Financial Review

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DOW + 263 = 16,380
SPX + 24 = 1886
NAS + 41 = 4258
10 YR YLD + .05 = 2.20%
OIL + .27 = 82.97
GOLD – .70 = 1239.20
SILV – .10 = 17.37

The markets were down for the week, even with the bounce Friday. For the week, the Dow and the S&P each dropped about 1%; the Dow was down 164 points on the week, and the S&P was down 20 points. The S&P is now down for 4 consecutive weeks.

Let’s take a look at the charts. Earlier in the week I talked about support and resistance. Someone mentioned to me that they weren’t quite clear on the concept. So, here is a good way to look at these topics. Support is the floor and resistance is the ceiling. Think of a chart as a staircase under construction. The stairs are being built, hopefully higher and higher, and to prop up the stairs, you have to have a structure, or floors and ceilings. When you break through the ceiling to a new higher level, that ceiling then becomes the floor for the next level up. In other words, resistance becomes support. If the staircase of price falls, the last floor will catch you, or provide support. Then to go higher yet again, you will have to punch through that ceiling, or resistance, again.

So, let’s look at support and resistance for the major indices. The Dow Industrials dropped below support last Friday, when the price dropped below the 200 day moving average at 16,592. On Monday, the Dow dropped below another level of support at 16,310, slightly below the old low of 16,333 on August 7. Tuesday, the Dow was just slightly lower, trying to cling to that level of support. Wednesday, was another big down day. Thursday was an inside day, just slightly down; an inside day means the high and the low were within the range of the highs and lows for Wednesday. Then today we got a bounce.

So, as of today, we have a new floor, which is the low for the day of 16,118. The next ceiling, or level of resistance is 16,310, and then the next level of resistance is the 200 day moving average at 16,586, and then the next level of resistance is the old high on September 19th at 17,350. That means the Dow would have to break through three ceilings to get back to new highs. Keep in mind the idea of the staircase, and as we go through each ceiling we have to have something to prop up the staircase. We would need very strong earnings, or accommodative monetary policy, or something that could justify those prices going higher.

Now, the really important short-term level of resistance and support is around 16,310. If we look back over the past few months we find that that level served as support in April, May (twice in May), and August. That’s important because the more times that floor supports the market it indicates that that is a level where the floor is very strong. If the Dow cannot hold above the 16,300 to 16350 level, then the next support level is around 15,350 from back in February. So, if next Monday or Tuesday, we take out today’s low of 16,118, the next level of support is all the way down to 15,350.

For the S&P 500 index the 200 day moving average is at 1906, which is also the low from August. Of course that level was breached at the start of the week. And so now the old level of support at 1906 becomes the new level of resistance. Then, the next level of resistance would be the old high from September 19, at 2019. If the S&P 500 can’t hold above today’s low of 1864, we might expect to drop down to the next level of support. The next levels off support are at 1815, the old low from April; then at 1737, the old low from February.

Today’s price action would indicate that the indices are trying to reverse the slide. If you use candlestick charts, the pattern today could be described as a morning star. The morning star is a three candle pattern. The first candle was Wednesday, which was a big down day; yesterday was a neutral day (slightly positive on the S&P 500 and only slightly negative on the Dow), or what is known as a doji; and today we had a strong positive day that closed above the high from Wednesday.

When found in a downtrend, this pattern can be an indication that a reversal in the price trend is going to take place. What the pattern represents from a supply and demand point of view is a lot of selling in the period which forms the first black candle; then, a period of lower trading but with a reduced range, which indicates indecision in the market; this forms the second candle. This is followed by a large white candle, representing buyers taking control of the market. Today, you have to think that some of the hedge funds and big money players were stepping in to buy the dip, or pick up bargains, or to cover short positions. And if you want to increase your probabilities, you would wait for confirmation in the fourth candle, however today’s move was big enough that more aggressive traders might not wait. With the usual caveat that I don’t know what the markets will do on Monday, you don’t know; nobody knows. None of this is a guarantee, it is just looking at probabilities.

Another consideration is that we are still in a very long and strong bull market; the past couple of weeks have not changed that overall trend. We’ve had a few whiffs of panic, lots of indecision, and reasons for concern, but we haven’t seen a full-fledged freak out. The possible exception to that, at least in equities, would be the Russell 2000 index of small cap stocks, which saw a 10% drop, or what is considered a correction; and there we saw a nice bounce back this week. The Russell was down about 3 points today, but for the week it is up about 30 points at 1082.

There are several possible reasons why small caps have found support, including: bargain hunting and short covering, but also small caps have less international exposure; and with global weakness, especially in Europe, the small caps are a way to focus on US growth. And even though the economic news in the US has not been great, it has been reasonably good and it has been better than most other global markets.

Today, the Thomson Reuters/University of Michigan preliminary October reading on the overall index on consumer sentiment came in at 86.4, up from 84.6 in September, and the highest since July 2007.

And separate data showed groundbreaking for new homes rose more than expected last month. Housing starts rose 6.3% to an annual 1.02 million-unit pace. Newly issued permits also rose. You’ve got to think the recent reduction in rates will have a somewhat positive effect for the housing market in the next couple of months.

Toss in a few good earnings reports today: GE’s third-quarter net income rose 10% to $3.5 billion, or 35 cents per share; that was better than expected. Revenue, at $36.1 billion was a bit under guesstimates, but then GE raised guidance on revenue.

Morgan Stanley (MS) reported an 87% increase in third quarter earnings, as they got back to their investment banking roots, and focused on bond trading and wealth management; and working on the Alibaba IPO also helped.

Honeywell (HON) reported net income rose to $1.17 billion in the quarter, or $1.47 per share, from $990 million, or $1.24 per share, a year earlier. Honeywell also raised the low end of its full-year forecast range for both profit and revenue, and said it is looking for acquisitions. Not a big surprise as Honeywell is very involved in aerospace, which has been very strong this year.

Schlumberger (SLB) reported better than expected earnings and revenue. Schlumberger is in the oilfield services business, and they provide drilling technology and equipment, and construction services and such. Of course, the drilling activity in the US has carried over to that sector. Of course, it will be interesting to see how the oil sector fares moving forward as oil prices are down more than 25% from the June highs.

Earlier this week, Russian President Vlad Putin warned that Russia might reduce gas supplies to Europe if Ukraine steals from the transit pipeline to cover its own needs. In June, Russia cut off supply to Ukraine over what gas exporter Gazprom said were billions of euros in unpaid bills. Without Russian flows, there is concern Ukraine might have to siphon off gas from flows transiting the country en route to Europe this winter. Today, after talks with leaders from Europe and Ukraine in Milan, Italy, Putin said a deal had been reached that would ensure gas supplies to European buyers “at least for the winter.” More talks continue in Brussels next week.

Also, earlier this week, Credit Suisse published a report saying rising inequality in the US is at levels that have been associated with recessions in the past, and that the ratio of income to wealth is at the highest level since the Great Depression. Today, Federal Reserve Chairwoman Janet Yellen delivered a speech in Boston at a conference on inequality, and she said the increase in inequality is a concern for her. Though Yellen didn’t go so far as to echo Credit Suisse’s recession alarm, she did warn that rising inequality risked doing serious harm to the overall strength of the US economy. Yellen noted that living standards have been “stagnant” for most Americans for the past few decades, and that is an unhealthy development for an economy that relies mainly on consumer spending to drive growth.

Yellen also stepped just a little outside the boundaries of monetary policy to hint at the idea of more federal funding for education. The Boston Fed named education as one of the four “building blocks of opportunity” that could help reduce inequality, with the other three being parents’ financial resources, starting a business, and inheritance.