Wednesday, December 12, 2007

When fundamentals and technicals collide

The Fed made it's hardly unexpected 25 basis point rate cut, and the market reacted like it was a big surprise. Too much hope and not enough reason priced into the market, contributed to the large decline. The 50-day MAs were there in the end to be the bull spoiler, and the warning sign for trouble. The reason for the reversal will eventually fade to memory, and we will be left with a chart which said the 50-day MA was resistance. But that would only tell half the story. Yesterday was a great example of how key market events and technical parameters can work together. The presence of 50-day MA (or 200-day MA, even the 20-day MA) was a flag to suggest the market was susceptible to a significant news event - even one as expected as the Fed announcement. The chance for a ho-hum response to the Fed announcement was never going to be high. The Dow could have just as easily added 200 points if the perception for what the rate change meant for the stock market was positive. Had the market rallied, yesterday's lows would have been great support. As it stands, yesterday's highs (in combination with the 50-day MAs) are now significant resistance for Tech, Small and Large caps.

The same combination of technical and fundamental drivers played a role in the last rate cut. I pulled the following from my November 1st post on my website/newsletter:

...Bulls are in trouble. Not only have Tech [NASDAQ and NASDAQ 100] breakouts reversed, but have done so on heavier volume - leaving large bull traps in the wake of the Fed decision. Both of these indices generated whipsaw signals in their MACD trigger lines - another mechanism which will have trapped bulls on the (former) Fed breakout. The warning signs were clear in the underperforming semiconductor index, and it was somewhat ironic to see this index relatively unscathed by the broad sell off. What is of greater concern for bulls is the action in the large caps [Dow and S&P]. Both left large bearish (and somewhat complicated) "falling three method" continuation patterns. The Dow cleaved through its 50-day MA and it's almost a turkey shoot to reach its 200-day MA. Adding insult to injury, nearly every heavy volume day since the start of October has been a distribution day and today was of no exception, not the kind of form which key breakouts are made of. The S&P at least was able to finish on its 50-day MA, but there isn't room for lots of optimism.

Back to the present, of all indices to watch, small caps have the strongest bearish qualities:

[1] A confirmed series of lower highs and lower lows
[2] A "Death Cross" (long term bear signal) between their 50-day MA and 200-day MA
[3] And a clear stochastic 'sell' signal following the index reversal off its 50-day MA.

The combination of weak factors was a shorts heaven for Russell traders. This makes ~800 a very important area for the Russell. Should the Russell push past above 800 it would likely clear both 50-day and 200-day MAs and force shorts into covering. It would also bring the index closer towards negating the series of lower highs and lower lows. As it stands now, a retest of November lows looks very much on the cards and bulls will need all their resolve if this is not to turn into greater bloodshed.

Watch closely.