The headlines this week shouted out that Home Depot (HD) posted a 44 percent increase in 1st quater profits. Looking a little closer at the details we find that the reason this number looked so good was because it was compared to the year ago quarter when HD wrote off the expense of closing its Home Expo stores. What the headline doesn’t tell you is that sales were down 10%, not exactly good news. Savy traders took this opportunity to book profits on the home improvement store’s 50% rise since the March lows.

HD’s story illustrates what has been happening over the last couple of weeks in the financial markets. Traders have been taking profits on this two month rally by selling to investors that are afraid they are going to miss the boat on a new bull market. If we have a real bull market, the is no need to hurry.

The SP 500, DJIA, and MNX all made their first ‘lower’ high in a couple of months this week. It was a good time to initiate some bearish option trades. Watch the 875 level in the SP 500, 8200 in the DJIA, and 134 in the MNX for support.  If these hold, expect the stock market to stay in a trading range for a while. If they break down, this pull back will become a full fledged correction.

JD

As you should know by now, I have been waiting for confirmation that the stock market’s bounce off the extreme lows in March had run out of gas. Yesterday those signals arrived. The most significant of those was the Nasdaq gapping right through its 200 day moving average, failing to hold this key support level. In addition, Momentum has turned negative and most oscillators, including Stochastics and MACD, have rolled over, signaling the end of the up trend.

We do not expect the market to fall to its March lows, but rather provide opportunities for investors to get back into stocks at better levels. The SP 500 could find support at 25 point intervals as low as 800.  The DJIA should find support around 7800, while the MNX is likely to hold up around 128.

JD

Bob makes an excellent point in his sarcastic remarks about the euphoria in the financial markets. Just because the pace at which the economy is getting worse is “slowing down” is not an indication that it is getting any better. Why do all the talking heads seem so happy?

While this situation is a perfect real world example of what technical analysts call a divergence, you can not trade on a this alone. We have seen a divergence between the stock market prices and momentum indicators several times in the past year. The problem with a divergence is the fact that a market can stay over bought or over sold for a long time.

The lesson here is that you need some type of confirmation that a market that is losing momentum has actually started to move in the opposite direction. To illustrate my point, let’s review a couple of my comments over the last couple of months.

On March 8th, I pointed out that the falling market was losing momentum based on a divergence with the momentum indicator. While the brave could have bought the next day because the market had been over sold for a few weeks, it would have been safer to wait until you had confirmation that the down trend had been broken.

On the other hand, let’s go back to my comment on April 5th. At that time, I pointed out that the market rebound was losing momentum. It is now a month later and the stock market is still over bought. These extremes can run for quite a while, as you might recall from the market’s recent fall.

The lesson here is simple, don’t jump the gun! Anticipating that a market is going to turn around will work some times, but there are many times when that turn around will be a long time coming. Wait for confirmation before placing a trade.

The current market rally will subside eventually, so if you have been along for the ride on this bounce be ready to take your profits. If on the other hand you agree with Bob and I that this market is likely to go back and test the March lows, do not place a trade and then hold your breath waiting for that to happen.  Let the market tell you when it is time to take action.

JD

Well, things are still getting worse in the economy but at a slower pace.  Yipee!  Now, doesn’t everybody feel better?  The non-farm payrolls came in at a better than expected loss of -539k.  The unemployment rate edged up .4%  to 8.9%, the worst since 1983.  As people pile into the market expecting either a V, U or W shaped recovery, I think what will happen is it will be an L.  It will take years to work through this.  This will prove to be nothing more than a bear market rally.  This is a new era of capitalism from the government strong arming the secured creditors of Chrysler to coercing the CEO of BAC to go through with the purchase of MER.

If you are long stocks, I would be short atm calls and I would sell call spreads in the spx to take the delta risk out of your portfolio.

BA

The stock market continues to consolidate at resistance levels we have been writing about for several weeks, not surprising given the 25% rise from March 9th to April 9th. The longer this consolidation continues, the more likely we are building a base for the market to continue higher. While the Nasdaq continues to lead the way, it is now bumping up against its 200 day moving average. Any decisive move above that would indicate the beginning of the end of the bear market.

What concerns me most about this market environment is the extreme optimism shown by both individual investors and the financial media. The economy is still getting worse, just not as fast as it was a few months ago. The stock market is still going up, just not as fast as it was a few weeks ago. This divergence continues to indicate that we are still likely to have about a 10% pull back before the upward momentum continues.

JD