The Unfortunate Truth About an Overbought Stock Market

Writing about financial markets is probably the most challenging endeavor I have ever immersed myself into. I am a trader first and a writer second, but I have really come to enjoy scribing missives about financial markets because it really forces me to concentrate on my analysis.

Writing for the general public has really enhanced my perception of the market and forced me to dig deeper and learn new forms of analysis. I find myself learning more and more every day and the beauty of trading is that even for the most experienced of traders there is always an opportunity to learn more. As members of my service know, I strive to be different than most of my peers as my focus is on education and being completely transparent and honest.

I want readers to know that I was wrong about my recent expectations regarding the European sovereign debt summit. I was expecting the Dollar to rally based on the recent price action and quite frankly I expected stocks to falter after running up nearly 15% into the announcement. My expectations could not have been more untimely and incorrect.

I share this with you because as I read and listen to market pundits discussing financial markets I find that too many writers and commentators flip flop their positions to always have the appearance of accuracy. In some cases, there have been television pundits that stated we were possibly going to revisit a depression in 2012 no more than 5 weeks ago. These so called experts have now changed their positions stating that we have started a new bull market in recent weeks. How can anyone take these people seriously?

Financial markets are dynamic and consistently fool the best minds and most experienced traders out there. Financial markets do not reward hubris. If a trader does not remain humble, Mr. Market will happily handle the humbling process for him. I was humbled this week. I was reminded yet again that  financial markets do not take prisoners and they show no mercy. I am sharing this with readers because I want you to know that I refuse to flip flop my position without first declaring that I was wrong.

When I am wrong, I will own up to it purely out of sense of responsibility. My word and my name actually mean something to me, and while I strive to present accurate analysis I am fallible and I will make mistakes. The key however to the mistakes that I make is my ability to learn from them and the past week was a great learning opportunity.

After regrouping and stepping back after the price action on Thursday, a few key elements really stood out to me regarding recent price action. First of all, in the short term we are extremely overbought. The chart below illustrates the number of stocks in domestic equity markets trading above their 20 period moving averages over the past 5 years:

Overbought Stock Momentum

What is apparent from the chart above is that prices are almost as overbought right now as they have been anytime in the past 5 years. The number of domestic equities trading above their 50 period moving average over the past 5 years is also nearing the highest levels seen during the same period as the chart below illustrates:

Trading Stock Market Momentum

Equities trading above the 100, 150, and 200 period moving averages are somewhat subdued by comparison meaning in the short run a possible correction appears likely. The longer term time frames are no longer oversold, but they have considerable upside to work with before we could declare that they are overbought.

Additionally, the details of the European Union’s supposed solution have not yet been released raising questions going forward. Every move that is made will create unintended consequences. As an example, since Greece had 50% of their debt written down why would Ireland or Portugal refuse to pay their debts in full?

The Irish and Portuguese governments are going to come under pressure from their constituents to renegotiate the terms of their debt based on the agreement that was made with Greece recently. Spain politicians will likely be under pressure as well. The decisions made in these so called bailouts reverberate across the geopolitical spectrum. Moral hazard still exists, it just evolves over time.

The risk premium of sovereign debt has to be adjusted since credit default swaps did not trigger payment as the write downs were considered “voluntary.” Thus credit default swaps are not the answer to hedge sovereign debt as it would appear that governments have the ability to write down debt without triggering a default based on the status of the write down. The long term unintended consequences could be severe and are unknown at this point in time.

In addition to the unknown factors impacting the European “solution”, next week the Federal Reserve will have their regular FOMC meeting and statement. There has been a lot of chatter regarding the potential for QE III to come out of this meeting. While I could be wrong, initiating QE III right after the Operation Twist announcement would lead many to believe that Operation Twist was a failure.

