Walking the Razor's Edge in the Markets

This has been a very interesting period for the markets. Let's take a look at where we've been, where we are, and a few possible options on where we're going.

A couple of weeks back we started talking about the potential for the dollar to enter a short term inverse head and shoulders pattern, which would have negatively impacted stocks (Note that all non-dollar assets are tightly correlated, meaning they've been trading together. This market has been trading on whether the dollar continues to decline or not. That's very important...) Instead, the dollar failed to enter the pattern and instead entered a pennant pattern, which broke down last week:

At roughly the same time, the S&P was nearing a head and shoulders pattern, which would have taken it down considerably. Many of the bears jumped the gun and shorted the pattern before the neckline was obvious, and the market rallied:

Gold also broke through:

Assets have generally been moving up since, and commodity based currencies (like the Canadian dollar, the Australian dollar, and the Norwegian Krone) have been on a tear.

A week or so has gone by. We noted the important levels that the markets needed to break through and warned of some potential obstacles for the stock markets, including a double top, and a megaphone top. Now, we're going to expand this viewpoint and look at these markets again. Let's start with the dollar.


The dollar continues its downtrend, but in the short term is now showing oversold. It is also nearing support at 78.40. We may see a bounce at this level, if not before. If it occurred before the resistance level and then continued its decent through support, that would be very bearish and good for the asset markets.


If we zoom out a bit and visit it again, we can see the downtrend line just below the 50 day moving average acting like a "ceiling." A break through that line to the upside on any bounce would be be bullish for the dollar, at least short term.


If we look at the dollar on a weekly chart to get a sense of the intermediate term, the dollar is oversold on that scale as well, but has downward momentum. You can see the various lines of support and the sloping downward channel. If it breaks down strongly from the 77.80 level or so, it's along fall to minor support at 74, then down to 72, which was the low in March of 2008.

The big question is whether or not this is going to be a small bounce and a run up like we saw last year that ultimately crashed the markets, or is it going to be a small bounce that allows the asset markets to consolidate before continuing the trend.

Let's look at the equity markets for clues.


Momentum is still on the side of the asset markets, though they are overbought in the short term. There's a lot of tight bands of resistance just ahead of the market, and volume is declining. However, as we've stated before, the summer is a perfect time to prop up the market values while the volume is weak, so let's see how it pans out.

As we're compiling this data today, the markets have weakened. The S&P needs to hold out over 946 to keep the "double top" talk at bay. If it closes at that level or higher and consolidates while the dollar moves up a bit, it's likely to be ready to challenge the 956 level and remove the double top talk. At the same time, a close below 946 sends a negative signal that's going to make some people pay attention.

Given the momentum of the markets, but by no means a presumption, let's look at some scenarios where the dollar weakens and assets move up--just to see what obstacles and opportunities lie ahead.


Assuming we get past the "double top," there's that megaphone pattern that no so many folks seem to be paying attention to. This is an important level because it seems that the S&P may be around 1000 at the top of that pattern. If you recall, the 1015 level is the 38% Fibonacci retracement level. 1000 is also a round number, and markets tend to find resistance at that level. It would be tough to break that point, and it may be that this is the point of market failure.


If we look at the S&P on a weekly chart, we see that it's nearing overbought levels. If it can hang in there and get the short term overbought stochastic down, it may just run up like mad and hit that 1000 mark.

Today's closing is very important above 946 to see if it has the will to continue. If it does, then there's something that traders are watching. It's most evident on the DJIA:

It's an inverse head and shoulder with an apparent neckline somewhere around here. A break to the upside would take the DJIA to somewhere around 12,000. On a similar S&P chart, that level is close to 1300. Is it going to happen? Seems as if the bulls are eyeing this pattern and will try to activate it. They may not be watching the megaphone, though, so it's going to get interesting.

NOTE that for this pattern to be real, a bottom reversal head and shoulders needs to have an increase in volume on the break out. It may be the mother of all head fakes if it doesn't. Watch it closely.

Gold and oil will be important to watch as they are sensitive to the economic climate.


Oil is not yet overbought. If the market continues higher, it may need leadership to change from the stock market to the crude market. There's a clear channel of possible resistance just ahead, so crude may be the key area to focus on in the next few days. Positive moves there and a hold in the S&P above 946 will be good today.


Gold has broken its downtrend and is approaching overbought. It needs to hold 940. A break above 960 will make the longer term chart really interesting:
The inverse head and shoulders is still a possibility. If oil breaks 960, it needs to run at 1000 this time. It would probably happen in conjunction with a stock market run up.

To summarize, the next few weeks are going to make or break this bull market run. We suspect a fake out that will fail in the next month or so after it sucks more money in from the sidelines. Then one more big leg down in the stock markets. That, we believe, will likely mark the bottom of the paper markets with a long grind in store for the real economy.