Today we are less than six months from the next presidential election. No one knows what the outcome will be. But I thought it might help us gain some perspective to review where the markets were four years ago—six months prior to the 2008 election.

The chart below shows price movements of the S&P 500 in 2008. I added a red arrow to highlight the third week of May. As you can see, the index rose in March and April and reached a peak in mid-May. This chart includes two indicators: a moving average convergence divergence (MACD) and a relative strength index. Both of those indicators were positive and at their strongest points of the year in May 2008.

With the benefit of hindsight, we know that while there were positive signs in May 2008, in reality we were in the beginning stages of a horrible recession. As the chart shows, the S&P 500 declined from 1,450 to about 750 over the next six months.

While the S&P 500 has since staged a nice rebound, as I write this it sits at about 1,300. It has never made it back to that May 2008 level.

Now let’s review the current situation. Below is a chart of the S&P 500 over the past year. I added a red line to the chart to highlight an important support level that the index broke this week.

I am not generally a believer in trying to forecast market movements based on chart patterns. But over the past few weeks, most major indices have formed what could be described as a classic double top. Double tops are usually followed by weakness. Since making that second top at the start of the month, the S&P 500 and other major indices have declined sharply. As a result, most technical indicators are negative and indicative of positions that could continue to decline.

The gold line on the top portion of the chart is a 50-day moving average (MA). Notice that the S&P 500 broke below its 50-day MA early in May and has continued to fall.

The middle portion of the chart is a MACD. It is negative and is signaling that market momentum is downward. The RSI in the next section is showing virtually the same thing.

The bottom portion of the chart is a stochastic oscillator. A couple weeks ago I wrote that the only hopeful sign for the resumption of the rally was that the stochastic had reached an oversold level—something that usually indicates a rebound. But after a couple days of positive market movement, stocks turned down again and so did the stochastic. When this indicator rolls over during an already oversold condition that is generally a sign of significant weakness with additional price deterioration likely.

The bottom line is that there is no reason for optimism in the near future for stock prices. Technical indicators are all signaling more market weakness. Of course that is no guarantee that stock prices will collapse or even continue to decline.

Four years ago things were looking up in May, only to fall apart quite rapidly. So the best we can do is trust our indicators and keep our fingers crossed.

Flint Stephens

For the past several days, oil and gas prices have been in a free fall. Once again the media is dialed in on oil and discussing everything from how this will impact the presidential election to what the effect will be on oil company profits.

No one can dispute that oil and gas costs are critical components of the U.S. economy. But sometimes a slightly longer-term view can help us gain perspective.

Below is a chart showing the price of United States Oil Fund (USO) going back to early 2007. The first thing that becomes apparent is that the current oil price is well below the levels of 2007, 2008 and the early part of 2009. In fact, despite the hype early this year, so far in 2012 the oil price has not reached its 2011 high. From the middle months of 2009 until now, oil prices have traded in a fairly narrow channel.

With this longer-term perspective, the question people should be asking is why gasoline costs the same as 2008 when the current price of oil is only half the 2008 level. Unfortunately, I can’t answer that. But based on some technical indicators, I might be able to forecast what to expect from oil prices in the near future.

Below is a six-month chart of USO. The two periods to focus on are the end of February and the past week or so. On the top portion of the chart, you can see the price peak near the end of February. The gold line is a simple 50-day moving average (MA). I used a pink arrow to highlight the gap between USO’s price and its MA. When the distance between the two expands as much as it had at that point, one can typically expect the gap to narrow. In other words, the price is likely to come down.

The two bottom sections of the chart show a Relative Strength Index (RSI) and a stochastic oscillator. I added pink shaded areas to these indicators to show that they both had reached overbought levels that typically precede a downturn.

What this means is that at the same time the financial media was forecasting $4 or $5 a gallon gas, these technical indicators were signaling a downturn in oil prices. That turned out to be exactly what occurred.