With interest rates at or near all time lows and the recent rally we have seen in the stock market, it does not make sense that QE III would be initiated during this meeting. It is possible that if QE III is not announced the U.S. Dollar could rally and put pressure on risk assets such as the S&P 500 in the short to intermediate term. If this sequence of events played out, a correction would be likely. The following is a daily chart of the S&P 500 with possible correction targets in place:

SPY Overbought Stock Market

Right now it is a toss up in the financial blogosphere as to the expectations of where price action will head. Are we near a top? Is this the beginning of a new bull market? I scanned through several charts Friday evening and Saturday morning and came to this realization. If the market is going to breakout and this is not a top but the beginning of a major bullish wave higher, then the Nasdaq 100 Index (NDX) has to breakout over the 2011 highs.

The Nasdaq 100 Index is comprised of stocks such as AAPL, GOOG, INTC, and YHOO. In order for a new leg higher to transpire, hyper beta names like AAPL and GOOG have to breakout higher and show continuation with strong supporting volume. If the NDX does not breakout over the 2011 highs, a top could potentially be forming. The daily chart of the Nasdaq 100 Index is shown below:

QQQ Overbought Market

In conclusion, the short term looks like a possible correction could play out. However, it is critical to note that the longer term time frames are more neutral at this time. Furthermore, if price action cannot penetrate the 2011 highs for the Nasdaq 100 Index, I do not believe that a new bull market will have begun. If the Nasdaq 100 Index cannot breakout above the 2011 highs, we could be putting in a potential top going into the holiday season.

In closing, I will leave you with the thoughtful muse of famed writer and minister Hugh Prather, “Almost any difficulty will move in the face of honesty. When I am honest I never feel stupid. And when I am honest I am automatically humble.”

Subscribers of OTS have pocketed more than 150% return in the past few months. If you’d like to stay ahead of the market using My Low Risk Option Strategies and Trades check out OTS at Options Trading Signals.Com and take advantage of our free occasional trade ideas or a 66% coupon to sign up for daily market analysis, videos and Option Trades each week.

J.W. Jones

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Dan Strumpf: Crude Oil Pauses As Europe Debt Questions Persist

Crude oil futures edged lower Friday, as traders paused amid uncertainty over the details of the European Union's rescue package for Greece. Light, sweet crude for December delivery settled 64 cents, or 0.7%, lower at $93.32 a barrel on the New York Mercantile Exchange. Brent crude on the ICE futures exchange settled down $2.17, or 1.9%, to $109.91 a barrel.

Futures ended slightly lower as market participants reflected on the rescue package unveiled by European Union officials on Thursday. The package, aimed at staving off a disorderly default of Greece, sent crude futures soaring on Thursday. But questions persisted over how the EU will implement the plans and if they will be enough to solve the debt woes.

"The lack of details out of this European summit really questions the feasibility of this euro zone debt deal," said Peter Donovan, vice president at Vantage Trading, an oil options brokerage in New York.

Oil market participants were closely eyeing the negotiations over European sovereign debt because of fears that the debt crisis could spread to other countries in Europe or elsewhere. That could trigger a prolonged economic slump that would weigh heavily on crude oil demand.

Positive developments in Europe over the last month played a large role in the recent crude market rally. Even after Friday's decline.....Read Dan's entire post at Rigzone.



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EIA: Recent Gasoline and Diesel Prices Track Brent and LLS, not WTI

Since the beginning of 2011, the spot price of West Texas Intermediate (WTI) crude oil, a traditional benchmark for the U.S. market, has trailed the spot price of other crude oils, including Brent, a global benchmark, and Louisiana Light Sweet (LLS), a Gulf Coast crude oil similar to crudes run by many U.S. refiners. Because few U.S. refiners have easy access to WTI crude oil, this price divergence has not directly translated to lower prices for U.S. refined petroleum products, such as gasoline and heating oil.

Instead, these product prices have more closely tracked the prices of Brent and LLS. Through October 25, the prices of Brent and LLS are up 20% and 18% in 2011, respectively; the prices of wholesale diesel fuel and gasoline on the U.S. Gulf coast are up 21% and 13%, respectively; meanwhile, the price of WTI is up just 2%.

