Monday, September 14, 2009

There is A Real Risk the Third Quarter High is in Place

for the SP500 with all trade below 1039-1041
If you’re not short already, you’ll risk missing the turn.

The problem with being perpetually short is the need to be willing to be perpetually chased out of the
market for an untold number of short-covering rallies. This strategy works well for nimble traders that
have a great feel for market behavior. The reason I start this report off with the saying “if you’re not short
already is that you will indeed risk missing the turn. We got a lot of ground to cover, here, so let’s start
with the big picture on the weekly charts, then move right into the daily and intraday charts.
Don’t Mess with Mr. 18

The bearish momentum on the 18 month moving average is sloping into 1020 this week. This extremely
active moving average is aggressively bearish as we end the 3rd Quarter of 2009, sustaining a trade above
it for any length of time on the initial challenge as we head into October is almost laughable. The last time
the SP500 challenged this moving average was May 2008, not a pretty result, given how our policymakers
made missteps throughout the balance of the year by not implementing mechanisms to successfully
resolve future Bear Stearns failure events. Choosing to make the entire financial system a government-
sponsored zombie can hardly be said to be a laudable policy choice for the long term. There may be very
little virtue in these short term policies being implemented for the long term, but hey, it is what it is. But I
digress, the point is that, at the very least, one must be hedged or rebalancing one’s portfolio if long up to
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this point. The market is encountering the stiff headwinds of the bearishly sloped 18 month moving
average. Be safe. Get protection and enjoy the game.

The identified resistance zone a month ago was 1028-1052. This is half way back to the Oct 2007 high
and a 58% advance off the March 2009 low. The rally to 1048 last week fell just shy of the 58% advance
target. The 58% advance target was the inverse of the 58% decline into March 2009. The high set last
week. You will want to note that Sept 11 2009 is the same day of the month that set the high in October
2007, the 11th.

We can not neglect to point out that the last time fiscal and monetary stimulus was this strong happened to
be in 1975, when tax cuts and fiscal spending quadrupled the federal deficit. The initial rally off the

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December 1974 low stalled out after a 55% advance 7 months later. This is quite approximate to the 58%
six month advance off the March 2009 low.

A ten-week 12% correction ensued following the 55% initial advance in 1975. I expect the correction to
follow will be a minimum of 9-12% targeting 922-952. This would include a retest of the 9-11 lows at
939, the 1998 lows at 929-936, and as we can see on the daily chart below, a test of the Q1 and Q2 2009
highs at 943 and 957 respectively.
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 Where We are on the Three Peaks and Domed House on the Daily Chart

The chart above indicates the SP500 has put in the point 7 high on the Three Peaks and a Domed House
pattern, or nearly so. The pattern indicates that a point 10 low is apt to form shortly. The signature
attribute about point 10s in this pattern is that they are sharp and sudden. They are volatile and can be deep
corrections. It is NOT a surprise when these sharp breaks occur. Roughly speaking, we want to bracket
that 50% retrace to the July Q3 lows at 952 as the first key support. 952 falls smack dab between the Q1
high at 943 and Q2 high at 957. It is near here that we should expect market participants to begin slip into
their dip-buying modality and dip-buying behavior in Q3 and Q4. That may or may not be “too close to
the market.” If volatility really kicks in high gear, we could see a retest of the Q3 lows at 865.

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Such an event can not be ruled out ahead of the mid-October economic calendar which includes the
October 14 retail sales report for September. This will be one ugly month over month report because the
cash for clunkers program ended in August. So, the September retail sales report in mid-October will be
particularly ugly. Like a bad kidney stone, until the retail sales report for September has passed, risks to
the downside will outweigh the upside risks.

I have insisted for several weeks that until the September 15 retail sales report “has passed” risks would be
to the upside. That is to say the govt programs, tax cuts, and boosts to social security have created short-
term boosts to retail sales in the summer of 2009. The goosing of the retail sales report has in turn goosed
the stock market. The biggest risks to investors occurred after the June 11 retail sales report. Investors
bought the rumor, sold the news. The same thing is about to happen again. But investors need to be wary
of one fact, the stock market does not need to set a new high on the Sept 15 retail sales report. The high
could well have been set on Friday September 11, and investors are now getting positioned short or short-
hedged ahead of that report.

