Why This Impressive Rally Is Showing Some Signs of Slowing Down (AGQ, XLE, XME, UNG, IWM)

Chris Ciovacco: As of 3:15 p.m. on Friday, we have four factors that tell us the odds are increasing for the market to pull back soon (Monday or Tuesday):

FACTOR ONE: RECESSION CALL

The Economic Cycle Research Institute (ECRI) has a very good track record in terms of forecasting economic downturns. You can read the full text of one of their recent press releases here – they sum up the statement this way:

It’s important to understand that recession doesn’t mean a bad economy – we’ve had that for years now. It means an economy that keeps worsening, because it’s locked into a vicious cycle. It means that the jobless rate, already above 9%, will go much higher, and the federal budget deficit, already above a trillion dollars, will soar.

Here’s what ECRI’s recession call really says: if you think this is a bad economy, you haven’t seen anything yet. And that has profound implications for both Main Street and Wall Street.

The ECRI analysis aligns with our work – stocks and commodities do not perform well in the early stages of a recession. The ECRI outlook also supports our current deflationary and defensive holdings.

FACTOR TWO: RESISTANCE

FACTOR THREE: SHORT-TERM BEARISH DIVERGENCES

FACTOR FOUR: VOLUME IS WEAK

With only an hour and a half left of trading on Friday, the lack of conviction behind today’s rally can be seen in the low intraday volume of the following economically sensitive ETFs. If hedge funds and institutions were interested in buying today, the volume numbers below would be at least headed for an average day. Given the scope of the recent gains, you would expect higher than average volume showing confidence in the economy and “improving” situation in Europe. The volume figures shown below are abnormally low, highlighting concerns about the economy, staying power of the current rally, and situation in Europe.

The limited interest in trading silver (NYSE:SLV) on Friday and the close of 31.34 leaves the deflationary door open similar to 2008 (see article with levels to watch). According to IBD, the volume during the entire move from the October 4 low has been weak:

But volume faded 3% on the Nasdaq and 14% on the NYSE (was lower on Friday relative to Thursday), according to preliminary data. Nasdaq’s volume hasn’t hit even an average pace since Oct. 5, while the S&P 500’s trading has been below par since Oct. 4.

Could stocks continue to move higher early next week? Sure they could, but Friday’s action clearly shows the short-term momentum to the upside is slowing.

While the current rally has been very impressive, it is not out of character for a typical bear market countertrend move. More upside is quite possible with logical S&P 500 short-term reversal points coming in between Friday’s close of 1,224 and 1,260. We mentioned back on August 12 a bear market rally could revisit 1,260. A move above 1,260, especially for more than two or three days, would put a dent in the bearish case. We will continue to favor the long-term trends, which remain down, and maintain a deflationary bias. We will also monitor the markets for a more observable shift to negate the longer-term bearish case. The market is rarely as good (or as bad) as it looks, especially after a vertical rally.

Written By Chris Ciovacco From Ciovacco Capital Management, LLC

Chris Ciovacco began his investment career with Morgan Stanley in   Atlanta in 1994. With a focus on global macro investing, Chris uses  both  fundamental and technical analysis to assist in managing risk  while  looking for growth opportunities around the globe in all asset  classes.  If you are looking for an independent money manager or  financial  advisor, Ciovacco Capital is worth a look. Chris graduated  from Georgia  Tech with Highest Honors earning a degree in Industrial  and Systems  Engineering in 1990. His experience in the professional  ranks began in  1985 as he began working as a co-op for IBM in Atlanta.

Ciovacco Capital Management, LLC (CCM) is an independent money management firm serving clients nationwide. By utilizing extensive research, disciplined risk management techniques, and a globally diversified approach, CCM prudently manages   investments for individuals and business owners. Our focus is on   principal protection and purchasing power preservation in an   ever-changing global investment climate.

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