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Crude Oil, Gold and Natural Gas Market Commentary For Friday Morning

Crude oil was lower due to light profit taking overnight but remains above the 38% retracement level of the May-October decline crossing at 90.56. Stochastics and the RSI are overbought but remain neutral to bullish signaling that additional short term gains are possible.

If December extends this month's rally, the 50% retracement level of the May-October decline crossing at 95.32 is the next upside target. Closes below the 20 day moving average crossing at 86.22 are needed to confirm that a short term top has been posted.

First resistance is the 50% retracement level of the May-October decline crossing at 95.32 Second resistance is the 62% retracement level of the May-October decline crossing at 100.08

Crude oil pivot point for Friday morning is 92.98

First support is the 10 day moving average crossing at 89.61
Second support is the 20 day moving average crossing at 86.22

Double Tops and Pivot Points Explained

Natural gas was higher due to short covering overnight while extending this month's trading range. Stochastics and the RSI are oversold but remain neutral to bearish signaling that sideways to lower prices are possible near term.

If December renews this year's decline, monthly support crossing at 3.225 is the next downside target. Closes above the reaction high crossing at 4.039 are needed to confirm that a short term low has been posted.

First resistance is the reaction high crossing at 4.039
Second resistance is the 25% retracement level of the June-October decline crossing at 4.133

Natural gas pivot point for Friday mornings trading is 3.774

First support is Thursday's low crossing at 3.724
Second support is monthly support crossing at 3.225

Today’s Stock Market Club Trading Triangles

Gold was lower due to light profit taking overnight but remains above the 50% retracement level of September's decline crossing at 1729.40. Stochastics and the RSI are overbought but remain bullish signaling that sideways to higher prices are possible near term.

If December extends the aforementioned rally, the 62% retracement level of September's decline crossing at 1775.20 is the next upside target. Closes below last week's low crossing at 1604.70 would confirm that a short term top has been posted.

First resistance is the overnight high crossing at 1754.00
Second resistance is the 62% retracement level of September's decline crossing at 1775.20

Gold's pivot point for Friday morning is 1735.40

First support is last week's low crossing at 1604.70
Second support is September's low crossing at 1535.00


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ExxonMobil 3rd Quarter Profits Soar 41%

ExxonMobil's third quarter earnings surged 41% as the oil giant continued to benefit from high oil prices and stronger refining margins. Shares were up 1.4% at $82.20 in premarket trading as the results topped estimates.

The world's largest publicly traded oil company by market value has reported stronger results in recent quarters thanks to high oil prices and improved refining performance. Investors are watching this week to see how much of a drag, if any, recent oil price volatility and renewed concerns about the global economy will put on the sector's recent surge in profits.

ConocoPhillips posted a jump in adjusted third quarter profits on Wednesday, though charges weighed down the bottom line. Chevron is expected to post strong profits on Friday.

ExxonMobil reported a profit of $10.33 billion, or $2.13 a share, up from $7.35 billion, or $1.44 a share, a year earlier. Revenue increased 32% to $125.33 billion. Analysts polled by Thomson Reuters most recently forecast earnings of $2.12 a share on revenue of $113.56 billion.

Exploration and production earnings grew 54% amid higher prices for oil and natural gas, partly offset by a production decline of 4%. Refining and distribution business earnings were up 36% amid stronger refining margins. ExxonMobil said it spent $5.5 billion for stock repurchases, buying back 72 million shares. The total included $5 billion of buybacks to reduce shares outstanding.


Posted courtesy of Rigzone.Com


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PetroChina Third Quarter Net Beats Estimates

PetroChina Co.’s third quarter profit growth outpaced gains by rival China Petroleum & Chemical Corp. as higher crude oil prices helped counter refining losses at Asia’s biggest company by market value.

Net income rose 7.8 percent from a year earlier to 37.4 billion yuan ($5.9 billion), PetroChina said yesterday. That surpassed the 33.3 billion yuan mean estimate of six analysts surveyed by Bloomberg. Sinopec, as China Petroleum is known, said profit increased 3 percent to 20.2 billion yuan.

