the last couple of days:

• ‘Fast Money’ Recap: Nowhere to Go
  Guy Adami said he thought the Dow Jones Industrial Average was going to trade above 9,000 today. “If the Dow closes below 7,800, we will see 6,000 next,” he said. The Dow fell 223.73, or 2.6%, to 8273.58 at the close of trading on Monday.
• S&P 500 ‘Almost Certain’ to Retest Low, JPMorgan Says
  Nov. 12 (Bloomberg) — U.S. stocks are “almost certain” to revisit the five-year low reached Oct. 10, according to an analysis of historical trading patterns by JPMorgan Chase & Co. . . . The average Wall Street forecast calls for the S&P 500 to gain 30 percent to 1,118 by Dec. 31 — more than twice as much as the biggest-ever advance to close out a year, according to year-end predictions compiled by Bloomberg. Strategists were even more bullish at the beginning of the year, predicting that the S&P 500 would end 2008 at a record 1,632.
• S&P 500 Index’s ‘Retest’ of Low Fails to Spur Rally
  Nov. 18 (Bloomberg) — The Standard & Poor’s 500 Index is poised to extend this year’s 42 percent drop after a rally from last week’s five-year low lasted just one day, say analysts who study charts of trading patterns and prices to forecast changes in stocks. . . . “Historically you would’ve had a better charge from the bulls at this point, and it hasn’t developed,” said Jeffrey de Graaf, a senior managing director at ISI Group Inc. in New York, in a telephone interview. . . . De Graaf, the highest-rated technical analyst in Institutional Investor magazine’s survey the past four years, said other indicators suggest stocks will keep falling. . . . “The final low will be much lower than this,” and may not occur before the fourth quarter of next year, de Graaf said.
• Berkshire’s Credit Risk Soars on $37 Billion Bet
  The cost to protect against Berkshire being unable to meet its debt payments, based on credit-default swaps, is more than four times that of rival insurer Travelers Cos. At those levels, the swaps are typical of companies rated Baa3 by Moody’s Investors Service, one level above junk. The price may have risen on concern that the billionaire’s firm could lose a $37 billion bet on world stock market values more than a decade from now.

The bottom line? Everyone is resigned to their fate, projecting lower lows. Bonds were higher on today’s sell off, telling us that sell buttons are not being pressed across the board (no panic). Looks to me that the market has made the transition into the discouragement phase of The Investor Sentiment Cycle. More on correlation HERE.

The Mamis High/Low Barometer
Let’s take a look at our market barometers to see what the market says. Mamis took the 52-week new highs and new lows statistics for the S&P 500 index and plotted the 10-day simple moving average of the net differential.

S&P 500: Mamis 10-day MA of Net New Highs/Lows

He particularly liked to look at the big picture using statistics from the NYSE:

NYSE: Mamis 10-day MA of Net New Highs/Lows

I will review the rest of our barometers overnight for members.

• Yamada Sees Growing Chance Stocks May Break 2002 Lows
  [WATCH VIDEO]
  Nov. 18 (Bloomberg) — Louise Yamada, managing director of Louise Yamada Technical Research Advisors, talks with Bloomberg’s Tom Keene and Ken Prewitt about the outlook for the U.S. stock market. Yamada also discusses the duration of economic slowdown and investment advice.

Relative strength analysis is based on comparing the price performance of ABC vs. XYZ. It is NOT THE SAME as Welles Wilder’s RSI indicator. For example, we can compare the performance of a sector vs. the S&P 500 Index, or we can compare a stock and it’s peers against the sector index. This process gives us quantitative information that helps identify the leaders and the laggards. There are three simple ways to chart relative strength.

Method One: Percent Change from X Date
Let’s use the nine core Sector SPDRs as an example of how relative strength analysis is used to survey and monitor sector rotation.

Sector Performance Relative to S&P 500
CLICK TO SEE LARGER IMAGE

We choose a date (October 11, 2007 was the top) and plot $SPX, XLY, XLP, XLE, XLF, XLV, XLI, XLB, XLK and XLU on a percent change basis. The thick grey line is the S&P 500 Index while the colored lines are the nine Sector SPDRs (colors are the same as on the chart below where there is a legend).

Method Two: Rebased Against Benchmark from X Date
The second method is to deduct the performance of the benchmark so that the absolute performance against the benchmark is plotted.

Sector Performance Rebased Against S&P 500
CLICK HERE TO SEE LARGER IMAGE

The benchmark index (S&P 500 Index in this case) becomes the zero line after rebasing.

Method Three: RMI Paintbar and Histogram
Relative strength analysis is exactly what our RMI Indicators measure. The RMI.Histogram is another way to visualize performance. It provides a detailed, bar-by-bar account of a stock’s performance against the benchmark index (or a sector against a benchmark) and helps identify potential swing trade entry points.

