A bullish reverse “Head & Shoulders” pattern appears to be developing on the CBOE S&P 500 Volatility Index (VIX) suggesting that a sharp move higher in this index is likely to occur soon. While bullish for buyers of “volatility”, this pattern is clearly bearish for the S&P 500 Index, since there is a high inverse correlation between the two.

Thursday night’s revelation of J.P. Morgan’s unexpected “hedging” loss of roughly $2B, along with worries that similar losses could be present on the balance sheets of other big banks has clearly moved to the “front line” of investor fears. The impact of last week’s European elections and the policy shifts that they imply, have also altered the uncertainty factor that trouble investors.

A series of sub-par trading sessions (volume wise), a cloud of relative indifference to either good or bad news, and the sense that investor confidence is eroding again has resulted in a period of “range trading” in recent weeks, despite higher-than-expected consumer confidence readings.

A decline in commodity prices along with persistently low 10-year Treasury and Bund yields might be viewed as evidence that capital is shifting away from risk assets and into assets that are perceived to be “safe”. While the “safety” issue is debatable, the expectation for another round of quantitative easing is growing. Before such an announcement could be made by the Federal Reserve, however, a broad based selloff in equity prices might occur first.

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A weaker-than-expected 2.2% rise in Q1 GDP, a disappointingly dismal monthly jobs report and a likely political shift away from austerity measures in Europe sent German 10-year bunds to a record low yield of 1.58% last week. In concert with German yields, yields on U.S.treasury 10-year note (TNX) fell to a closing level of 1.88%. While Friday’s close was still above its record low of 1.696% set last September, they appear poised to set new record lows in the weeks just ahead.

While a shift away from austerity in Europe hints of a move toward massive fiscal stimulus and the possibility of a rise in inflation rates, the more immediate threat of a default on sovereign debt in Spain or Greece is troublesome in the near-term for stability of European banks.

Adding to the likelihood of a move toward lower 10-year note yields was a sharp drop in crude oil prices on Friday. An unexpected 2.84 million gain in crude oil inventories pushed the overall U.S. stockpile to 375.9 million barrels, a 21-year high.

Although monthly technical oscillators remain in an extreme condition on U.S. 10-year Treasury notes (TNX), a push down toward key “channel bottom” support (in terms of yield) that now sits at the 1.40% level is clearly possible.

Currently, U.S. 10-year notes remain above German bunds as well as Japanese JGBs, which are currently offering yields below the 1% level making U.S. bonds relatively attractive. Nevertheless, the Treasury department is scheduled to sell $24 billion fresh 10-year treasury notes on Wednesday, which could temporarily depress bond prices and lift yields a bit in front of the auction. It will be the auction results and the digestion of those notes that could trigger a renewed move toward lower yields.

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Although a number of analysts have recently speculated that the Federal Reserve Open Market Committee might be forced to raise short-term interest rates well before their pre-announced commitment to keep them low throughout “at least” late 2014, the Dow Jones Utility Index (DJU) continues to edge higher. In a slow, but deliberate fashion, investors who are focused of securing returns from either interest on bonds or dividend yielding equities have pushed utility stock prices higher. Retirees, pension managers and conservative investors concerned about capital preservation are clearly included in this group.

Still, the prospect of “operation twist” coming to an end this June has some observers concerned that a steeper yield curve could emerge later this year. That being said, worries over European sovereign debt, a recent decline in commodity prices and continued weakness n the housing market have teamed up to push 30-year fixed mortgage rates near record lows with this past week averaging 3.88%.

With utility stocks typically providing yields in excess of 4%, such as Exelon (EXC at 5.40%), First Energy (FE at 4.70%), Duke Power (DUK at 4.70%), Pepco Holdings (POM at 5.5%), PPL Corporation (PPL at 5.30%), American Electric Power (AEP at 4.90%) and many others, the allure is compelling. Communication stocks such as AT&T (T at 5.40%) and Verizon (VZ at 5.00%) are appealing as well.

Nevertheless, a growing number of analysts have been favoring a shift away from utility and communication stocks and instead into large capitalized growth stocks since the beginning of the year. As a result, utility stocks did under performing during Q1 2012.

Still, the chart of the Dow Jones Utility Index (DJU) suggests that a broad, bullish reverse Head & Shoulders pattern that targets a minimum move up to the 525 level continues to play out. A move up to 525 is an 11.83% rise from Friday’s close of 469.46, not including dividend yields. This is a compelling prospect considering that global growth is likely to remain restrained over the next few quarters.

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With the presidency of French conservative Nicolas Sarkozy in jeopardy, worries that the alliance between Sarkozy and German Chancellor Angela Merkel (known as Merkozy), which favors austerity over massive fiscal stimulus in the Euro Zone, may be in jeopardy as well. Renewed worries that the regional debt crisis in Europe is worsening, particularly in Spain (and possibly inItaly) put downward pressure on the Euro Dollar last week. Conversely, the U.S. dollar index (DXY) appears to be in position to extend higher despite concerns that the economic recovery in the U.S. may be running out of steam.