PetroChina, which gets almost three times the operating income from energy exploration than Sinopec, benefitted more from higher oil prices as it boosted output to meet demand in the world’s second largest economy. Chinese energy companies are adding oil and gas assets from Australia to North America to curb losses from selling fuels at state controlled prices.....Read the entire article.


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Crude Oil Settles at a New 3 Month High, Natural Gas and Gold Extend Rally

Crude oil closed higher on Thursday as it extending this month's rally. The high range close sets the stage for a steady to higher opening on Friday. Stochastics and the RSI are overbought but are neutral to bullish signaling that sideways to higher prices are possible near term. If December extends the rally off this month's low, the 50% retracement level of the May-October decline crossing at 95.32 is the next upside target. Closes below the 20 day moving average crossing at 85.56 are needed to confirm that a short term top has been posted. First resistance is the 50% retracement level of the May-October decline crossing at 95.32. Second resistance is the 62% retracement level of the May-October decline crossing at 100.08. First support is the 20 day moving average crossing at 89.06. Second support is the reaction low crossing at 83.40.

Natural gas was lower Thursday while extending this month's trading range. Stochastics and the RSI are diverging but neutral signaling that sideways trading is possible near term. Closes above last Monday's high crossing at 4.039 are needed to confirm that a short term low has been posted. If December renews this year's decline, monthly support crossing at 3.225 is the next downside target. First resistance is the 25% retracement level of the June-October decline crossing at 4.133. Second resistance is the 38% retracement level of the June-October decline crossing at 4.336. First support is today's low crossing at 3.724. Second support is monthly support crossing at 3.225.

Gold also closed higher on Thursday as it extends the rally off September's low. The high range close sets the stage for a steady to higher opening on Friday. Stochastics and the RSI are bullish signaling that additional strength is possible near term. If December extends the rally off September's low, the 62% retracement level of the 2008-2011 rally crossing at 1775.20 is the next upside target. Closes below last Thursday's low crossing at 1604.70 would confirm that a short term top has been posted. First resistance is the 62% retracement level of the 2008-2011 rally crossing at 1775.20. Second resistance is the 75% retracement level of the 2008-2011 rally crossing at 1826.50. First support is last Thursday's low crossing at 1604.70. Second support is September's low crossing at 1535.00.


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Phil Flynn: Gulf Coast Surprise

What fun is an oil inventory report without a little surprise now and then. The Gulf Coast, famous for its beautiful beaches, its spicy cuisine, and let's not forget to mention its oil refineries and oil import terminals, gave the weekly EIA data a Louisiana kick. A surge in Gulf Coast oil imports caused a large, whopping jump in U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) of 4.7 million barrels from the previous week. That puts supply at 337.6 million barrels and keeps it in the upper limit of the average range for this time of year. Thanks to that Gulf Coast surge!

But let's go even further south, down to Brazil! Blame it on Rio! Well not yet anyway but in the future Brazil is going to be a major oil player. The EIA said that, "Brazil will be responsible for some of the world's largest increases in oil production in the coming decades. Advances in seismic imaging have enabled the discovery of offshore "pre salt" deposits of oil in Brazil's Campos and Santos Basins.

These pre salt fields, so-called because they lie under massive layers of salt, are located 18,000 feet below the ocean floor under more than 6,000 feet of salt. Brazil already produces 2.1 million barrels per day (bbl/d) of crude oil and lease condensate, yet just became a net exporter in 2008. Pre salt development, coupled with the ability to meet a large share of domestic demand with Biofuels, is projected to transform the country into a major oil exporter."

You might also blame Rio for the drop in distillates. The EIA say's distillate fuel inventories decreased by 4.3 million barrels last week and are in the middle limit of the average range for this time of year. The drop comes as demand surges for diesel as harvest is underway.

Yet demand for gasoline continues to be poor. The EIA says motor gasoline inventories decreased by 1.4 million barrels last week and are near the upper limit of the average range. Both finished gasoline inventories and blending components inventories decreased last week.

