I speak of this only because we potentially are forming a new bear flag.  After extreme oversold conditions the markets finally held a previous low Monday and rallied.  This had been expected for a few days but anyone trying to catch the knife last week had their fingers chopped off… repeatedly.   We had mentioned a potential bounce level to 1338 minimum [May 22, 2012: Market Bounce Arrives - How Durable?] but as of Tuesday mid day the rally only hit 1328 as it was rejected by the quickly falling 10 day moving average.  Then yesterday started horribly as news surfaced that discussions / preparations for a Greek exit from the EU are formally starting behind the scenes, and it really looked like the bears would take charge.  Instead it was a trap, as rumors out of Europe that (a) Merkel supports backstopping all EU bank deposits (b) Italy and France support Eurobonds [May 22, 2012: Are Eurobonds Coming?] and/or (c) pick your rumor, hit.

The larger picture is this environment is akin to summer 2010 and latter 2011 where headline rumors, European comments, intervention hopes dominate the landscape and the market is herked and jerked around while in a downward path.   The action is violent in sharp contrast to January and February of this year.   Stocks are moving en masse as correlations return, and individual stock picking is nearly useless again.  Meanwhile the safe havens – the U.S. dollar and Treasury bonds, surge.  Therefore, unless you know the rumor/intervention hope of the day ahead of time it's really not a place anyone with intermediate term views is going to risk a lot of capital.

Speaking of the bear flag, yesterday's sharp rally to take markets out of steep losses to very modest gains helps define a current potential bear flag range of about 50 points: S&P 1290 to 1340.  While we did not reach the 1338 in the S&P 500 I am still going to include that in the range as that is a multi month resistance/support level the market has been dealing with throughout the year.   So just as I said in mid April what happens WITHIN that range means nothing.  The market could be UP 25 S&P points or DOWN the same, but as long as it's within that range it is only a basing activity and nothing but "white noise".  And until further notice it is has the potential of a new bear flag forming.   Of course we sit almost smack dab in the middle of said range today.

If you turn this chart upside down you would call this very bullish…. we'd be saying after a large move up, the market is going sideways for a few days to digest the move.  Hence, it is only fair to lean bearish when we have the inverse situation.  The market can always differ and change things – technicals are only a roadmap and in a world of massive intervention they can quickly be obliterated as said roadmap.  So if we hear that to stop bank runs every single cent of bank deposit in the Eurozone will be backstopped by the ECB or "Germany" (with what money???) you will get a 'face ripper' type rally I am sure.  You can see that from yesterday where nothing but rumors got the Dow up 200 points from the low.  We repeat the same pattern year after year now, downfall, bad news, crisis, intervention, rally.  Rinse, wash, repeat.

As for economic news overnight – it continues bad.  China continues to weaken, but I think commodities have been telling us this for months.  Expect more easing in the future although they cut reserve requirements 50bps a week and a half ago.  And Europe data is also very weak, but this should come to no surprise to anyone.  I think some/much of this is 'priced in' the market but the mess that is the Eurozone remains the key issue.  Everyone awaits the authorities to swoop in and "fix it" (kick the can).  My thesis that QE3 is arriving has not changed since last fall, and is only being strengthened by the day.  In fact we might get coordinated global central bank action since the level of worries are global – we'll see in a few weeks.