I did not mention the moving average convergence divergence (MACD) on the middle section of the chart. Through the six-months covered by the chart, the MACD shows a pattern of lower lows and lower highs. That is a bearish formation, but it wasn’t apparent in late February. Hindsight makes some of these things much easier to see. The MACD rolled over in early March, but only after the other two indicators already signaled a change.

Now let’s consider the current situation. This time I used green to highlight the current situation. Once again there is a significant gap between the price of oil and its MA. This time, however, it is on the downward side, indicating that and upturn in oil prices is likely.

Likewise, the RSI and stochastic oscillator are at overbought levels, signaling that the price of oil is likely to rebound. The MACD is negative, but not at an overbought extreme.

The combination appears to be giving warning about an upward move in oils prices—just in time for the Memorial Day holiday driving season.

Of course, technical indicators are not always correct. There is no guarantee that oil prices will rebound. But rarely is the consensus among these indicators as clear as at present.

I should add one important disclaimer. The stochastic oscillator, the MACD and the RSI are good at forecasting turning points. They do not forecast the amplitude of the ensuing move. In other words, the price of USO could rebound from 36 to 38 or even to 50. Because the highest level of the recent three-year trading channel is at about 46, it is probable that the rebound will not push the price above that level.

Flint Stephens

The fundamental situation seems to be deteriorating as well. Although the April jobs report released today showed that the U3 unemployment rate ticked down to 8.1%, much of the underlying information was dismal. The economy is creating few new jobs and more people are dropping out of the workforce.

Gas prices are still high, though they have backed off slightly from their highest marks. Europe is reeling from continued economic challenges, the latest involving Spain. And Americans are concerned about their own bulging deficits.

The cumulative impact is that people in general–including those on Wall Street–lack confidence in the U.S. economic situation.

Below is a chart of the Nasdaq that shows how technical indicators are rolling over and beginning to favor the bears. During the first quarter, the Nasdaq was the strongest major index. In April, the Dow took over the top spot. Usually the Nasdaq leads during rallies and the Dow performs better during periods of market weakness as investors and traders shift assets toward bigger and stronger stocks.

The gold line on the chart is a simple 50-day moving average (MA). After briefly dipping below its MA mid-month, the Nasdaq (and other major indices) climbed back above that indicator. But weakness Thursday and Friday sent it back below that level.

The middle section of the chart is a moving average convergence divergence (MACD). This indicator is now resting right on the zero line and is in jeopardy of moving into negative space.

The bottom portion of the chart is a relative strength index (RSI). In order for stocks to advance, the RSI needs to trend above 50. The latest market activity pushed it below that mark again. For April, the RSI is spending more time below 50 than above. That is a negative sign.

All of this means that the overall market picture appears to be shifting from a positive bias toward the negative. That does not mean the situation won’t change again. But it certainly means that investors must keep a close watch on what is occurring.

Flint Stephens

Right now major stock market indices are also in limbo as they wait for a definitive answer about the direction and strength of the economy.

April is poised to go down as the first losing month of 2012 for major market indices, but the situation could be worse. After sliding sharply for the first week, stocks have since been moving mostly sideways.

The first three months of the year produced a strong rally and the recent pullback has only been a few percentage points. Today investors and traders would all like to know whether the strong advance that carried stocks through the first quarter is going to resume or whether an even more serious correction is about to begin.

Unfortunately, no one knows the answer. Right now technical and cyclical indicators are also giving mixed signals.

The chart below shows the performance of the S&P 500 (SPX) over the past six months. I added the New York Stock Exchange Composite (NYSE) for comparison. As the chart shows, NYSE has not fared quite as well as SPX in recent weeks. While the two are highly correlated, NYSE has definitely been the weaker. That is significant because NYSE includes all of the thousands of stocks that trade on the New York Stock Exchange. It is a much broader representation of what is occurring with stocks than the S&P 500.

