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THE BULLS HAVE BEEN READY to declare a new upleg in the market on the basis of the positive reaction to a few good earnings reports. But that has not been the reality so far in July.
Low volume notwithstanding, price action in the short term has been to the upside. But the Standard & Poor's 500 has now run into a rather strong ceiling, making this week an important inflection point (see Chart 1). Moreover, poor action by many stocks with good earnings—the bulls' strongest rationale for the recent upmove—is at odds with their optimism.
Chart 1
Earnings season kicked off this week with a bang, and the market got a boost from such market bellwethers as Alcoa (ticker: AA) and Intel (INTC). It would seem that the news tipped from bad to good to keep the gains coming. Good news should beget good price action, so there is nothing unusual here.
Let's step back a bit to see what really happened to some of these earnings leaders. Alcoa released better-than-expected numbers Monday and promptly soared after hours. Indeed, the stock opened Tuesday over 4% higher than it closed Monday.
But by the end of the day the gain was pared to 1%. In other words, it gave up most of its gains to close in the lower third of the day's range. What we thought should happen -- a strong finish -- was not reality.
Railroad stock CSX (CSX) also beat its numbers after the close Monday, giving both economists and stock-market bulls reason to cheer. It traded higher Tuesday morning but closed lower on the day. That formed what chart watchers call a bearish outside-day reversal (see Chart 2), a short-term signal that the trend that preceded it was over. Given the huge volume traded during that outside day, the bears had a pretty good case.
Chart 2
Once again, what was expected to sustain the rally failed to meet those expectations. Seeing some of the early stars of earnings season sold on the news is probably not good for the market's health.
To be sure, some stocks acted relatively well on good earnings -- Intel and Expedia (EXPE), for example), unlike Alcoa and CSX. But Intel's gains were fading as the overall market traded lower Wednesday afternoon.
Stocks that reported lackluster earnings, such as Yum Brands (YUM), were punished. This operator of well-known casual restaurant chains fell 3% after the close Tuesday, erasing two days of gains in the process, and remained lower Wednesday.
The calendar also may start to work against the market. The Commodity Trader's Almanac points out that a run-up into the summer earnings season is not unusual; in other words, buy the rumor. It reports that selling the market on July 15 and holding until July 26 results in a 70% chance of success over the past 27 years. So, sell the news.
This is a part of well-known seasonal tendencies for the stock market. The Commodity Trader's Almanac finds that July usually starts the worst four months of the year in the Nasdaq. July also falls in the middle of the worst six months for the Dow Jones Industrial Average. To quote the Almanac, "Market conditions that tend to start out strong early in the month tend to fade towards the middle to end of the month."
Again, this is what frequently is seen this time of year. It does not always work, to be sure. But given the huge run higher that we've already had in little more than a week, and the overhead resistance now in effect across major market indexes, it does seem to be the better bet.
Getting Technical Mailbag:Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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