Written by Jared Levy, Editor, Smart Investing Daily
Tuesday, 22 March 2011 10:26
Eleven days ago, I noticed a major shift in some closely watched correlations and saw a marked change in some of the indicators that I follow, indicating a further breakdown in the markets. At the time of that Smart Investing Daily article, the index (SPX) was trading at about 1,305. After a 55-point (4%) drop, the markets as of this past weekend looked like they might be finding some support, but don’t be fooled.
The S&P 500 gives us an excellent representation of the broad market and many chartists (including me) turn to it for guidance on the overall direction of the market.
For the near term at least, I have major concerns about the technical bullish “trend” that we had been in up until mid-February. It’s quite common for stocks to take a “breath” and either move sideways (consolidate) or actually move lower for a short period, then resume trend higher.
A break in a bullish trend is normal, but when major basic indicators no longer support a “bullish” trend, it may be time to reverse course. This might be what is happening now. This bearish sentiment is also backed by some key fundamental data. Also, don’t let one or two-day rallies fool you into a false sense of confidence.
Patterns Emerge
Looking at the chart below (taken before the open on Monday), you can see the convergence of the 20-and 50-day moving averages. That level of about 1,302 is an area that I have deemed the “fail point,” clearly marked with a red arrow. You probably won’t find this term in any technical charting books, but it’s really simple to understand.
When the 20-day moving average crosses below the 50-day, this can indicate a change in a short-term trend (perhaps lasting a couple weeks). Furthermore, if the stock’s price, or in this case the S&P 500’s price, is below the 50-day, that is even more reason to stay bearish.
*I began writing this at 4 a.m. on Monday before a day of travel — amazing how the S&P moved right to the 1,300 mark…
We are at a serious inflection point in the market at least from a technical perspective. If the S&P hits that level of 1,302 and does not climb above it with strength and hold there, I would NOT be looking to get long! Even worse would be a complete failure of the index at that level. To me, a failure could spark some serious selling.
I’m not saying that the market can’t recover in time; I am specifically referencing the action for the next couple of weeks, perhaps until earning season begins.
If we don’t rally at all from here, look to the 1,264 level for some support; then the next leg down could take us to 1,224. The latter may be more realistic given the circumstances.
The Pieces Don’t Fit
Housing
I have heard the argument that the P/E ratio of the total S&P 500 is relatively low. I know that some are saying housing is slowly recovering, but you know that’s just not good enough. For most Americans their home is the only asset (besides stocks) that keeps up with inflation.
Since home prices have been retreating to pre-2003 levels, one would think that if we were truly recovering and Americans realize that their home is just the only thing that can keep up with inflation, existing home sales would be screaming — but they are NOT. Granted, they have strengthened, but we saw the same thing last year, then a fizzle (take a look at the chart below). Without a stable housing market, I have a problem with betting the farm on a real recovery.
Perhaps we are going to truly have a jobless recovery (here in the U.S.). From my vantage point, it’s no longer about U.S. employment, but population growth, modernization and employment abroad that is fueling the majority of the “recovery” here in the States. So I guess the American worker is screwed, but our GDP and stocks can still grow?
Take a look at the unemployment rate chart (month over month) below; does that chart spell strong consumer to you?
(P.S. This chart does not include the total unemployment rate, nor does it adjust for skew in the size of the “labor” pool. More on that later…) Unemployment rate chart (month over month) View larger chart
Inflation
So you would think if more people were unemployed and their houses worth less, inflation must be low… maybe prices are even dropping. Nope…
Well, Chairman Bernanke doesn’t seem too worried, but take a look at the chart below. It displays the monthly changes in average prices that consumers pay for goods, on a year-over-year basis. Again, it doesn’t take a rocket scientist to see that prices and unemployment are still very high and our home values are basically dead in the water.
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Putting the Puzzle Together
Something’s got to give and I don’t know if it’s prices — food, materials, energy, etc. — or stocks themselves suffering from higher input costs and weak consumer demand.
But you know, with all that’s going on in the world, I don’t see oil dropping sharply within the next month. Top that off with continued demand from China and the globe for food and infrastructure, and I don’t see a sharp decline in food or material demand.
I am more concerned about the profitability of companies that can’t generate as much revenue from high material, food and energy costs and that can’t make millions on a weak consumer. There are many companies that fall into this category.
Consumer spending around the world is what will drive demand in those businesses. The conundrum is that there are many companies that have benefited greatly from the rise in energy, food and materials, and perhaps they towed the rest of the market along for the ride.
Right now, the American consumer is still struggling to a great extent on average, and at the end of day, I don’t care how good “consumer sentiment” is; without consumer real strength (not some monthly sentiment reading), many companies can’t grow profits. A wise man once told me that stocks can’t go higher without increasing profits (for very long).
We will know soon enough when earnings season begins April 11.
Editor’s Note: Things are about to change drastically in the U.S. and around the world. But it may not be the reason you think. There’s a growing crisis creeping just under the surface of our nation’s financial problems. When this “under-crisis” finally breaks through the surface, expect all hell to break loose.
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Eleven days ago, I noticed a major shift in some closely watched correlations and saw a marked change in some of the indicators that I follow, indicating a further breakdown in the markets. At the time of that 
