Equity markets appear to be under pressure once again today with the Dow Industrials (US30 CFD) dropping decisively through 11,000 and the S&P 500 (SPX500 CFD) breaking down through its 2006 closing low of 1,223.

Why are the 2006 correction lows so technically important? This is because markets tend to move in a four-year cycle relative to U.S. presidential elections. Traditionally, equity markets have tended to be soft in the first two years of a president’s term, bottom near the mid-term elections, and then strengthen through the last two years of the term heading for the next presidential election. Between 1970 and 2000, the four-year cycle low for the S&P 500, which occurred in 1974, 1978, 1982, 1987 (possibly delayed from 1986), 1990, 1994, and 1998, all occurred at higher levels.

This trend appears to have changed in this decade as the 2002 low was lower than 1998, while the 2006 low was higher than 2002. A break of the 2006 low this year, however, may suggest that bears have gained the upper hand again and equity markets could trend significantly lower in the coming months. Investors should note that the 2002 low was 21% lower than the 1998 low. A similar decline from the 2006 low would suggest possible longer-term downside toward 966, which is close to a retest of the 1998 low of 955 but still well above the 2002 low, which was near 775. Note that other potential support levels appear near 1,165 and 1,050.

The Dow Industrials (INDU), meanwhile, have not only dropped through 11,000, a key psychological level, but also 10,900, and appear to be trending toward a test of their 2006 low, which was near 10,650. If that level were to fail, the next zone of previous long-term support would appear in the 9,775 to 10,000 area.      

Sector rotation in the U.S. also suggests that investor sentiment may be becoming more cautious. Leading decliners in the U.S. appear concentrated in the financial sector including Freddie Mac (NYSE: FRE, Stock Forum), down 31.9%, and Fannie Mae (NYSE: FNM, Stock Forum), down 25.7%, despite the U.S. government support. Also, Wachovia (NYSE: WB, Stock Forum) has declined by 13.8%, Istar Financial (NYSE: SFI, Stock Forum) has fallen 10.6%, and Fifth Third (NASDAQ: FITB, Stock Forum) has dropped 8.2%. On the other hand, the health care sector, an area traditionally viewed as defensive, has been climbing, with Genzyme (NASDAQ: GENZ, Stock Forum) up 2.3%, Baxter International (NYSE: BAX, Stock Forum) up 2.0%, Schering-Plough (NYSE: SGP, Stock Forum) up 1.4%, and Johnson & Johnson (NYSE: JNJ, Stock Forum) up 1.6%.

There also has been a rotation of capital today from resource consumers to resource producers, suggesting that investors expect commodity prices to remain high. Airlines across North America have been in decline, with UAL (NASDAQ: UAUA, Stock Forum) down 17.1%, ACE Aviation (TSX: T.ACE.B, Stock Forum) down 12.2%, and Jazz Air (TSX: T.JAZ.UN, Stock Forum) down 6.6%. On the other hand, gold producers have been climbing again with Centerra Gold (TSX: T.CG, Stock Forum) up 9.2%, Alamos Gold (TSX: T.AGI, Stock Forum) up 1.8%, Newmont (NYSE: NEM, Stock Forum) up 0.8%, and Barrick Gold (TSX: T.ABX, Stock Forum) up 1.5%.

Combined, this rotation of capital suggests that investors remain concerned about the possibility of stagflation following today’s U.S. economic data releases. In June, U.S. producer prices rose by 1.8%, higher than the 1.4% expected by the market, while U.S. retail sales rose by only 0.1%, below the 0.4% increase expected. This data suggests that a stagflationary period of sluggish economic activity and rising prices may be underway. This could make it difficult for central bankers to lower rates, and with the banking system apparently still dealing with major structural problems, business conditions could remain challenging in the U.S. for some time, which may impact the outlook for corporate earnings and share prices.    

Upcoming educational webinars

In the coming months, Colin Cieszynski will be presenting a series of free webinars on trading for accredited investors from coast to coast. 

Date                Time                Topic                                      

July 22             7:30 pm ET      Developing a Trading Strategy 1:
                                               What Kind of Trader Are You?

For more information on these and additional CMC Markets seminars, please go to CMC Markets Seminar Registration Page at http://www.cmcmarkets.ca/en/content/education/free_seminars.do

This commentary is based upon technical analysis. Technical analysis is the study of price and volume and the interpretation of trading patterns associated with such studies in an attempt to project future price movements. Technical analysis does not consider any of the fundamentals of an underlying company, and as such is inherently uncertain and should not be the only factor considered by an investor in making an investment decision. 

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