Importantly, the U.S. dollar index (DXY) is now approaching a test of primary downtrend resistance that sits at the 81.65 level. A break above this resistance would increase the likelihood of a possible extension up to key “cross” trend line resistance currently sitting at 87.25.

In recent years, history has shown that a rise in the DXY is usually accompanied by a decline in stock prices as well as an increase in price volatility. Further, a decline in commodity prices as well as drop in bond yields as usually associated with dollar strength as well.

A failure to rise above 81.65, however, would likely help keep equity prices range bound until, perhaps, the November elections. That being said, it is important to the Euro Zone that growth in the U.S., as well as inChinacontinues play out. It would be a stabilizing influence on the European economy as their self imposed austerity measures get their debt ratios down to manageable levels. A decline or a significant slow down in either the U.S. or China could instead frighten investors globally.

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After stalling out at the 1,422 level on April 2^nd (albeit an interesting point that 1,422 is a numerical anagram of that date: 4/2/12), the S&P 500 Index (SPX) has seemingly been in a consolidation phase. This post-Q1 phase has been characterized but sharp intraday price swings and a rise in the CBOE S&P 500 Volatility Index (VIX) since its 13.66 low was scored on March 16th. Fundamentally, “earnings season” has now begun with some positive surprises having already been announced. Forward guidance as well as geo-political events, however, have kept investors in a defense posture, particularly after coming off such a stellar first quarter performance.

Overbought technical conditions on weekly charts combined with last month’s disappointing employment report may have also forced many investors to look for better points of “entry” before committing cash.  While the vagaries of economic reports out of Europe swinging both bullishly or bearishly at times, there is reason to expect global growth to be limited at best.

As a result, investors continue to search for reasonable “entry” points on specific company names or sectors. When looking at the S&P 500 Index itself, it appears that the first key “cross” trend line support now sits at 1,319, but rises gently over time. If that level is reached quickly, however, current overbought conditions will not have had enough time to diminish very much. That leaves the door ajar for a more pronounced adjustment lower, unless fresh positive fundamental events become the focus.

As the “sell in May and go away” mantra draws closer, the bigger issue at hand is whether the 1,319 level can hold as support. Lower gasoline prices, a string of better-than-expected weekly initial jobless claims combined with a slew of upbeat earnings guidance would clearly help. Worries over the slowdown in China, the financial problems of both Spain and Portugal, and the expectation the state and municipal job layoffs (as their collective budget deadline of June 30^th approaches) could cause investors to trim positions and “wait and see”. An increase in political President election-year rhetoric could also be cause for a pause.

Thus, a solid break below key trend line support at the 1,319 level on the SPX could trigger a more pernicious response from investors.

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With a number of technical oscillators on weekly charts bearishly positioned, the Reuters/Jefferies CRB Total Return Index continued to slip last week, extending a decline that originated in late February. Natural gas prices have led the path lower and have proved to be the weakest. Despite oversold conditions and a reduction in drilling rigs from 886 a year ago to 647 now, some observers predict that sub $2 prices will arrive soon. In contrast, gasoline prices have increased steadily and are now at uncomfortable levels. Nevertheless, the notion of rising commodity prices has been waning in recent weeks due to diminished expectations for another round of quantitative easing (QE). In turn, this has resulted in lower precious metal prices as well as lower prices of copper, nickel and aluminum.

A number of grain charts, including soybean, wheat and corn, also suggest that a correction to lower levels appears likely over the months just ahead.

Friday’s weaker-than-expected employment data, however, could revive the idea that QE is not entirely off the table. Increased signs of a more pronounced decline in global growth (particularly in the Euro zone and China) might also raise the prospect of more QE in the months just ahead.

For now, the Reuters/Jefferies CRB Total Return Index appears to be aimed for a test of key “cross” trend line support located at the 293.50 level. If that level fails to hold as support, however, the worry would be that a solid extension to the downside could result. While troublesome for commodity producers and farmers, such a break would be very positive news for consumers as well as for companies who are large commodity users. That being said, it is worth keeping a sharp eye on the 293.50 level.

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With stochastic studies rising positively on long-term (monthly) charts, it appears that the Dow Jones Transportation Average may be aimed for a test of key “channel top” resistance that currently sits at the 5,675 level. While the absence of an overbought condition on monthly charts is supportive of higher levels, a bearish technical divergence in the form of a Moving Average Convergence and Divergence (MACD) non-confirmation signal is present as well. A “non-confirmation” signal occurs when the price of a security or an index achieves a new high, but the corresponding MACD oscillator does not. Such a condition suggests that bullish price “momentum” is on the wane which, in turn, is considered to be a big yellow flag of caution.

Another area of concern is that the pattern of the Dow Jones Transportation Average for the past three years resembles one that occurred between 2005 and 2008. In that case, one could argue that a bearish Head & Shoulders pattern had formed albeit with its “right shoulder” equaling the height of the “head”. But there’s the rub, because the current set-up suggests that the likelihood of a “channel top” test is reasonably good and a possible and similar “head & Shoulders” pattern could once again occur. If this transportation index fails to break above channel resistance again, a good deal of investor consternation might well emerge.