I say that investors are getting hedged short ahead of the retail sales report for several reasons. First, most
all of the major highs and lows were set on Friday this year. These Friday dates include March 6, June 5,
Aug 7 and Aug 28. Now, the August 28 high has a peculiarity that I want to take pains to point out.
Investors knew that Tuesday’s Sept 2 ISM report would be friendly, but what did they do. They got
hedged short on the Friday before, and the friendly report was treated harshly. Yes, there was some
rankling in China about their central bank removing stimulus, but heck, there was no offset from the
friendly ISM report, the stock market simply tanked that day. Could a new move high set on Tuesday’s
Sept 15 retail sales report and squeeze shorts yet again? Yes, it could, but, then again, if we don’t get a
high close today, and closes this Monday low like Monday August 28 closed low, the shorts will be
encouraged to stay short into tomorrow’s retail sales report and ride out whatever upside volatility they
need to with room to still throw out more short hedges above last weeks highs.

Momentum on the intraday chart has shifted overnight from being outright bullish to being simply neutral
to bullish. This happened last in late August and then rolled over. Now, this week happened to open at
1029 on the Dec 09 contract. This is the daily high close of August for the continuation contract. The
bullish moving average is sloping into 1031 today. Below 1029, the stock markets short term bullish
momentum will roll over and we will begin a full blown market correction into October.

That is why investors and traders will be trying to get short today above the August high on the Dec
contract at 1034 and around 1038-1041. They do not know whether there will be a high close or a low
close on the SP500 today. Broadly speaking, however, if the short sellers win the day today in the 1034-
1041 zone, and do not get chased out with a high close and prices roll over to the downside below 1029 by
end of day today, well then it should be curtains for the second advance off the March 2009 bear market
cycle low.

The intraday charts are shown on the next few pages.

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 EP 120

Not only did investors get short ahead of Tuesday Sept 2nd ISM report on the Friday prior, they also got
short on Friday August 7 prior to the August 13 retail sales report. By the time the Aug 13 retail sales
report came out at 7:30 am, the stock market was too far below the high of Friday August 7 to take it out
when the friendly August 13 number came out. Thus the potential for a low close today makes a strong
case for traders and investors to be hedging themselves short today in the simple event that when the

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friendly number comes tomorrow, investors sell the good news because they have already bought the
rumor.

Revisiting the Domed Pattern on the Intraday Chart

For the past several weeks, I have focused on the Sept 1 ISM to the Sept 15 Retails Sales report as the
time window to expect an intermediate cresting of the stock market. I have also outlined that Lindsay’s
Three Peaks and a Domed House pattern on the intraday chart would be cresting in this time window. The
“dome” on this pattern are points 21-to-23. As we can see, the time window the dome has crested in has
actually been Aug 28 to Sept 11. August 28 was two days before the Sept 1 ISM report and Sept 11 was

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two days before the Sept 15 retail sales report. Yes, a high close today would likely set up the potential for
a spike high on the Sept 15 retail sales report, But, if the stock market “sits down” by end of day today,
setting new move highs on the retail sales report will be that much more difficult. Whether a higher high
sets tomorrow or whether it set on Friday Sept 11 matters little.

This report allows for a nominal new high to be set on Tuesday’s retail sales report before correcting. This
possibility detracts nothing from working premise that the stock market is at its weakest moments after
retail sales reports this summer, as seen in both July and August. The conclusion is that the downside risks
will far outweigh the upside risks near term after the Sept 15 retail sales report, for roughly one month. In
other words, this 58% advance off the March 2009 lows will come to a conclusion as the government’s
short term stimulus from cash for clunkers no longer gooses the month over month retail sales reports. The
only flaw in this analysis is that my recency bias is not validated by subsequent price action and market
behavior. Big whoop, I can live with a small margin of error and adjust. So can you in your own risk
management strategies.

Oh, and that intraday domed pattern, btw, is a leading indicator. There are 28 total points to the pattern.
The signature attribute to the point 28 low is that it retests the point 10 low, which in this case is the Q3
low at 865 set at the onset of the earnings season when Whitney made her bullish call on the banking
sector. Nice call Whitney. A retest of the point 10 low would be to “round-trip” the 3rd quarter. Because
this is an intraday count, and not the daily count, I want to seriously caution bearish traders not to overly
commit to this 865 target. If it is not reached by October 14’s kidney stone of a retail sales report, let it go.
There is a mountain of support bulls can cling to in the 922-952 price zone, and the point 10 low on the
daily pattern count, just may not get through it. We just don’t know from here.

It is truly a buyer beware market after the Sept 15 retail sales reports. You don’t want to end up with
buyers’ remorse like those one in four cash-for-clunker buyers. Give the market a chance to breathe, allow
it to oscillate to the downside for a month, until that Oct 14 kidney stone of a retail sales report “has
passed.” I’ll bet my bottom dollar you will be glad you did!