• The euro zone composite PMI, a combination of the services and manufacturing sectors and seen as a guide to growth, fell to 45.9 this month from April's 46.7, its lowest reading since June 2009 and its ninth month below the 50-mark that divides growth from contraction.
• Markit, which complies the PMIs, or purchasing managers indexes, said the reading was consistent with gross domestic product, which stagnated in the first quarter, falling by at least 0.5 percent across the region in the current quarter.
• "The flash PMI figures for May look horrible and provide a clear warning that euro zone GDP will almost certainly show a contraction in Q2 after stagnating in Q1," said Martin van Vliet at ING.
• Across the channel, official data showed Britain's economy shrank more than first thought between January and March, after the deepest fall in construction output in three years, while government spending made the biggest contribution to growth.
• PMI data from Germany, Europe's largest economy, showed its manufacturing sector contracted at a far greater pace than was expected, and its service sector saw minimal growth. In neighboring France, both sectors contracted faster than predicted by most economists.
• German business sentiment also dropped for the first time in seven months in May, the Ifo think tank said, missing even the most conservative forecasts, in a sign that Europe's largest economy is vulnerable to euro zone turmoil despite holding up well until now.
• HSBC's Flash China PMI, the earliest indicator of China's industrial sector, retreated to 48.7 in May from a final reading of 49.3 in April. It marked the seventh straight month that the index has been below 50.  "The series of highly disappointing April activity data – exports, imports, industrial production and retail sales indicators all fell short of even the most pessimistic forecasts – the first gauge for economic activity in the current month is a further signal that internal and external headwinds are still biting into economic momentum," said Nikolaus Keis at UniCredit.

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Of course a denial by another official would send the market up 1% immediately.  Rinse, wash, repeat – year #3.

The bigger picture right now is all stocks are moving as one asset class as our massive correlations return.  Until that changes it is very difficult to bother to be a stock picker.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

We're in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That's why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that's a good thing.

How do you expect Europe to fare?

Europe is probably the most interesting case of a deleveraging in recorded history. Normally, a country will find out what's best for itself. In other words, a central bank will make monetary decisions for the country and a treasury will set fiscal policy for the country. They might make mistakes along the way, but they can be adjusted, and eventually there is a policy for the country. There is a very big problem in Europe because there isn't a good agreement about who should bear what kind of risks, and there isn't a decision-making process to produce that kind of an agreement.

We were very close to a debt collapse in Europe, and then the European Central Bank began the LTROs [long-term refinancing operations]. The ECB said it would lend euro-zone banks as much money as they wanted at a 1% interest rate for three years. The banks then could buy government bonds with significantly higher yields, which would also produce a lot more demand for those assets and ease the pressure in countries like Spain and Italy. Essentially, the ECB and the individual banks took on a whole lot of credit exposure. The banks have something like 20 trillion euros ($25.38 trillion) worth of assets and less than one trillion euros of capital. They are very leveraged.

Also, the countries themselves have debt problems and they need to roll over existing debts and borrow more. The banks are now overleveraged and can't expand their balance sheets. And the governments don't have enough buyers of their debt. Demand has fallen not just because of bad expectations, although everybody should have bad expectations, but because the buyers themselves have less money to spend on that debt. So the ECB action created a temporary surge in buying of those bonds and it relieved the crisis for the moment, but that's still not good enough. They can keep doing that, but each central bank in each country wants to know what happens if the debtors can't pay, who is going to bear what part of the burden?

What's your outlook for the U.S.?

The economy will be slowing into the end of the year, and then it will become more risky in 2013. Then, in 2013, we have the so-called fiscal cliff and the prospect of significantly higher taxes, as well as worsening conditions in Europe to contend with. This is coming immediately after the U.S. presidential election, which makes it more difficult. This can be successfully dealt with, but it won't necessarily be successfully dealt with. We have the equipment and the policy makers, and as long as policy is well managed, we'll be okay.

What of China and the emerging economies at this point?

They are doing much better in the following way: They were in a bubble, and when I say a bubble, I mean a debt explosion. Their debts were growing at a fast rate. Their debts were rising relative to income and they were growing at rates that were too fast. Those growth rates have slowed up significantly and probably will remain at a moderate pace. They are in pretty good shape but will be subject to the deleveraging of European banks.

