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Posted on 4 June 2011 | 4,444 views

Has a 2011 Top Just Formed in the U.S. Stock Markets?

There is no sure thing when timing the stock market but when price action and other “Technical Analysis” stock indicators confirm fundamental economic issues, it’s a good bet to go with the flow. Right now, the flow is down — the level of debt the government has taken on to aid an economic recovery is at the extreme and has become extravagant because of the financial crisis. U.S debt stood at 92% of GDP at year-end 2010, on par with beleaguered Portugal’s level of public debt.

It appears a tipping point may finally be here. The government, through legislative programs and actions at the Federal Reserve, has spent trillions to stimulate economic growth following the recent economic crisis but the historically enormous stimulus has failed to generate a robust economic recovery, illustrated plainly by sub-par GDP growth and anemic employment numbers.

Examining the price and volume action in the major market averages, the most obvious problem is the third failed rally attempt in the averages since the May 2, 2011 high. Downtrends begin as a series of failed rally attempts and each failed attempt disheartens buyers and draws in more aggressive selling. Volume lately has typically picked up on the downside and lightened up on the rally attempts, opposite of a healthy environment.

Leadership has also grown thin, meaning lower quality stocks have been leading lately while stocks of many companies with better financials and growth prospects have languished. Weak financial stocks present another overhang; the stock market typically struggles when financials are weak and they have weakened considerably this year as evident by the action in the Financial Select Sector SPDR ETF (Stock Symbol: XLF), down 11% since its peak in February, compared to down 2% in the S&P500 index as of yesterday’s close. These intermediate-term negatives coincide with another observation: rallies following major bear markets (like the one ending in March 2009) typically run into resistance after two years of trending up, and that is where we find ourselves today.

Moody’s is now placing Bank of America (Stock Symbol: BAC), Wells Fargo (Stock Symbol: WFC), and Citigroup (Stock Symbol: C) on review for possible credit downgrade.

Current indicators suggest that the May 2011 top may be a major top and one such indicator highlights a lack of participation of the so-called smart money since the March 2009 low. The indicator, called the “McCurtain Most Actives Advance Decline Line” (MAAD), counts daily the twenty most active issues on the New York Stock Exchange, adding one for issues up and subtracting one for issues down.

Plotted on a chart, when the ensuing line moves in tandem with the market averages, the logic is smart money is embracing the rally, but when the line lags, smart money is dubious. This indicator has lagged the market since the March 2009 low and more recently, the “McCurtain Cumulative Volume Line” has not confirmed the market’s rally since the April 2010 highs. Historically, such a non-confirmation occurs halfway through a rally and if April 2010 was the half-way mark of the rally from the March 2009 low, the top would be expected in May 2011.

The decline off a major top can take one to two years to play out, with several sharp bear market rallies within the overall decline. Given the magnitude of the economic distortions in the current economy caused by the enormous government stimulus, I would not be surprised to see a sudden crisis develop and a concurrent “Crash in Stock Prices” within the next six to nine months.

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