Bumpy Road Ahead

Editor’s note: this column was originally published on Capital Essence’s CEM News. It’s being republished as a bonus for the loyal readers. For more information about subscribing to CEM News, please click here.

Good Morning. This is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Thursday May 7, 2009.

Stocks rallied Wednesday as investors cheers the better-than-feared ADP Employment Report and early reports about the government’s stress test results, which suggested that a majority of major banks are well capitalized. Overall it was a good day with the Dow Jones industrial average gained 101 points, or 1.2%, to finish at 8512.

Also contributed to the overall optimism was report that the Senate has approved an amendment that could make it less costly to exit the TARP program. Many diversified banks and regional banks shown a double digit gain on the news.

Chart 1.1 – Wilmington Trust (daily).

After hitting a multi-year low in March, Wilmington Trust (WL) turned around and traded its way higher. It worth noticing that initially profiled in our April 8 “CEM News – Daily Trading Ideas” buy list, the Mid-Atlantic regional bank had gained more than 70%. While the overall price structure remains bullish, Wednesday’s massive advance had pushed prices above the red zone, or overbought territory. In a normal market condition, this is considered extreme overbought and some sorts of pullback consolidation should be expected; although since the market collapsed in late 2007, we’ve been experienced an extraordinary market condition, so normal technical behavior might not work here. Immediate resistance is about 19. This is a significant resistance with the confluence of the 38.2% Fibonacci retracement of the 2006-2009 decline and the November low. Support is about 12.90, or the white line on the chart.

The idea that the economy has started to bottom has helped put in a bid in the energy sector. U.S. light crude oil for June delivery gained 2.50 to settle at 56.34 a barrel on the New York Mercantile Exchange. The oil services HOLDRs (OIH) added 3.5% to finish at 101.70. As matter of fact, this had confirmed the validity of the “bullish breakout” scenario that we’ve traced out in our April 8 Market Outlook when we wrote that: “price action in the past couple of weeks had been encouraging. It looks like the sector is holding to the short-term trending average, which might offer a strong floor for another run to the upper end of the five-month trading range, about 87. This, if taken out, will trigger a massive rally that points to a test of November high, about 102.”

Chart 1.2 – Oil services HOLDRs (daily).

Looking at the one year daily chart of OIH we can see that there is currently a test of the November high at 102.50. Not only that this is a tough level to overcome, the sector is pretty much overbought in a short-term basis so we could experience some type of correction over the next couple of days. In short, while OIH had got overbought and future price weakness is likely, our “US Market Trading Map” stills bullish on the sector, so the pullback, if and when it happens, will stay healthy as long as it holds above the 88.50 level, or the white line on the above chart.

Yesterday we said that: “the S&P 500 index seems to hold very well to the 900 level. This is very encouraging. This suggests an increase in risk appetite. And until this stat changes, we should expect to see new money coming into the market.” The boarder market index resumes its recently advance, added about 16 points or 1.7%, to settle at 919 – the highest level since January 9.

Chart 1.3 – S&P 500 index (daily).

At 919, the S&P is only 15 points or 1.6% away from January closing high at 934.7. So, we’re expecting to see the retest before the end of the week. This, if and when it happens, will push the market into the extreme overbought situation. In a normal market condition, the situation often harbingers a significant downside correction. As noted above, current market condition is everything but normal, so the bulls shouldn’t get into any serious trouble unless they lose the 875 level. That, if taken out, will trigger a massive sell-off into the 800 level.

In summary: looking ahead, we’re anticipating further gains in equities. Although, the market has got extremely overbought as it approaches key overhead resistance, so we should expect some types of headwinds over the next couple of days.

Thanks and Good Trading!
(By: Michelle Mai for Capital Essence)

Note: Michelle Mai writes technical analysis for Capital Essence and is the editor of Capital Essence’s “Market Outlook” newsletter. To receive the daily edition, please subscribe. It’s now available at a monthly rate.