Rising transportation costs, weaker demand for raw materials fromChina, or the approach of a possible “fiscal cliff” after this year’s Presidential election is resolved could each contribute to a slowdown in transportation activity heading into 2013. Renewed worries over European debt issues could reemerge as a threat as well.

All of these concerns should cause Dow Theorists to pay heed to the outcome of the expected “channel top” test. Those observers need to see the Dow Jones Transportation Average rise and confirm gains scored by the Dow Jones Industrial Average in order to boost confidence that the economy is on sure footing.

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As Q1 2012 comes to close, it is worth noting that the CBOE S&P 500 Volatility Index (VIX) has already tested and held key long-term trend line support now at 13.66 back on March 16th. With worries over European sovereign debt diminished and on the “back burner”, and withU.S.domestic economic data continuing to show improvement at a modest pace, low volume sessions have prevailed in recent weeks. In addition, a number of upwardly revised earnings estimates have helped steady the S&P 500 index and contain wide intraday price swings.

That being said, history has shown that once this particular VIX trend line has been successfully tested, a relative “peak” in equity prices occurs soon after. Moreover, it is usually followed by reversal to lower levels within weeks or possibly months of the initial test.

“Window dressing” in front of quarter’s end will likely keep a firm bid to equity prices this week. Still, “earnings season” will soon begin and with it, position squaring in the form of profit taking could result.

Nevertheless, first key resistance now at the 1,425 level on the S&P 500 has yet to be reached. Nor has key resistance near 13,700 on the Dow Jones Industrial Average been tested either. As a result, near-term strength followed a correction to lower levels later this spring might be the path that key equity indices eventually take.

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Characterized by a steady rise since the December 2011 low of 1,158.67, the S&P 500 Index is now within striking distance of testing key upward sloping trend line resistance now sitting at 1,424. Although nearly in an overbought condition, monthly stochastic studies are just a whisker away from being so, which raises a yellow flag of caution to the bearish case. Nevertheless, the “spot” CBOE Volatility Index (VIX) has already tested key trend line support (now at the 13.66 level) which was needed to confirm a market peak. History has shown that a test of this downward sloping trend line has matched up well with the past four relative “market peaks” that occurred in May 2008, April 2010, February 2011 and April 2011.

That being said, a number of market sectors appear to be poised to score additional gains that could force equity prices higher than the 1,424 resistance level would be consistent with. They include banks, semiconductors, healthcare, and the NASDAQ 100 Index (QQQ). A solid resurgence in the Dow Jones Transportation Index along with new breakout highs in the retail and consumer cyclical sectors must be viewed as bullish too.

Continued improvements in weekly employment data, signs of stabilization in the housing sector, and an increase in C&I loans suggest the domestic economy does appear to be on the mend.

Without trying to get overly rosy while looking at the rear-view mirror, there remain a number of challenges on the horizon as well. Higher gas prices, a jump in the U.S. trade deficit to $52.6B in January, it’s highest reading in more than three years, a slowdown in China’s growth rate, and toned-down but ever present worries over tension between Israel and Iran are there, but largely “known” by traders and investors.

As a result, there is a chance that the 1,424 area could give way to buying activity, which at this point might be the “surprise” that is not expected. If such a break were to occur, an extension up to key trend line resistance near 1,495 could result. Coincidentally, that level would “match up” better with similar trend line resistance seen on the Dow Jones Industrial Average which sits in the 13,650 to 13,750 area, depending on how the trend line is drawn. It might also match-up better with a possible test of “channel top” resistance on the Dow Jones Transportation index, which sits near 5,750.

The inability to rise above 1,424, or a break below steeply rising trend line support currently at 1,340 would go a long way, however, to suggest that a correction to the downside on the S&P 500 Index (SPX) may soon be at hand.

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After more evidence that the jobs picture had improved, yields on U.S. Treasury 10-year notes continued to edge higher last week. Skepticism over whether accelerating job gains might occur over the intermediate-term was still being debated, however. Some observers pointed to similar employment optimism as year ago, that eventually gave way to another spate of job related disappointment.

One aspect of current conditions that compares differently from last year was the agreement just reached by bondholders over the Greek debt swap deal; and a decline in the implied threat of contagion. While worries over these problems have not gone away, they have diminished a bit for now.

Modest improvements in the housing markets and a better-than-expected 3.0% rise in Q4 2011 GDP also helped frame the picture of an improving economy. As a result, a gradual shift away from U.S.treasury 10-year notes (TNX) and a move toward equities has occurred. And while that shift will likely continue over the near-term, a rise above key “cross” trend line resistance at 2.50% may prove to be a difficult challenge. It is clear, that the Federal Reserve has already made a commitment to hold interest rates near 0% through at least late 2014. Moreover, once the upcoming November elections have been resolved, either party will likely begin to engage in a program of curbing spending and/or raising taxes.

Those conditions have led some economists to expect both CPI and wholesale prices to rise at a greatly diminished rate next year.

If so, 10-year treasury yields might rise over the near-term toward the 2.50% level, but decline again if the 1,420 level on the S&P 500 index (SPX) holds as resistance; and if a more conservative approach toward debt deleveraging begins to emerge.

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