The blue line on the top section of the chart is a 50-day moving average (MA) of SPX. Over the past three weeks, SPX has hovered right at that MA. One can view this as a positive because the index has not dropped strongly below its MA. However, it can also be seen as a negative sign because SPX has not had sufficient strength to rebound back above its MA.

The next section of the chart is a moving average convergence divergence (MACD) indicator. It is drifting sideways right at the zero level. The message that gives is that SPX doesn’t have much momentum in either direction.

That is pretty much the same message we get from the next section of the chart. The relative strength index (RSI) is hovering at the 50 mark. If it were trending above 50 that would be a sign that market strength was sufficient to sustain an advance. If it were dropping sharply below 50, we could infer that the market downturn would continue. At its present position, we are still just waiting to find out whether or not we will be attending the prom.

The bottom section of the chart is also inconclusive, but offers a glimmer of hope. The stochastic oscillator just turned upward again before it reached a highly oversold level. That is often a positive sign of a market upturn and possible advance.

For the time being, our best advice for investors is to hold tight and wait for addition confirmation about which direction the market will go when it break out of this sideways pattern.

Flint Stephens

That does not mean that stocks are back on totally solid ground. Most indicators are still in an area where two or three days of sharp selling could push them to into a negative mode. But at least for this week they turned upward again.

One of the major concerns continues to be the unemployment situation. Data from the Bureau of Labor Statistics (BLS) showed that the jobless rate dropped to 8.2% in March compared to 8.3% in February. But that number does not tell the whole story.

As explained in previous blogs, this number is called the U3 rate and does not accurately reflect all unemployed workers. For example, the U3 rate does not take into account discouraged workers who have not applied for a job in the previous month or the long-term unemployed who have given up looking for work.

A better gauge of total unemployment is the U6 rate. U6 for March was 14.5% and over the past year the U6 rate has ranged as high as 16.2%. It is easy to argue that even the U6 rate does not give a complete picture of the employment situation. For example, it does not take into account independent business owners whose earnings have dropped or workers who have seen a salary reduction.

It is important to know as well that the unemployment rate comes from a sample and as a result is subject to the weaknesses of the survey method. The BLS has a lengthy explanation of its sampling methodology on its website. If you would like to know how the rate is determined, it is interesting information and you can find it at this link:
http://www.bls.gov/cps/cps_htgm.htm

One paragraph stood out for me:

“A sample is not a total count, and the survey may not produce the same results that would be obtained from interviewing the entire population. But the chances are 90 out of 100 that the monthly estimate of unemployment from the sample is within about 290,000 of the figure obtainable from a total census. Since monthly unemployment totals have ranged between about 7 and 11 million in recent years, the possible error resulting from sampling is not large enough to distort the total unemployment picture.”

In other words, if the BLS is off by 290,000, that is a small number compared to the 7 to 11 million who are unemployed. But consider that a minor fluctuation in the weekly number of new filings for jobless benefit claims is often enough to move the markets. Over the past year that weekly number has ranged between 365,000 to about 435,000.

The following information comes from a Feb. 3, 2012 Reuters news report:

“In a new report from the Pew Charitable Trusts, it’s revealed that those suffering the longest from the unemployment epidemic exceed any monthly statistic dating back to the Second World War. The Labor Department figures that 5.5 million would-be workers have been without employment for 27 weeks or longer, accounting for around 42.9 percent of the total tally of unemployed Americans.

“The consulting firm Hamilton Place Strategies based out of Washington estimates that as many as 3 million additional unemployed workers have been without jobs for just as long but are not taken into consideration by the US government. For those unfortunate many, the Department of Labor simply stops including them in statistics once they are determined to have simply ‘given up’ on the job hunt. They add in their study, however, that even if bettering economic conditions prompt those considered to have given up to reevaluate the job hunt, the government’s ‘official’ unemployment rate may once again surge to unfavorable numbers as the country’s still staggering economy would not be able to create work for them.

