It's Decision Time For The Bulls

That may be a rather dire statement but the reality is we are at a significant inflection point for the American equities markets. It doesn't mean the end of the world nor does it mean we are headed for a mind numbing decline but we are at a crossroads for the bulls. They may slice right through it but I'm very suspect of any market action this weak. Especially given how overbought many commonly used internal measures are with such weak action. I'm looking for as much confirmation to start putting on a heavy short position if the action doesn't get any better than what we've been seeing. As weak as this rally has been, I am not getting the type of clear indication of topping activity which was clearly telegraphed in early May. ie, With such a weak rally, I expect us to peter out but it hasn't happened yet.

I mentioned earlier today that we hit a six year 50% pivot on the OEX today. Coupled with three charts I am going to show you, it looks like the bulls have some muscling to do if they are going to hold the line here. I don't think they can much longer but what I think really doesn't matter. It's what they do.

First chart is of the Russell 2000, R2K. Of the small, mid and large cap indices, the small cap Russell 2000 has been the market leader this cycle. The R2K has been extremely weak on this rally. The index is at a very strong 61% Fibonacci retracement level while also sitting at the top of a rising channel. 740 defines both the channel top and the Fib level.

The second chart is of the S&P 500 where the index is in a nice rising channel but has also reached resistance at the prior high. While I doubt we will stop at exactly the old high, there is still resistance in this entire area. A rising wedge resistance line lies directly above as does a Fibonacci level a handful of percentage points higher.

The third chart is of the Transports. The Transports are another cycle leader which are extremely weak. That should not be surprising as many commodity and energy stocks are falling off of a cliff. Remember commodity equities typically lead their respective commodities. The Transports were positively correlated to energy commodities for fundamental reasons and they had great pricing power because of it. One was because they were hauling all of the finished goods from China, another because they were hauling all of the raw materials to China and a final reason was because rails have a nearly 5X cost advantage over other shipping methods when oil is this high. Falling energy is a sign that fundamentals in these leaders is likely at a negative inflection point. Transports are also at a Fibonacci retracement level and trendline resistance level. The Fib level is marked on the chart. Weeks of attempting to launch a rally while the market moves up is not a good sign for the economy or the Transports. I have written time and again that I believe the Transports are also in bubble territory with their bubble brethren, energy. To provide evidence of this, the Transports have been this overbought two times in eighty years. Once the index fell over 95% and the other time it fell nearly 50%. Now 95% is pretty extreme but don't think we can't get the kind of correction which will devastate you financially or make your favorite food Pepto-Bismol. The risks are high and regardless of the type of correction, one needs to practice strong risk management when risk is elevated. ie, Covered calls, long/short strategies, cash or more reasonably valued sectors.

Note: Coal stocks are being annihilated. Fording is down almost 50% in a few months and Peabody is down nearly 60%. This is not an orderly decline. People are running for the door. You want to step in here and buy the dips? Think twice. These stocks will hit a rally point somewhere because at this rate they are going to be at zero by the end of the year. But unless you are a trader, forget about it. Peabody rose to nearly $80 this year. Just a few years ago it was under $4. What's fair value? Closer to $4 than $80. This is a coal stock. Not the cure for cancer. We've got coal coming out of our ears from a supply standpoint. Energy is a bubble and we aren't running out any time soon. If you like the energy story, and it surely is a plausible investment as it has performed well for decades, buy when the Fed is reflating, not now. ie, You don't need to believe in peak oil to make money in energy stocks. Exxon Mobil has crushed nearly any other large cap investment over a period of thirty years. Even when oil was at $10.