While it seems like the European Union and U.S. government are stuck in a never-ending game of Whac-A-Mole, it's also apparent that more moles are popping up more quickly, needing more force to be subdued.
Some of the more stubborn and persistently recurring moles have been a weak housing market (as tracked by the iShares Down Jones U.S. Real Estate ETF), declining home-building activity (SPDR S&P Homebuilders ETF), high unemployment, weakness in the financial and banking sectors (SPDR Select Sector Fund-Financials and SPDR KBW Regional Banking ETFs), and potential country defaults. The Greek mole has been whacked over the head enough to bruise the mallet.
For right now, however, the mole that's holding the stock market captive is the stalemate deficit situation. But regardless of if, how and when the deficit mole gets whacked, this summer (or late summer) may turn quite ugly.
Here are few reasons why:
Poor Seasonality
In terms of seasonality, August is one of the worst months of the year. A silver lining is provided courtesy of the presidential election year cycle. Pre-election year Augusts tend to perform much better than the average August.
While the government's thumb may keep the scale tilted towards the bullish side in August, the months of September and October tend to be bearish, even in pre-election years.
A Looming Market Peak
The S&P is laboring on a 10-plus year bearish M formation. "The ETF Profit Strategy Newsletter" has been tracking this pattern for several months and wrote on April 3:
"There is strong Fibonacci projection resistance at 1,369. In terms of resistance levels, [this trading level of around 1,370] is a strong candidate for a reversal of potentially historic proportions."
The S&P 500 (tracked by the iShares S&P 500 Index ETF) spiked to 1,370 on May 2 and reversed sharply. However, for a confirmed bear market, the S&P would have had to drop below structural support of around 1,250 in June.
The "June 15 ETF Profit Strategy Update" outlined this support and pointed out that as long as it doesn't get violated (in fact it recommended to go long), the possibility of new highs remains on the table.
Since then, the Nasdaq-100 (QQQ) has rallied to new all-time highs. The Nasdaq Composite, S&P 500 and Dow Jones got close to new highs but reversed before (the newsletter recommended to close out long positions at S&P 1,345 and went short at 1,325).
Even though things look bleak, I wouldn't write off the possibility of new highs just yet. If the S&P rallies after a potential debt deal, it would offer a good opportunity to short the market. If it doesn't, it may fall straight into the summer doldrums.
Weakening Demand
The Dow Jones Transportation Index (IYT) provides two possible clues for investors:
1) Transports rallied to new highs on July 7, while the Dow Jones Industrial Average was unable to better its May 2 high. According to Dow theory, that's bearish.
