We had earlier commented that last week's trading action was suggestive of an 'inside week' formation - a consolidation after recent steep losses. This week's action was similar, with the front-line indexes staying confined within last week's trading range, forming a 'double inside week'. Inside weeks are continuation patterns, with double inside weeks being even more so. Bears have certainly taken a breather after the sharp blood-letting in January. Despite the ups and downs during the week, bulls can probably claim a semblance of victory at the end, considering multiple negative news-flow (dismal Philly Fed data, sharp rise in inflation, crude rising to over $100 a barrel), finishing the week with less half a percentage gains. Other markets, however, did much better, with Bovespa closing the week with 7% gains.
S&P 500 - Weekly Chart
The trading action from the panic January lows can be likened to that of a bearish pennant. A bearish pennant occurs because prices seldom decline in a straight line for an extended period of time. Prices will typically take brief pauses, seemingly to 'catch their breadth', before resuming their trend. The lead-in phase (the pole of the bearish pole & pennant formation) occurs as the market adjusts to unfavorable events/news-flow pushing prices sharply lower, with nervous sellers and fresh short-sellers being quite willing to sell even at lower prices. As prices drop, early sellers who had sold short at higher levels look to cover their positions even as some others start bargain-hunting. The forces are now balanced between those who are willing to support the market in anticipation of a rebound and those who believe the negative economic/fundamental developments warrant lower prices going forward. The stock begins to consolidate in a narrowing range on decreasing volume, even as the bearish news-flow and negative market sentiment persists. Things finally come to a head, when a negative news trigger comes out that leads a secondary collapse in prices through the lower line of the pennant formation. This phase (lead-out phase) is marked by a noticeable increase in volume as sellers - new and old - outnumber the bargain-hunters and the profit-takers. Prices decline sharply in this period - usually as much as the height of the pole - albeit at a slightly more gradual pace.
Dow Jones Industrials - Daily Chart
While the action over the last few weeks fits this description rather nicely, it is important to remember that patterns that everybody looks at and recognizes tend to have a high failure rate. Everybody seems to have an opinion on what this consolidation means for the market. As with any chart pattern, the challenge is not how to trade the break, but what to do once the break occurs.
Interestingly, the indexes witnessed a phenomenal rebound (as much as 250 points on the Dow Jones Industrials) in the last half hour on Friday after CNBC reported that a bailout plan for troubled bond insurer Ambac Financial could be announced next week. As had occurred on Wednesday as well, investors at times set aside existing concerns and snap up stocks either to cover bets that stocks would fall or amid genuine, if tentative, optimism that policymakers could help right the economy. Wall Street's bursts of optimism haven't proved to be long-lasting though. A government-backed plan to aid bond insurers could nevertheless help boost confidence in the bond market, where a lack of confidence has choked the flow of money.
We dissect the Philly Fed manufacturing survey this week. Manufacturing has been reasonably resilient thus far; but as the survey reveals, chinks are developing on that front as well. We will keenly watch whether the ISM Manufacturing index, that measures manufacturing activity on a national scale, comes along similar lines (slated for release on March 3). We next review the looming prospect of stagflation that has been further emboldened by this week's CPI data. It is a catch-22 situation for a Fed that is caught between two evil damaging forces. This should make for an interesting read.
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