What will be the surprise for today? My guess is a bigger than expected injection on gas storage! Report today!

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Evidence Supports the Bears’ Case for the S&P 500

I am not one to discuss fundamentals or macro views, but this situation in Europe is beginning to morph into a media frenzy. Price action in the marketplace is changing rapidly in short periods of time based on the latest press releases coming from the Eurozone summit.

I cannot help but comment on the seemingly arbitrary actions coming from this high profile meeting. Nothing has happened that market participants were not already privy too. The European Union is going to strengthen their EFSF fund by levering it up roughly 4 : 1. I have yet to hear how exactly they plan on doing this, but this action was no surprise to anyone that has read an article about the sovereign debt crisis in the past month.

There was also discussion about backstopping European banks’ capital position. Since European banks are holding billions (Euros) of risky sovereign debt instruments, it would make sense that their capitalization is a primary concern of Eurozone leaders based on current fiscal conditions. I would argue that the banks should be well capitalized regardless of economic or fiscal conditions in order for a nation to have a strong, vibrant economy that has the potential to grow organically.

The final piece of this week’s political nonsense involves write-downs on Greek debt in the neighborhood of 50% – 60% in order to stabilize Greece’s debt to GDP ratio. Apparently Eurozone leaders want to structure the write down so as to avoid payouts by credit default swaps which act as insurance against default. How does a bond take a 50% – 60% valuation mark down without a creating an event that would trigger the payout of CDS swaps?

If a write down of that magnitude does not trigger the CDS swaps, then I would argue they are useless as a tool to hedge against the default risk carried by sovereign debt instruments. If the CDS swaps do not payout as projected by European politicians, the risk assumed by those purchasing government debt obligations around the world would be altered immediately.

The impact this might have on the future pricing of risk for government debt instruments could be extremely detrimental to their ability to raise funds in the private market. Additionally, the write downs would hurt European banks’ capital positions immediately. If the CDS swaps were to pay out, bank capital ratios would suffer as those who took on counter party risk would be forced to cover their obligations thereby straining capital positions even further potentially.

Price action today suggested that the equity markets approved of the package that European leaders were working on. However, the biggest push higher came when news was released that China was interested in purchasing high quality debt instruments as a means to help prop up poorly capitalized banks and sovereign nations in the Eurozone through an IMF facility.

The market did an immediate about face which saw the Dollar selloff while the S&P 500 rallied higher into the close reversing a great deal of Tuesday’s losses. Inquiring minds wish to know where we go from here? I would be lying if I said I knew for sure which direction Mr. Market favored, however that did not stop me from looking for possible clues.

It has been a while since I checked out the short-term momentum charts that are focused on the number of stocks in U.S. domestic equity markets that are trading above their 20 & 50 period moving averages. The charts below illustrate the current market momentum:

Equities Trading Above the 20 Period Moving Average

It is rather obvious that when we look at the number of stocks trading above their 20 period moving average that momentum is running quite high presently. This chart would indicate that in the short-term time frames equities are currently overbought.

Equities Trading Above the 50 Period Moving Average

A similar conclusion can be drawn when we look at the number of stocks trading above their 50 period moving averages. It is rather obvious at this point in time that in the short to intermediate term time frames, stocks are currently at overbought levels. This is not to say that stocks will not continue to work higher, but a pullback is becoming more and more likely.

Additional evidence that would support the possibility that a pullback is likely would be the  recent bottom being carved out in the price action of the U.S. Dollar Index. The U.S. Dollar has been under selling pressure since the beginning of October, but has recently started to show signs that it could be stabilizing and setting up to rally higher.

The daily chart of the U.S. Dollar Index is shown below:

The U.S. Dollar Index is sitting right at major support and is oversold based on historical price action. If the Dollar begins to push higher in coming days and weeks it is going to push equity prices considerably lower. Other risk assets such as gold, silver, and oil would also be negatively impacted by higher Dollar prices.

