Sentiment Needs Correcting...

Jack Steiman from SwingTradeOnline.com at 01/18/10

This is what likely needs to happen. I have talked about the short-term risk for some days with the primary trend still being higher. Within those primary trends there comes a time when markets need to pull back lower. That needs to take place when sentiment gets too heavy on the bullish side of things. We now see sentiment readings very close to levels that have caused pullbacks in bull markets just about every time although timing it is virtually impossible. A 37.5% spread as of the week of January 4th and this isn't great news for the bulls although far from a death knell. 37.5% more bulls equals a top soon to come and its possible the top was put in yesterday given some weekly engulfing candles on our Nasdaq/NDX charts (non confirmed on the Dow/S&P 500/Wilshire 5000).

When you get this overbought on the oscillators and on sentiment you usually need to create the opposite effect meaning you need to scare folks so we can balance out the froth. How can we scare folks is what the big money thinks about and clearly the answer is to bring the market down further than many think reasonable within a bullish trend and to bring down leading stocks below their 50-day exponential moving averages when most thought there was no way for that to take place. These corrective moves usually need some time to finish themselves off as willing buyers are there at pullbacks initially and only over some weeks will they finally begin to give that process up when they see it's no longer working.

That's when fear creeps up on the bulls enough to knock down the froth and allow for the market to stop selling. We may need to breach those 50-day exponential moving averages on the daily index charts just to get the bigger scare if that's what it'll take to get the bulls from not buying every pullback. For now the top looks to be in short-term. This by no means necessarily tells us that the longer-term market is finished going higher. We'll take this day by day and be VERY CAUTIOUS with new plays. The markets stalled on two consecutive attempts at our 1150-1160 backtest area on the S&P 500 seen in our Monthly Chart below.

We saw earnings start in earnest last night and this morning when Intel (INTC) and JP Morgan Chase (JPM) reported their numbers. INTC was a blow out. It soared in after hours trading but fell very hard today. It sold off on great news. Classic market topping action.
JPM wasn't so good and that's when the market futures started to fall this morning. That was the perfect excuse for the bears to pounce as JPM is a leader. It said revenues were down unexpectedly and that they weren't going to give a dividend for now as business just didn't warrant such a program. That's not what the market wanted to hear I'm sure. They wanted to hear things were going much better and they wanted to see revenues explode far beyond expectation.

The market got everything it didn't want and nothing they did. JPM was the excuse the market bears waited for and now we find ourselves wondering what it will take for stocks to rise on good earnings. Good news being sold is what we also see at tops thus we have the nasty combination of sentiment and good earnings being sold. Anything that has been up decently prior to their earnings report probably can't say much right now to get their stocks higher but it is important for the medium and longer-term to report good numbers.

The one area that can really bring this market down for a decent correction are the stocks that started this whole mess to begin with and that's the financial stocks. JPM is the king along with Goldman Sachs (GS) but JPM disappointed. If they disappointed then the odds race higher that the rest of that sector won't report very good revenues or earnings as well and this sets up more selling from very heavily weighted stocks within this area of the market. That will put pressure on the S&P 500 for sure.

If stocks like Apple (AAPL), Google (GOOG) and Amazon.com (AMZN) lose their 50-day exponential moving averages that will also cause pressure on the market. Leading technology stocks are the perfect tonic for deeper selling if they lose those critical 50's with some force. Financials are looking like the best sell candidates but we can also look for high beta technology stocks to join the fray as they teeter on the edge here. One bad day from here and they all snap. Take a look at our charts below and you can clearly see we are a gap down move from taking out some key Supports.

The other thing we need to keep an eye on is for the commodity world and that's the action of the PowerShares DB US Dollar Index (UUP) or the ETF for the dollar. That ETF has a direct connection to the commodity stocks and if that ever breaks over 23.20 it will fly and cause the commodity stocks to crumble for a while. It's not close to that level yet but it did have a decent day today although it's still far from a great play. We must respect it, however, thus know that if you're in long a bunch of commodity plays, you'll want to watch 23.20 and the UUP. Over that level on a closing basis is trouble for commodity bulls.

Look folks, there comes a time when all bullish trends need to pause for some time to reset things. That can only happen when some fear and decent selling comes in to play. We finally have the gap down reversal that looks for real as many stocks lost big support levels today. We need this. It's healthy. Bull runs, if they're to continue, need periods of bad action to bring in fear and unwind all the very overbought oscillators on the daily and even weekly charts. Look at it as a good thing as it'll afford very good buying opportunities down the road. I warn you all about getting too bearish for the long term at this moment in time. If something takes place while this correction moves along that says we need to think otherwise, I'll adjust. For now I look forward to some decent selling to bring the bears back in to the game and ratchet up fear on the side of the bulls. One day at a time here please.
I'll be going very easy on any new long positions for some weeks I'd gather and will short if an opportunity presents itself. Please adjust your short term bullishness. Be open for what's possible medium to longer-term.

We moved back to a heavy cash stance late week given the likelihood that we were going to see some Weekly Bearish Engulfing Candles which did occur in some groups and they can sometimes usher in a change of trend. The Retail ETF RTH broke down Friday after a poor mid-week report. The Semiconductor Sector which remains in a longer-term uptrend took it on the chin after we got a "sell the news" event post the Intel earnings report. The Telecom sector was also under some heavy pressure. Most groups are testing back to their respective Rising Support Lines off the March lows and will likely be undergoing major tests next week as earnings unfold. It’s common to see some corrective action after the majority of the key reports are out. Keep a close watch on the Financials and Transports in the week ahead as many inflectional reports are due out of those areas.