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On Monday, Standard & Poor's revised its long-term outlook on U.S. debt from "stable" to "negative." But it was the stock market, not the bond market, that took it on the chin. After all, it was stocks, not bonds, that doubled since March 2009.
In the low-interest rate and high-liquidity environment of the past two years, it's easy to understand why stocks have performed well. But a negative outlook on U.S. debt suggests the end of easy-money policies may be closer than investors had hoped.
If liquidity dries up, then stocks will struggle.
Technically, the S&P 500 was already in a precarious position after stalling near its February high (see Chart). Momentum and volume indicators showed internal weakness even though the market's rebound from the Japanese earthquake and tsunami seemed strong.
Standard & Poor's 500
Last week, I wrote here that shifts in leadership did not bode well for stocks (see Getting Technical, "The Defensive Team Takes the Field," April 13). Weakness in technology and financial stocks is usually not consistent with a healthy rally. And emerging leadership in defensive areas such as health care, tobacco and food at the same time makes it even more of a warning.
Another problem that was perhaps more worrisome was the pervasive bullishness in investor attitudes. Again, in last week's column I wrote that investor surveys pointed towards complacency and a general view that the market is going to keep moving higher.
Indeed, the Chicago Board Options Exchange Volatility Index—known better by its ticker, the VIX—closed Friday at its lowest level since July 17, 2007, the day the Dow rose to 14,000 for the first time. A low reading of the VIX, the market's so-called "fear gauge" suggests a lack of investor worry.
Given current investor concerns such as Middle-East unrest, European debt problems and U.S. unemployment, the lack of fear as evidenced by the low VIX reading seemed to indicate that the market turned a blind eye to problems.
In technical analysis, we trade on what is happening and not what should be happening. But we also must be alert for when sentiment- based indicators reach extremes as the VIX did last week.
To be sure, the stock market has had serious shocks before and rebounded quickly, if not on the same day the news came out. The feeling was that liquidity would find its way into stocks and any dip was a buying opportunity. However, thanks to the S&P downgrade, liquidity is now less of a given. Things are not quite the same as they were just last week even though the U.S. still officially holds its triple A credit rating.
The question now is where the market can go. Although this forecast was seriously sidetracked, I still believe a total of 10-12% correction is in the cards. Last month, I outlined the case for the Dow Jones Industrial Average to drop to the area of its November 2010 low in the 11,000 area (see Getting Technical, "The Correction Is Well Underway," March 16).
At the time, the market moved below the rising trendline that supported the rally since August 2010 and the key 50-day moving average. Further, trading volume was bearish as more shares changed hands on days when sellers dominated than when buyers were in control. There was an urgency to sell, not to buy.
In today's market, we can add the change in leadership as mentioned above as well as the breakdowns of many leading stocks. For example, Apple (ticker: AAPL) moved below short-term support and is now in the red, albeit not by much, for the year.
Superstars in the economically sensitive, or cyclical, sectors have also seen breakdowns. And it is across the board from Caterpillar (CAT) and US Steel (X) to General Motors (GM) and aerospace giant General Dynamics (GD),
And metals miner Freeport McMoran Copper & Gold (FCX), considered to be an economic bellwether by many, fell hard last week and continues to take a beating.
Investors should now take heed. Even if the U.S. never loses its top-notch credit rating, the specter that it is possible has now come to light. In the markets, perception is reality.
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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