Head & Shoulders Top Or Double Bottom?

Monday, August 16, 2010
Stock Market Commentary:

The major averages traded in a narrow range and hovered in and out of the black before closing higher as investors digested tepid economic data from the US and Japan. Volume totals on Friday were reported lower on the NYSE and on the Nasdaq exchanges versus the prior session, which was a sign that institutional investors were not buying shares aggressively. Advancers narrowly led decliners on the NYSE and Nasdaq exchange as the major averages closed relatively flat for the day. New 52-week highs outnumbered new 52-week lows on the NYSE but trailed new lows by a large margin on the Nasdaq exchange. There were only 11 high-ranked companies from the CANSLIM.net Leaders List made a new 52-week high and appeared on the CANSLIM.net BreakOuts Page, up slightly from the 6 issues that appeared on the prior session. 

Global Economy Continues To Slow?

Overnight, Japan said its economy slowed sharply last quarter with GDP missing forecasts. Japan’s economy grew by +0.4% on an annualized basis which was less than the Street’s estimate. This put pressure on overseas markets and US futures. The global recovery theme encountered more trouble after a weaker-than-expected report on the New York manufacturing sector was released. Since last week’s Fed’ meeting, approximately $1.9 trillion has been wiped from the value of global stocks. The benchmark S&P 500 fell over -4% since August 9 which put the latest rally under pressure.

Q2 Earnings Top Estimates, But Will It Continue?

It is important to note that since earnings season began in early July, the major averages have enjoyed decent gains on the premise that Q2 earnings were strong. So far, Q2 earnings have topped the average estimate at more than +75% of the 438 companies in the S&P 500 which reported their results. The data shows that, on average, earnings grew by +51% while sales rose by +9.3%. Looking forward, investors are now concerned whether or not the healthy results will continue during the later half of the year. Elsewhere, the National Association of Home Builders/Wells Fargo confidence index slid to 13 this month which is the lowest reading since March 2009 and down from July’s reading of 14. It was also lower than the Street’s estimate for 15 and sharply lower than 50 which means respondents still view conditions as poor.

Market Action- Rally Under Pressure:

The technical action in the major averages has deteriorated significantly.  Not all of the major averages managed to rally above their recent chart highs, and all have now sliced back below their respective 200-day moving average (DMA) lines. It is also worrisome to see the number of distribution days pile up in recent weeks which puts pressure on the current seven-week rally.  Whenever a market rally becomes under pressure (as it is now), it is usually wise to err on the side of caution and adopt a strong defensive stance until the bulls regain control.

It is important to note that the major averages are currently tracing out either a massive head-and-shoulders top or a potential double bottom pattern. There are three possible scenarios from this juncture: the market will trigger a fresh technical buy signal and trade above the middle of the “W” (dotted line shown below) or it will trigger a fresh technical sell signal and take out the neckline of its H&S top (recent lows, not shown). The third possible scenario is that it continues to move “sideways” until one of the aforementioned scenarios plays out. Only time will tell how this unfolds and patience is paramount until either pattern resolves itself. Trade accordingly.

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