When looking at a few market sentiment surveys last week, it is clear that pessimism was acute at the beginning of last week’s trading session. Some had bearish sentiment approaching levels not seen since the March 2009 low. Highlighting that feeling was another net outflow from equity funds and into bond or money market funds. Still, there is a question as to whether market sentiment is currently bearish enough to cause an extension to the equity rally that ignited last Wednesday.

Clearly, the jobless numbers were just a little bit better than had been expected. That said, John A. Challenger, CEO of Challenger, Gray & Christmas, said “layoffs have diminished significantly in the last year” leaving “the economy poised for more job growth as demand grows and the willingness of companies to take risks grows.”

From a technical point-of-view, an interesting situation may be taking place in equity prices that could be linked to this observation. Although bullish “reverse head & shoulders” patterns are generally seen at price extremes, it appears that a modest one may be developing now on the S&P 500 index (SPX). Its “neckline” sits at 1,130 with an “objective” of 1,250. Such a move is not currently expected, particularly in front of this year’s mid-term elections.

Nevertheless, a rally extension could unfold if enough “cash on the sidelines” perceives the current environment to be offering a lot of value in light of a possible turn-around, albeit modest, in the jobless numbers.

Since this particular “reverse head & shoulders” pattern it not forming at a true price extreme, the current technical set-up could, on the other hand, reflect a possible “sucker’s rally” that may merely be part of wide trading range that could prevail for some time to come.

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In front of the release of August’s employment data this Friday, a series of economic reports released over the past two weeks has investors deeply pessimistic once again. As a result, the “run-to-safety” trade into U.S. Treasury securities pushed interest rates (across the yield curve) to new lows before a correction occurred toward the week’s end. Contributing to investor fears was a sense that the Federal Reserve has done most of what it could do, and most of what was expected of it to help nurse the struggling economy back to recovery. This wide-spread appraisal appeared to gel in the wake of last week’s central bank’s conference in Jackson Hole, Wyoming, and despite Fed Chairman Bernanke’s pledge to do even more.

Moreover, mounting pressure now appears to be shifting toward Washington to utilize more fiscal stimuli in front of the elections, a time that is considered too ticklish to get anything accomplished for many an incumbent.

It is no wonder that technical analysts are worried that a bearish “Head & Shoulders” pattern on the Dow Jones Industrial Average could play out to the downside. If it did, it would make investor sentiment even worse, despite last quarter’s better-than-expected earnings reports.

Since most analysts believe a legitimate turn-around in both the stock market and in the economy requires a healthy banking system, a renewed look at the Keefe, Bruyette & Woods U.S. Bank Index (BKX) is in order. With oversold conditions present, it is important to note that the BKX is now approaching a test of two key support areas that are very close to each other. The first is trend line support drawn off the lows since August 7, 2009 that sits at 42.75. The second is “channel bottom” support at 41.75 drawn off a series of highs and lows that date back to March 6, 2009. Although trend line support will change very little over the coming months, it is worth noting that “channel bottom” support does rise over time.

As a result, the 41.75 level holds great importance for the BKX and the overall condition of equity prices over the intermediate-term. If it holds and turns the Keefe, Bruyette & Woods U.S. Bank Index to the upside, a giant sigh of relief should occur for many investors. A solid break below, however, would be a big negative and a major concern.

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A clear sense of unease, underscored by another stunning flight into U.S. Treasury securities, has engulfed the equity markets. An unexpected 500K jump in initial weekly jobless claims reinforced the notion that that employment picture is far bleaker than previously thought. Adding to this dark economic outlook was a report issued by Fidelity Investments on Friday noting that hardship withdrawals from 401(k) retirement saving plans rose to the highest level in 10 years during the second quarter. Further, Fidelity reported that the percentage of 401(k) participants that had an outstanding loan against their account rose to a record high of 22% during the second quarter, with an average loan amount of $8,650.

With a number of economic observers worried that the Federal Reserve may be “running out of bullets” in the attempt to turn around and sustain an economy recovery, investor confidence has become more unnerved. Renewed fears over Greece as well as concerns over domestic municipal budget woes resurfaced last week as well.

With a backdrop of continued equity fund outflows and an increase in “fixed income” or bond fund inflows, it may be worth noting that the Dow Jones Industrial Average appears to be forming an unusual type of Head & Shoulders pattern that appears very similar to one that developed between 2007 and 2008. In both cases the “neckline” of their respective patterns is characterized by a steep downward sloping pitch. Of course, the current market for the DJIA is 3,000/4,000 points lower than during the 2007/2008 period, which is worthy on note since Head & Shoulder patterns often show up at extremes in the market. While the current market maybe relatively extreme when compared with the March 2009 selloff low, it is not similar to the 2007/2008 buying extreme, which set an all-time high for the DJIA back then.

