“Since I seldom am the bearer of upbeat news, I thought I’d pass along the cheery forecast from market strategists at Lehman and Deutsche Bank, namely, that the Standard & Poor’s 500 index will have its best six months since the second half on 1982 in the second half of 2008.

I happen to remember that period. The markets had been though a grinding loss of faith in securities, not just stocks. Philip Brothers, a commodities broker, had bought the storied Salomon Brothers; Goldman had done a reactive deal, a purchase of a commodities trader, J. Aron, which turned out to be a horrifically bad deal on any cashflow analysis (commodities went promptly into retreat shortly after the deal was concluded; J. Aron was soon hemorrhaging cash and pink slips) but in the very long term helped Goldman’s strategic position. The few fixed corporate bond deals being done were at coupons of over 15%. Similarly, very few equity issues were being done (who would want to sell stock at such low multiples?).

It on a specific day in August that thinks turned, I think August 12, that word went through Goldman like wildfire that the bear market was over. Sadly, I don’t recall the trigger for this change in sentiment (it preceded Volcker’s relenting on his dose of high interest rates, which occurred in October 1982).

The Bloomberg piece is skeptical of these forecasts, as am I based on my recollections of the reference period. Markets and sentiment are no where near as ground down as they were then. The S&P 500 earnings multiple was around 10. And given how weak the economy had been, there was ample room for both earnings improvement as well as multiple expansion.

But hey, I could be all wet. And another Bloomberg story points to a bullish indicator: record short interest. High levels of shorting means an improvement in stock prices can gain strong momentum from short covering.”

From Bloomberg:

Deutsche Bank AG, Lehman Brothers Holdings Inc. and UBS AG say the Standard & Poor’s 500 Index will gain the most in 26 years during this year’s second half. That isn’t going to happen, if history is any guide.

The S&P 500 will rise 18 percent by January, according to the consensus projection of 10 U.S. strategists surveyed by Bloomberg. The forecasts are based partly on estimates that profits will jump 50 percent in the fourth quarter after falling for the past year.

Even if that happens, it may not be enough. In 2001, the last time profits fell as much, they then had to climb for three straight quarters before stocks rebounded. Analysts’ earnings estimates for this year still represent a decline from 2006 levels, making the strategists’ optimism harder to justify, investors say.

“If they’re accurate, I’ll give them a big kiss,” said Randy Bateman, who oversees $15 billion as chief investment officer at Huntington Bancshares Inc. in Columbus, Ohio. “I don’t think those are very realistic figures.”

The S&P 500 dropped 1.2 percent last week to 1,262.90, coming within a percentage point of a “bear market,” defined as a 20 percent plummet from its peak in October. Based on the index’s closing price of 1,280 on June 30, the average strategist forecast of 1,515 by year-end calls for the biggest rally of any second half for the S&P 500 since Ronald Reagan was in the White House in 1982….

Strategists at Deutsche Bank, Lehman Brothers and UBS are the most bullish and expect the benchmark for American equities to climb to a record in the second half. Binky Chadha, Deutsche Bank’s New York-based chief strategist, says the S&P 500 will end the year at 1,650, up 29 percent from June 30.

Ian Scott, Lehman’s global strategist, is predicting an advance of 27 percent to 1,630, while David Bianco at UBS says the index will increase at least 25 percent.

The S&P 500’s rebound “is going to be one of the greatest roars we’ve seen,” Bianco said. “The market has way too many fears baked into the valuation right now. The fear out there is the earnings are about to collapse and interest rates are about to surge on inflationary fears. Neither is going to happen.”

Strategists’ annual forecasts have been off by an average of 14 percentage points since 2000, according to data compiled by Bloomberg. They haven’t projected an annual decline in at least eight years

At the start of the year, strategists told clients to expect an average 11 percent advance in the S&P 500 in 2008 to 1,634, Bloomberg data show. The measure has dropped 14 percent so far.

