Graham Summers’ Weekly Market Forecast (Get Defensive Edition)

by Graham Summers

Stocks have taken out the critical support lines of 1,294 and 1,275. We’ve also taken out the 50-DMA in a big way and are now closing in on the 200-DMA. If that line doesn’t hold: LOOK OUT BELOW.

I warned investors to shift into more defensive positions last week. The warning was well place: small caps suffered a far worse decline (nearly 4%) compared to the Dow (less than 2%).

Indeed, we’ve now entered a period of “risk off”. Small cap and Tech stocks, which lead to the upside, are falling hardest. Stocks in general are in full-scale correction mode, while Treasuries have begun to rally:

Treasuries and commodities were ahead of stocks here. And given the sharp rally we’ve seen in the former (and correction in the latter), stocks still have some catching up to do.

In the very near-term, we are oversold and could see a bounce early this week. However, every rally should be used to get more defensive as the primary prop for the stock market (QE 2) is ending in the next two weeks.

The one event traders will be hanging on to is the Fed’s FOMC meeting (June 21-22). If the Fed DOESN’T hint at additional liquidity measures, then stocks could enter a free-fall (the next Fed FOMC is August 9 2011).

Indeed, the Fed has gotten itself into an absolute bind. QE 2 bought roughly three months’ worth of improved economic data while simultaneously blowing energy and food prices through the roof. With public outrage soaring the Fed needs things to cool down before it can announce QE3 or anything like it.

The one exception to this would be if the markets enter a full-scale Crisis and stocks close in on 1,000 on the S&P 500. The most likely candidate to trigger this would be the Euro-zone where the “bailout game” might in fact be about to end. This combined with the ECB’s decision not to raise rates could result in the Euro currency getting VERY ugly in no time.

On that note, if we take out 140 on the Euro, that would be a major warning sign that we could be entering another round of systemic risk.

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