The position of the green and red histogram bars relative to the grey threshold line is very important. A number of combinations and permutations can occur. Price bars are colored based on information contained in the histogram according to these rules:

1. Green = Relative Outperformance = Histogram > 0 AND Histogram > Threshold Line
2. Red = Relative Underperformance = Histogram < 0 AND Histogram < Threshold Line
3. Yellow = POTENTIAL SWING TRADE ENTRY = all other combinations

In this case, we plot the individual Sector SPDR against the S&P 500 Index as the benchmark.

XLY Relative to S&P 500 Index

XLP Relative to S&P 500 Index

XLE Relative to S&P 500 Index

XLF Relative to S&P 500 Index

XLV Relative to S&P 500 Index

XLI Relative to S&P 500 Index

XLB Relative to S&P 500 Index

XLK Relative to S&P 500 Index

XLU Relative to S&P 500 Index

Oprah featured UGG Ultra Boot as one of “Oprah’s Favorite Things” in 2000 and 2007. UGG boots are made by Deckers Outdoor Corporation (NASD:DECK).

Daily Chart with InVivo Swing Trading Tools

The average price for these boots is usually over $200. This is a luxury item that has been worn by everyone from movie stars to toddlers. With much of the whole world in recession, will women continue to buy expensive UGG boots or settle for a cheaper knockoff that are sold everywhere?

The Peter Lynch Moment
When CROX knockoffs started to show up in malls and stores company management and analysts said that consumers would still want to buy the brand name. We didn’t think so.

Might the same thing be happening to DECK? UGG-type boots are now available at Payless.com for $29.99.

Deckers Outdoor (DECK)
Zacks.com analysts came out with a very detailed bullish report on the fundamentals of DECK. We have seen this movie before: analysts and investors with 1,001 reasons to be bullish based on a company’s fundamentals BUT the price action of DECK is telling us a very completely different story.

Daily Chart with 50- and 200-day Moving Average

DECK is probably in the late stages of the Overt Warning to Panic phase of The Investor Sentiment Cycle:

Overt Warning to Panic
The area of sustained directional trending price action to the downside takes place is between the Overt Warning and Panic phases. There will be some sort of catalyst. Perhaps it is an earnings warning or some point of economic data that leads the crowd to finally clue in that the nagging negative price action they have been watching is the beginning of something big and bad.

The 200-day moving average is broken, and CNBC alerts investors. Everyone knows that the ship is sinking. Those who bought in the churning top realize they are holding the bag and stop buying the dips. Smart money shorts each failing bounce. Stop losses are hit, and margin calls force liquidation. Supply simply overwhelms demand and price action becomes a one-way street.

The bulls are shocked and are in disbelief right now. They are hoping that DECK will have a strong holiday season. The bears are smelling blood and growing stronger with their conviction that DECK perhaps might not have a strong holiday season. The momentum players who have no problem being bullish OR bearish like trading DECK because of its volatility a trader’s paradise.

This will be a very interesting battle to watch between all three groups. You might be asking yourself has this happened before? Hmm, perhaps we can use DryShips Inc. (NASD:DRYS) as an example look how messy that turned out. Who could have foreseen that crash?

1. The Buckle, Inc. (NYSE:BKE)
2. The Talbots, Inc. (NYSE:TLB)

BKE and TLB are in the retail apparel industry. Retailers appeared on the momentum players’ watchlist in the late summer, but by early October the love was gone: they are being taken to the cleaners. Talbots is focusing on core business while BKE announced a big dividendfor their shareholders.

The Buckle (BKE)

Daily Chart with InVivo Swing Trading Tools

Daily Chart with 50- and 200-day Moving Average

The Talbots (TLB)

Daily Chart with InVivo Swing Trading Tools

Daily Chart with 50- and 200-day Moving Average

The 50/200 “Cross”

The thesis goes something like this: the up or “golden” cross (50-day MA moves above 200-day MA) is supposed to be bullish while the down or “death” cross (50-day MA moves below 200-day MA) portends to weakness.

A Word About Stock Picking

What you should do with these ideas are up to you. We believe individual investors should make speculative trades in individual stocks only with mad money after fully funding retirement accounts according to a balanced portfolio strategy. Use a well-defined process to evaluate buy and sell signals. You may wish to investigate these ideas further with the following questions in mind:

• Which phase of the Investor Sentiment Cycle is this stock in?
• Is there a valid reason for entering this trade? Is there a technical trade setup on this chart?
• Is it smart to follow the dumb money? Read the landmark research paper by Mullainathan & Thaler.
• Is this a classic behavioral finance trap?
• Do I have a position sizing strategy? Are all of my eggs in one basket?
• What’s a good spot to place a stop loss?

The information found in this article is designed to be educational. For additional information, please read Putting It Together.