“A monkey with an abacus is probably better at the end of the day,” said Peter Sorrentino, a Cincinnati-based senior money manager at Huntington Asset Advisors, which oversees $16.7 billion. “To read the strategists’ input is intriguing and thought-provoking, but at the end of the day, you’d better have your own tools. We’re nowhere near as optimistic as some of the forecasts.”…

Abhijit Chakrabortti, chief global equity strategist at Morgan Stanley, wrote in a report today that the S&P 500 is still too high relative to earnings and may decline as much as 8.9 percent to 1,150 if inflation accelerates. Merrill Lynch & Co.’s Richard Bernstein expects the index to rise to 1,400 in the next 12 months, according to a July 3 note to clients…

Profits at S&P 500 companies fell for three straight quarters and are estimated to have dropped 11.2 percent in the second quarter, according to data compiled by Bloomberg. Four consecutive periods of declines would be the most since the last recession in 2001….

“Earnings in a lot of sectors should look good,” said James Swanson, Boston-based chief investment strategist at MFS Investment Management, which oversees $204 billion. He expects the S&P 500 to gain 23 percent to 1,580 by Dec. 31. “Financials should be making money again. There’s certainly a lot of wreckage now, but there are bargains out there.”…

Shares may still drop even after earnings recover, which is what happened during the last recession. The S&P 500 lost 13 percent during the five quarters of profit declines between 2001 and 2002. In the last three quarters of 2002, when earnings increased again, the index fell a further 23 percent.

“There’s always going to be ebbs and flows in the economy, but we believe that this is a start of a significant bear market,” David Tice, founder of the $1.2 billion Prudent Bear Fund, said on Bloomberg Television. “We are going to pay the price for it with much lower stock prices.”

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XLF Monthly Chart: Red Support line near $20.00 testing almost 10 year lows. Also happens to be testing 3 standard deviations out away from the mean price around $32.00. The bonus trade sent out today is also a trade that would take advantage of a bounce in XLF off of the yearly support. There is a bit of a cushion to the downside in the upper $18 levels as the position needs to expire above that price by July expiration to be profitable.

Another reason for our bullish tilt comes from recent VIX (S&P 500 Volatility Measure) readings. Past highs in the VIX around 25 and are running into 3 standard deviation channel lines, and if you are one that subscribes to the reversion to the mean theory, we are looking for a return of the VIX into the high teens as the linear regression lines right through roughly 19 and a half. A lower and falling VIX reading is usually indicative of a push higher in the broad markets — more complacency and bullish sentiment is usually correlated with lifts in the markets BUT not always.

SPY & IWM Charts below (Triple bottom setups - Oversold RSI Readings):

And on a quick note, for those of you out there looking for exposure to either long or short Oil, the MacroShares Oil Up and Oil Down funds have begun trading. Symbols UOY and DOY respectively.

Good Trading!

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Fuel prices by the same accord have risen to a national average of $4.043, a number derived from benchmark statistics of average prices from organizations such as AAA and Oil Price Information Service. Recently, a Goldman Sachs analyst projected that crude will reach $150 a barrel by July 4^th. If realized, average prices of gas could be driven up as much as $0.20-$0.30. Historically, the summer season has been met with the age old adage, “Sell in May and go away, “ but this summer may be a bit different due to oil’s overpowering influence on the market direction and investor sentiment.

***

On Capital Hill, the senate republicans spared the largest five oil companies from an “unreasonable” windfall profit tax today. The proposed 25 percent tax would have been placed upon companies like Exxon Mobil, Chevron Corp., and Shell Oil in an effort to curb runaway profits.

“We are hurting as a country. We’re hurting individually as Americans … and the other side says, `Do nothing. Don’t even debate the issue,’” complained New York Senator Charles Schumer,. “We are hurting as a country. We’re hurting individually as Americans … and the other side says, `Do nothing. Don’t even debate the issue,’”

***

Wall Street finished only a hair higher today by 9.44 points with both the Nasdaq Composite and S&P 500 leaving a mark and finishing in the red by 0.43% and 0.24% respectively. Apple’s iPhone 3G announcement boosted Apple shares today, as well as the dampening crude futures, but worries over consumer discretionary spending, inflation, and the most recent round of mortgage write-off had investors on their toes. With the consumer sector especially taking a bit of a hit recently with the elevated gas prices, Chris Colarik of Glenmede Investment Management in Philadelphia states,

“If you bet against the consumer over the past several years, you would’ve been wrong. The consumer has held up surprisingly well. However, at some point there is a breaking point. I think some people believe we may be approaching that.”