“Additionally, the government has identified around 2.8 million Americans marginally attached to the job market in January. Per their own definition, that accounts for those who want to work and have looked for working during the last year but have not concentrated their efforts on the job hunt during the last month. They are also not accounted for in the Labor Department’s unemployment figure.”

In March, Federal Reserve Chairman Ben Bernanke expressed concerns that  improvements in jobless numbers might not be sustainable. “The job market remains far from normal; for example, the number of people working and total hours worked are still significantly below pre-crisis peaks, while the unemployment rate remains well above what most economists judge to be its long-run sustainable level. “

While Bernanke tried to put a positive spin on the employment situation, he admitted that, “On balance, an assessment of a broad range of indicators suggests that a substantial portion of the decline in the unemployment rate does reflect genuine improvement in labor market conditions.”

Given the current nationwide economic condition, any improved numbers are welcome. Obviously, however, the jobless situation remains a major concern for Washington and for Wall Street. And bad news about unemployment has the potential to quickly derail any market recovery.

Flint Stephens

As we noted two weeks ago, stocks just completed a powerful first-quarter performance. For the first three months of the year, stocks showed little weakness. After such a strong showing—especially with the fundamental economic challenges that persist—it isn’t surprising to see stocks take a breather.

The chart below shows the current situation quite well. This week the S&P 500 broke below its 50-day moving average (MA) for the first time since mid-December. That certainly must be viewed as a negative signal, but it is not necessarily evidence that a major correction is on the near horizon. As evidence, the last time this occurred the S&P 500 only stayed below its MA for a few sessions before it staged the strong advance that carried us through the past three months.

The next section of the chart is a moving average convergence divergence (MACD). The recent market weakness turned the MACD downward, but it has not yet fallen into negative territory. At this point it is impossible to know whether the indicator will slide below zero or whether it will turn upward again.

The relative strength index (RSI) which is the next portion of the chart is telling a similar story. The RSI dipped below 50, but if it recovers over the next few days and re-establishes its trend above the 50 level, then the current mark will not be significant.

What these three indicators are showing is that under current circumstances, caution is warranted. The next week or two will determine if this is just a short-term downward blip or if it is the beginning of a more significant intermediate correction.

The bottom section of the above chart should give hope to market optimists. This is a stochastic oscillator and it does a fairly good job of identifying investment turning points. This latest period of weakness has pushed this indicator to a low level. In many cases when the indicator reaches this level, a market rebound occurs.

The weakness of this indicator is that while it does a good job of identifying overbought and oversold market turning points, it is not predictive of the amplitude of the ensuing reversal. In other words, while a rebound is likely, it is difficult to forecast whether it will be minor or major. And we cannot say whether it is going to last for three or four trading sessions or for several weeks.

One more chart can help in the current assessment of market conditions. The image below shows a comparison of the Nasdaq, DJIA and S&P 500 over the past six months. While all three made good gains during this period, notice how the Nasdaq was at the bottom of the three around Thanksgiving and then jumped ahead of the other two major indices in March.

The Nasdaq is considered as an index driven by technology stocks. The general perception is that the Nasdaq does better than the other two blue chip indices when economic conditions are favorable. In a weak economy, money tends to shift away from the Nasdaq and toward blue chip stocks or bonds.

After the recent downturn, the Nasdaq currently remains the strongest of these three indices. If the market weakness continues, we would expect that the Nasdaq would accelerate its decline and slide below the other two indices.

So far, the Nasdaq is holding up better than the S&P 500 and the DJIA. Unlike those indices, the Nasdaq has not yet broken below its 50-day MA. As a result, there remains a possibility that this will be a minor correction and that stocks will quickly resume their advance.

The next couple of weeks are going to be important for stocks. If there is a reversal and stocks advance to new yearly highs, then that sets the stage for a rally that could continue for several more weeks or months.

On the other hand, if major stock indices fail to recover or cannot reach new highs, then it would not be surprising to see a much more significant correction that lasts for weeks or months.

Flint Stephens