Technical Analysis
A Technical Look at Next Week's Market
 By Mark Manning
RealMoney.com Contributor
5/16/2008 7:28 AM EDT
URL: http://www.thestreet.com/p/rmoney/technicalanalysis/10417060.html

There are two parts of the inflation story to discuss, with the first part occurring on Wednesday, when the U.S. Labor Department said the CPI index rose less than expected in April. That is a sign that the slowing economy may be bringing about a long-awaited easing of inflation. The core price, excluding food and energy costs, rose 0.1%. Last year, they rose 2.3%, which the Federal Reserve said was above their comfort zone.

To be frank, I don't know who out there believes these manipulated numbers that the government puts out. I think it's better if investors forget about what the government is telling them, and pay attention to the market's reaction to this type of news.

First of all, stripping out food and energy costs is a major portion of every U.S. citizen's expenses. Just ask the person walking down the street if he sees inflation when he goes to the gas station or grocery store.

Even though the Federal Reserve states that higher prices for food and energy are not overflowing to other areas of the economy, like wage inflation, the bond market may be telling another story. The other part of the story is that inflation trends in Asia could be pointing to a major shift in interest rates.

Bond Yields See a Bottom?

To see what is going on, let's first take a look at the 10-year Treasury yield index. You can see that it has been moving steadily higher since the bottom in March. Over the past month, it has been holding well above its 50-day moving average, and is currently right up against the 4% resistance zone.

A solid break above this area would likely suggest that bond yields have certainly bottomed and that a major change in interest rate trends are taking place. This will be one of the first major signals that bond traders see inflation that is much higher than the government's numbers.

CBOE 10-Year Treasury Yield Index
Click here for larger image.
Source: TC2000

The 30-year Treasury yield index is also showing that a significant long-term bottom is likely in. Major resistance lies around the 4.7% area, and a break above that level would change the long-term trend from down to up.

Technically, the chart is forming an important ascending-triangle bottoming formation. This becomes even more important since the long-term chart (not show) shows that the 30-year-yield lows in January and April have held the major support that was put in during the lows of 2003 and 2005.

CBOE 30-Year Treasury Yield Index
Click here for larger image.
Source: TC2000

Ease Inflation Through the Dollar

The Federal Reserve has been concerned that low U.S. interest rates are weakening the dollar, which pushes commodity prices higher, which leads to a spiraling inflation problem. The Fed knows that if they raise short-term rates -- or don't prevent the bond traders from doing it -- they can help contain the commodity run by giving a boost to the U.S. dollar and easing inflationary problems.

That may be one of the reasons that we have seen the recent run-up in the dollar from the March and April lows. So, the fact that interest rates may be rising would certainly be beneficial to the dollar, but it would likely put the commodity market into a correction mode.

You can see from the chart below that the dollar is still in a long-term decline and is currently approaching the 74 resistance level. If the price can break above that, it still has the 75 level to deal with, but there may be a good chance that we will see a run to the 77-78 level in the intermediate term. Long term, I continue to believe that the dollar is a flawed currency and the longer-term trend is probably down.

U.S. Dollar Index
Click here for larger image.
Source: TC2000

Possible Correction Provides Crude Opportunity

Regular readers know that I believe the long-term move in the commodities has a way to go. However, the area is looking overextended in the near term, and there continues to be negative divergences and institutional moneystream and volume during a recent move up.

For example, on Thursday, there was nearly a $4 intraday swing in oil prices that took crude to an all-time high of $126.43 per barrel. If you look at the chart of OIL, which tracks the Goldman Sachs crude oil index, you can see that the price has recently accelerated its uptrend, but has also experienced some heavy selling over the past couple days.

You can also see that the institutional moneystream has been moving down, while prices moved up. This intraday reversal may be the first sign of a short-term correction in oil prices in the next week or so. Of course, this all depends on the supply/demand situation, and any correction may offer investors a great opportunity to add to positions in the oil patch.

iPath S&P Goldman Sachs Crude Oil Index
Click here for larger image.
Source: TC2000

Volume Decrease Hits Commodities

You can also see that the commodities have continued to move up, as volume has decreased over the past few weeks, and that the institutional moneystream has been trending sideways, while the price has been moving up. If we do see a break in the red trend line, there is a good chance that there will be a correction at least down to the $32-$34 area, and that may be something we could see by next week.

Powershares DB Commodity Index ETF
Click here for larger image.
Source: TC2000
Last week I said that my indicators were pointing to and intermediate-term correction in the market indices. My indicators like the percent of stocks above the 40 day moving average were signaling that current risks remains very high. However, the market continues to remain very strong and proceeds to march ever-increasing higher. That has led my indicators to become even more stretched into the red zone. It certainly doesn't mean that the market is going to go into a major slide, but it does tell me that the risks are historically very high.

At time of publication, Manning had no positions in the stocks mentioned, although holdings can change at any time.

Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Manning appreciates your feedback; click here to send him an email.