Some Wall Street analysts are also predicting close to another $170 Billion in losses due to the the collapse of the subprime mortgage market last summer. Other concerns of spill over into the auto and credit card markets also have investors on edge. If indeed a spillover occurs, high default rates on auto and credit card loans may eventually cause extended, unforeseen damage in the prime and equity markets, in addition to the already surmounting pain of losses.

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For all of you contrarians out there, check out this 1.50 CBOE Equity Put/Call Ration intraday! Reversal anyone?

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While we know that this setup seems unlikely to play out as problems with “insert favorite economic doomsday scenario here” are still on investors minds. BUT.. but we may get some type of lift in the coming weeks, as the Fed will be making big moves at the monster truck rally on the 18th. Whether or not these cuts have been priced in, as I stated before, is still unclear. S&P came out saying today that the “END IS IN SIGHT!” in terms of the sub prime crisis. Whether or not that is true, there are many more global economic implications of the write-downs and fallout, so whoop-de-do. If the broad markets get a lift and some buyers decide to step in, SPY, along with most of the broad market will face some very heavy resistance on the way up, primarily the downtrend lines and moving averages. The chart above is a textbook hypothetical of what may happen, but we shall see.

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In my previous entry, I talked about the Summation Index as a possible indication of a developing move up, but as we have seen, the reading has spiked into positive territory, only to start heading south again. This is usually indicative of a move lower, but there will be some resistance in the -400 area. Time shall tell.

Here are some charts to give a visual perspective:

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While at first glance this chart looks intimidating, its not. The red and black area indicator is the NYSE Summation Index (A popular (or not so much?) market breadth indicator that is ultimately derived from the number of advancing and declining stocks in a given market. Many people regard it as an excellent indicator of the overall “health” of the market and the market’s current trend). Above we have a weekly chart displaying the index of choice, the SPY. On top, we have a weekly VIX measurement. Moving on…

A cross of the Summation Index into positive territory is usually indicative of the beginning of a bullish trend, while a dip into the negative is usually indicative of a bearish trend to come. As you can see on the chart, we are once again flirting with a break into positive territory. If it breaches into positive territory, in combination with a falling VIX (remember the previous post, also see descending triangle pattern lines on chart above), we may have the makings of a bullish lift in the coming weeks. Not to mention the extreme CBOE Put/Call Equity readings of late. See chart below:

Please comment with your thoughts below!

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As you can see in the chart above, the VIX has been forming a descending triangle pattern lately, which generally means that the VIX should be heading lower pending a violation of the base trend line (around 24). If it does indeed breakdown into the lower 20’s/high teens, the market should break the upper triangle trend line sure enough and head a bit higher. Just as the SPY has major upside resistance, so does the VIX at the key levels of both moving averages and recent swing lows at around 18.

With Friday’s selling, most thought it was the violation of the lower triangle trend line, but the market digressed. Monday should be interesting as either bulls or bears will make a strong case and perhaps we will see a close above or below the triangle trend lines, confirming a possible uptrend or downtrend.

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 As you can see in the chart above (as of yesterdays close) SPY temporarily breached the upper trend line of the triangle. Some traders take this trend line violation as a signal and get long, which I believe is jumping the gun a bit. On the other hand, other traders usually wait for a candle to close (we’re talking dailies here) above or below the trend line before committing to a long or short position. Options traders may try to get in before the break as well, picking up cheap OTM calls if there convinced SPY is breaking out to the upside, or visa versa picking up cheap OTM Puts if they think were headed south. Given the size of the triangle, traditional technical analysis states that the size of the move following a breakout is equal to the size of the base of the triangle, leaving us with a projected 10-12 point move in either direction as a target price.

Although a move to the upside is probable, the short term RSI readings indicate were getting slightly overbought. Also the fact that the volume through this consolidation has been declining doesn’t bode well for an upside move. Remember we still have major upside resistance at a few key trendline levels, as well as the moving averages to break. Options traders may also want to look at a front month straddle to capture any move… after all pressure is really building up. With the resurgence of $100 oil, stagflation talk, and nervous CPI numbers of late, it seems though the bears have a better argument than the bulls — but remember the market isn’t always rational.

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