[Jan 3, 2012:  Bridgewater's Views Still Gloomy on 2012]

[Jul 18, 2011: Bridgewater Associates - How Ray Dalio Built the World's Richest and Strangest Hedge Fund]

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Via NYT:

• When European leaders meet on Wednesday to discuss the troubles of the euro zone, France’s president will press the issue of euro bonds, his finance minister said in Berlin on Monday. Yet, while the German government has been receptive to many proposals to revive growth on the Continent, officials here said euro bonds might well be a step too far.
• Pierre Moscovici, France’s newly appointed finance minister, traveled to Berlin for talks with his counterpart, Wolfgang Schäuble. In a news conference after the closed-door meeting, both characterized the exchange as friendly and productive, but Mr. Moscovici acknowledged that the two men, and their governments, had real differences of opinion over pooling obligations to use the credit of the strongest European countries to prop up the weaker ones, an approach achieved through euro bonds.
• Mr. Hollande’s victory in the French election has pushed the question of how to kindle economic growth in the euro zone to the top of the agenda, challenging the focus of Chancellor Angela Merkel of Germany on trimming back budget deficits to reduce indebtedness.  Ms. Merkel has signaled flexibility on some of Mr. Hollande’s ideas, including more financing for the European Investment Bank and redirecting unspent European Union funds to try to fight unemployment.
• But the German government is staunchly opposed to euro bonds until deeper integration and harmonization of budgetary and public spending policies have been achieved. Most Germans see euro bonds as another way for fellow European states to benefit from, and ultimately drag down, Germany’s unblemished credit rating.
• In his remarks to reporters at Camp David, Mr. Hollande promised to raise the issue of euro bonds at the informal European summit on Wednesday, and said “I will not be alone in proposing them.” Prime Minister Mario Monti of Italy and Prime Minister Mariano Rajoy of Spain are expected to support him but the plan will have little chance without the backing of Germany, Europe’s largest economy.
• Mr. Hollande has his work more than cut out for him if he expects to bring the Germans around. In the absence of strict controls, German policy makers say, euro bonds would be comparable to the United States’ agreeing to pay off Mexico’s debts, almost like a blank check for nations that are in trouble for overspending in the first place.
• The European Commission floated the idea of bonds issued jointly by euro zone governments in November, suggesting that such “stability bonds” could be created “in parallel” with moves toward closer fiscal union, rather than at the end of the process, as the German government prefers, to “alleviate tension” in sovereign debt markets.
• “From an economic point of view this makes sense,” a commission spokesman, Amadeu Altafaj, said Monday. “But at the end of the day this is a political decision that has to be taken by the member states of the euro area.” Mr. Altafaj added that “any form of common debt issuance requires a closer coordination of fiscal policies, moving toward a fiscal union, it is a prerequisite.”

These last few points are key.  What is missing in Europe is a fiscal union.  Unlike the U.S. and its member states where a central organization controls the fiscal (and monetary) levers, there is no such thing in Europe.  Of course "member states" in the U.S. are simply states, and not entire countries – so the situation is far more complex across the Atlantic.  But to make a common currency viable eventually there is going to need to be a push towards a fiscal union.  Or the common currency should be disbanded – otherwise none of the currency adjustments that make individual countries competitive can occur.

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Just as we use Fibonacci levels to predict pullbacks, we can use it to predict snapback bounce areas.  First let's quickly discuss what has happened in May.  The S&P 500 has pulled back almost perfectly to its first major Fibonacci level – a 38.2% retracement of the October to early April move, we discussed this last week.  Within the context of the big picture if Friday's lows were "the low" a 38.2% retracement would be a very healthy intermediate term sign.  Obviously we won't know to be true until we have the benefit of hindsight down the road.    If Friday's lows are eventually broken, then the 50% and/or 61.8% retracement levels discussed last week come into play, but that's a discussion for another day.

In terms of this bounce we see a 38.2% retracement of the May drop would take the S&P 500 to just under 1340 and a 61.8% retracement to just under 1370.  Both of these are key levels that have come up repeatedly in the past.  The market spent all of February bouncing off 1340 and 1370 was the 2011 high.  Ironic how these levels keep repeating.

