Market Approaching Key Inflection Point

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 Monday July 6, 2009.

Our previous statement about: “Wall Street positioned bearishly in anticipating Thursday’s big bad job report” played out perfectly as stocks stumbled out of gate Thursday will all of the S&P 500’s sectors fell an average 3% amid the worse-than-expected non-farm payrolls report. Indication is that unless the employment situation starts to improve this is going to be a rough summer for stocks.

Last Tuesday we said that: “our “U.S. Market Trading Map” suggested that recent advance in energy prices has been much more consistent with a short-squeeze and normal retracement, rather than a legitimate bull-leg. We could be at risk to a significant decline over the next couple of days.” As anticipated, energy prices had fallen for three consecutive sessions. The U.S. light crude oil for August delivery lost $2.37 to settle at $66.94 a barrel on New York Mercantile Exchange. Low crude prices dragged down energy related stocks. The Energy Sector SPDR (XLE) lost 4.01% to finish at 46.16 – its lowest close since May 4. Any put options traded could have earned more than 100% in just 3 days.

Chart 1.1 – Energy Sector SPDR (daily).

As indicated above, XLE is currently sitting at the bottom of its short-term trading range. Not only that this level has been successful in repelling price action in the past, the oversold condition is another near-term plus for the bulls. So it wouldn’t surprise us to see at least an attempt to rally over the next couple of days. However, given that our “U.S. Market Trading Map” remains bearish on the sector, the rebound, if and when it happens, should be taken as opportunities to trim long positions or initiate new short-sell positions. Only a close above 50.39 (the white line in the chart) will begin to compromise the near-term bearish outlook.

Let’s take a look at the major indices:

Chart 1.2 – S&P 500 index (daily).

On Friday we’ve highlighted that our “U.S. Market Trading Map” has been projecting a sideway trading pattern on the S&P since May. After reaching pretty close to the top of its range on Thursday, the rally ran out of gas and the S&P quickly moved to the bottom of its range. Right now the most important thing to look out for is a retest of 880. That, if taken out, will break the two-month trading pattern and could trigger a massive decline into the important psychological 800 level. Meanwhile, a success test of 880 could prompt a retest of 950, or the top of its short-term trading range.

Chart 1.3 – Dow Jones Industrial average (daily).

As shown, our “U.S. Market Trading Map” has been looking at the Dow from a sell side since middle of June. Last week’s massive decline had brought the May-June lows back into view. This level was also the peak of the prior rally in April, so it wouldn’t surprise us to see an attempt to rally around this area. However, as the “U.S. Market Trading Map” indicated, the rebound should be short-lived. That’s said, the Dow might have to go down to 7700 before we can breathe a sign of relief and believe we’re headed higher again.

Bottom line: short-term, looks for an attempt to rally around the 880 level on the S&P 500 index. But as our “U.S. Market Trading Map” indicates, the rally, if and when it happens, could be short lived. In a longer term, market is fast approaching key inflection point as we’re heading into second quarter earning season. Right now, all indicators point to a break to the downside, so we should be prepared for more weaknesses over the next couple of weeks.

Thanks and Good Trading!
(By: Michelle Mai for Capital Essence)
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Note: Michelle Mai writes technical analysis for Capital Essence. To receive the daily edition, please subscribe. It’s now available at a monthly rate.

Tags: crude oil, DJIA, dow jones industrial average, energy sector SPDR, non-farm payrolls, s&p 500 index, spx, Wall Street, XLE