Members of my service know that I focus on several sectors to help give me a better idea about the broader equity markets. I regularly look at the financial sector (XLF), the Dow Jones Transportation Index (IYT), emerging markets (EEM), and the Russell 2000 Index (IWM) for clues about future price action in the S&P 500.

During my regular evening scan I noticed that all 4 sector/index ETF’s are trading at or near major overhead resistance. With the exception of the Dow Jones Transportation Index (IYT), the other 3 underlying assets have yet to breakout over their August 31^st highs. The significance of August 31^st is that is the date when the S&P 500 Index put in a major reversal right at the 1,230 price level before turning lower. It took nearly two months to regain the 1,230 level and its significance continues to hold sway.

The daily chart of IWM is shown below illustrating its failure to breakout over the August 31^st highs:

The chart above illustrates clearly that IWM has failed to breakout above the August 31^st highs. I am going to be watching IWM, XLF, & EEM closely in coming days to see if they are able to breakout similarly to the S&P 500. If they start to rollover, it will not be long before the S&P 500 likely follows suit.

Currently the underlying signals are arguing for lower prices in the short to intermediate term. While it is entirely possible that the S&P 500 rallies higher from here, it is without question that current market conditions are overbought in the short to intermediate terms.

Key sectors and indices are not showing follow through to the upside to help solidify the S&P 500′s recent break above the key 1,230 price level. Additionally, the U.S. Dollar Index is currently trading right at key support in addition to being oversold. At this time I am not playing the S&P 500 in either direction, but I will be watching the underlying price action in the U.S. Dollar Index closely. I will be watching for additional clues in the days ahead.

Market and headline risk is high presently.

Subscribers of OTS have pocketed more than 150% return in the past two months. If you’d like to stay ahead of the market using My Low Risk Option Strategies and Trades check out OTS at Options Trading Signals.com and take advantage of our free occasional trade ideas or a 66% coupon to sign up for daily market analysis, videos and Option Trades each week.

Chris Vermeulen & J.W. Jones

Crude Oil, Natural Gas and Gold Markets Summary For Wednesday October 26th

Crude oil closed lower due to profit taking on Wednesday as it consolidated some of this month's rally. The low range close sets the stage for a steady to lower opening on Thursday. Stochastics and the RSI are overbought but are neutral to bullish signaling that sideways to higher prices are possible near term. If December extends the rally off this month's low, the 50% retracement level of the May-October decline crossing at 95.32 is the next upside target. Closes below the 20 day moving average crossing at 84.99 are needed to confirm that a short term top has been posted. First resistance is the 50% retracement level of the May-October decline crossing at 95.32. Second resistance is the 62% retracement level of the May-October decline crossing at 100.08. First support is the 20 day moving average crossing at 84.99. Second support is the reaction low crossing at 83.40.

Natural gas was lower Wednesday while extending this month's trading range. Stochastics and the RSI are diverging but neutral signaling that sideways trading is possible near term. Closes above last Monday's high crossing at 4.039 are needed to confirm that a short term low has been posted. If December renews this year's decline, monthly support crossing at 3.225 is the next downside target. First resistance is the 25% retracement level of the June-October decline crossing at 4.133. Second resistance is the 38% retracement level of the June-October decline crossing at 4.336. First support is this month's low crossing at 3.747. Second support is monthly support crossing at 3.225.

Gold closed higher on Wednesday as it extends the rally off September's low. The high range close sets the stage for a steady to higher opening on Thursday. Stochastics and the RSI are diverging but turning bullish signaling that additional strength is possible near term. If December extends the rally off September's low, the 62% retracement level of the 2008-2011 rally crossing at 1775.20 is the next upside target. Closes below last Thursday's low crossing at 1604.70 would confirm that a short term top has been posted. First resistance is the 50% retracement level of the 2008-2011 rally crossing at 1729.40. Second resistance is the 62% retracement level of the 2008-2011 rally crossing at 1775.20. First support is last Thursday's low crossing at 1604.70. Second support is September's low crossing at 1535.00.


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