Obviously we are just speaking price levels in a vacuum, and dismissing the ever present news flow which continues.  Yesterday's bounce was attributed by the media to comments out China's premier that they will focus more on growth, and some push pull in Europe between growth and austerity.  The truth of the matter is any reason would have been fine as an excuse since the market had been so extremely oversold in the near term.

If one is bearish one would expect this bounce to peter out most likely as the S&P 500 gets closer to 1340… at max 1370.  Then the market at minimum to retest lows of last Friday, if not lower.  If one is bullish one would like to see an IBD "follow through day" 4 to 10 days from Monday….i.e. any day Friday forward.  This would be a 1.7% upward move in a major index on higher volume than the previous session.  To repeat, a follow though day does not mean a new bull move must happen (it fails 3 out of 10 times, as it did in late April), but there must be one for a new bull move to happen.

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

The dollar is taking a big hit here in the past 15 minutes… not sure what it means yet, but it's been on a rampage for 2+ weeks, as people flee to safety.  Speaking of rubber band – the dollar and US bonds are off the charts.

Keep in mind some G8 and other such meetings so those in the "know" will trade on whatever is to come out (if anything) while everyone else will speculate.

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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Meanwhile they are coming around to attack the names that had been holding up – see this homebuilder ETF.

So the averages look benign while the rotational correction continues under the surface… nothing is being left unscathed.   Bigger picture, after this oversold bounce (whenever it may come) we have a host of broken charts that will needs weeks of recovery to build any real base.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

• The U2 singer owns 2.3 per cent of the shares in Facebook through his private equity firm, Elevation Partners, which they bought for $90 million (£57 million) in 2009 and now stands to make a handsome return.
• Given the social media company is currently valued at over $100billion (£63 billion), this makes Bono's share worth over $1.5 billion (£940 million) and puts him well above Paul McCartney, who is currently the world's richest rock star with a fortune of £665 million.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

As for the market yesterday's losses have taken the indexes to the second major pullback area in the 1280-1320 range.  (The first obvious pullback range was 1340).  If you are a Fibonacci fan you can see below the S&P 500 has not even yet pulled back to the 38.2% retracement which would be near 1290.  That shows you how massive the run was from October til the end of March.

[click to enlarge]

I can't show it on stockcharts.com charts but the 23.6% retracement level was 1340.  The rising 200 day moving average is also 1280ish so the most bullish outcome here would be a convergence of that 200 day and the 38.2% retracement to form an ultimate bottom.  Less positive would be a 50% pullback to the 1240s, and then if we have to deal with lower levels than that, we can circle back at that time.

In the very near term this indicator of % of S&P 500 stocks below the 50 day moving average is reaching extremes.  Any reading below 20% is usually a flag saying we are late in the game and one of those infamous furious dead cat bounces should surface relatively soon.  Of course you do have outlier events such as last August when we saw readings in the single digits – also due to European fears.  (May 2010 was the flash crash if you recall)

So we are in one of those spots where the intermediate term is bearish but in the very near term a "rip your face off" rally has the potential to surface at any moment.  Hence an uneasy spot for bulls AND bears at this moment in the short term.  Unfortunately, a lot of damage has been done technically to individual equities and as we saw yesterday random spots of extreme oversold (gold miners, silver, a few other commodities) are what rallied – but those are 2-4 day type of bounce candidates, nothing lasting.

Last, if you are an uber bull who believes the Federal Reserve can literally run the markets as a puppet master, the scenario I outlined in April (one of two really), could be playing out. [Apr 1: Is it Really as Simple as Don't Fight the Fed?]

So as Operation Twist ends in June, and talk of sterlized bond buying to replace it happens, will back half of 2012 just be "that easy"? And does April-May… the only period the market may doubt a new easing program is coming down the pike, represent the only time this year the market "would be allowed" to correct?

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog