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Market Trouble Brewing on the Horizon

Short-term trend is up, but the charts are flashing some warning signs


Stocks finished down on Monday, and after peaking out at around 1 p.m., slowly moved a little lower again into the afternoon as both sides of the aisle proposed new plans for the U.S.debt ceiling and investors had much to digest. Health care was the worst-performing sector of the day as earnings results of hospital operator HCA Holdings (NYSE:HCA) kept the sector under pressure.

It is quite amazing that given the massive issues surrounding the debt piles in Europe and theUnited States, stocks and bonds aren’t falling off a cliff and investors aren’t building bunkers below their homes. To many, if not most, investors, this seems to defy logic, and that’s exactly where we find opportunity as traders.

The massive melt-up in risk assets off the 2009 lows can certainly be attributed in part to the various government stimuli packages around the world. At the same time, it is important to remember that the global debt concerns haven’t significantly affected corporate earnings.

Look at the 12-month chart of the Nasdaq 100, for example. It is at its best level in over 10 years and looking to break higher out of an eight-month consolidation phase.

Nasdaq 100 Chart

At the same time, many corporations have increased earnings per share through cost cutting as opposed to growth, and so one could certainly make the argument that underlying growth is lacking to justify much higher stock prices in the medium term. I would agree with such an argument, but would point out that it is a separate issue from the global sovereign debt concerns in the near term. And that brings us full circle: Stocks don’t necessarily have to sell off because of any potential imminent sovereign defaults — and they haven’t, at least not yet. But stocks will come under pressure in a more inflationary environment as EPS growth again decelerates.

Looked at in a different way, if the smart money was overly concerned about these debt problems, they certainly would have sold off the stock market and especially theU.S.bond market a long time ago. However, the U.S. Treasury market is still viewed as one of the few safe havens, and the chart of the 10-year Treasury note futures proves it. The bull market in Treasurys is still intact.

10-Year Treasury Note Futures Charts

I keep pointing out the chart of Goldman Sachs (NYSE:GS) as a proxy for the newfound bid in the financial sector. Yesterday, the stock again moved higher by 1%, confirming a breakout of the downtrend channel in which the stock has traded in since mid-May.

GS Chart

The S&P 500, despite closing down -0.56% yesterday, remains in a setup where the path of least resistance for the short term is up. If and when the index can overcome the 1,355 area (blue line) on a closing basis, it should give way to 1,370, which is the upside target I have spoken of for some time.

SPX Chart

Looking out beyond the next few weeks, however, I see dark clouds on the horizon. Much like semiconductors stocks, I look to the Dow Jones Transport Index as measured by the iShares Dow Jones Transportation Average (NYSE:IYT) as a leading indicator to sniff out the future direction of the broader market. The five-year weekly chart of this index shows we are again right at resistance levels from 2007 and 2008.

IYT Weekly Chart

Looking at a daily chart dating back to April 2011, we note the divergence between the RSI oscillator in the bottom part of the graph and price in the upper part of the graph. Such divergences are what I continually look for on the charts, and the fact that it coincides with multi-year resistance is a troubling sign. Additionally, please note the evening star candle pattern in early July, where prices gapped up, created a doji, and the following day gapped down again and headed lower (gray bubble).

IYT Daily Chart

Until those darker clouds arrive, however, we first will hopefully get a decision on the U.S. debt ceiling, which depending on the package that is being agreed upon, could lift the S&P 500 to somewhere near the 1,370 level. And the U.S. debt ceiling decision is likely to dictate trading until it is out in the open and understood by the markets.

Serge Berger is the head trader and investment strategist for The Steady Trader. Sign up for his free weekly newsletter.

Article printed from InvestorPlace Media, http://investorplace.com/2011/07/stock-market-trouble-brewing-on-the-horizon/.

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