Nevertheless, “patterns within patterns” technically can often be of a similar nature, akin to having the same sort of DNA in a sense. In this context, the hangover from the fear of an economic meltdown from a few years ago has not yet worn off, either domestically or globally. Memories of that period’s tumult remain fresh in many investors’ minds. Oddly, that may well be a good thing. After all, a lot of selling of equities has already occurred, with “cash on the sidelines” already tucked into extraordinarily low yielding U.S. Treasuries, FDIC insured bank CDs, corporate bonds and notes, gold, silver and, perhaps, into the safety of mattresses! Recently, a few well known hedge fund managers also tossed in the towel and closed up shop.

Although the DJIA may resemble that of 2007/2008 technically, market sentiment is very, very different. Still, equity markets do not like uncertainty which seemingly abounds today. Many changes, including the Health Care Bill and FinReg have decision makers at the business level handcuffed due to the technicalities of implementation. That condition, by itself, will tend to retard job growth. In the end, these kinds of concerns may well force investors to pay heed to the unusual looking “Head & Shoulders” pattern that may be developing now.

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Following a week’s worth of evidence that the economic recovery is sputtering, another leg of the “run-to-safety” shift into U.S. Treasury fixed income securities ensued. A spate of better-than-expected 2nd quarter earnings results took a back seat to a number of troublesome reports.

Initially, The Federal Open Market Committee announced that it would reinvest maturing mortgage-backed securities back into the government debt so that its balance sheet would not shrink. This was seen as a signal that economic activity in the U.S. was losing steam. Then, Cisco System’s Chief Executive John Chambers warned that he was seeing “mixed signals” and an “unusual uncertainty” following lower than expected first quarter sales. Adding to Wall Street jitters was an unexpected rise in weekly initial jobless claims to 484,000, the largest jump since February. Disappointing industrial production numbers in the euro zone worried investors’ confidence further. As a result, U.S Treasury 10-year notes ended the week at a yield of 2.688%, the lowest seen since March 2009.

Technically, the yield on 10-year Treasuries continues to decline within a downwardly sloped “trading channel” that has been in place since 1993. Although, weekly stochastic measures are falling rapidly, they are not yet in an oversold condition on weekly charts. Thus, an opportunity for 10-year yields to test key “cross” trend line support (resistance in terms of price) currently at the $2.40% level is possible.

If the 2.40% yield area fails to hold, however, it is worth noting that “channel bottom” support for 10-year U.S. Treasury yields now sits at $1.72%. Conversely, that would represent key resistance when thinking in terms of 10-year note prices. For this area to be tested, however, an extended period of worrisome news would likely be needed.

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Although taking some time to develop, the Dow Jones Utility Index (DJU) appears to be setting up for a solid move upward. A bullish “reverse head & shoulders” pattern that has been in the making since the post-Lehman Brothers plunge in October 2008 continues to form, targeting a potential move up to the 525 area.

Fostering this technical viewpoint is an apparent fundamental thirst for yield. Persistent pressures from pension plans, retirees, college endowments and others who rely on interest and dividends for their day-to-day needs are finding low yielding U.S. Treasuries, intermediate-term CD’s and money market accounts extraordinarily stingy.

While a good number of investors continue to tout their preference for the “return of their capital”, rather than “return on the capital”, others are becoming weary of that standpoint. As a result, there is a growing chorus of advisors that point out that many S&P 500 common stocks, including utilities, are paying higher dividend yields than are 10-year U.S. Treasury notes.

Because the balance sheets of most utility companies are typically laden with debt, the worry has been that rising interest rates would not only compete with yields on their common stocks as an investment vehicle, but would also become more costly to them as they routinely refinance their outstanding debt if in a rising rate environment.

Following Friday’s disappointing employment data, as well as Goldman’s Sachs’ forecast for the unemployment rate to inch up to 10% into 2011 and stay there for the remainder of the year, the expectation for interest rates to rise has once again been muted. In addition, a potential decline in interest rates could result in lower debt costs to utility companies, That, in turn, should make those who thirst for yield to take a harder look at utility common stocks.

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After Federal Reserve Bank of St. Louis President James Bullard noted that the U.S. economy might be getting closer to a Japanese-style outcome hinting that the risks of deflation were rising, yields on U.S. treasury securities declined once again. That said, other observers including Charles Plosser, president of the Philadelphia Fed, said that “I don’t think deflation, or sustained deflation, is a real problem at this point. It is hard to imagine how you can get that when you have got a trillion dollars in excess reserves sitting in the banking system or as long as expectations of inflation are well anchored.”

These viewpoints, as well as many others, underscore how the debate over inflation versus deflation has become more and more a front burner issue. While it is clear that wage pressures are extraordinarily muted at the moment give the employment picture, commodity prices as measured by the Reuters/Jefferies CRB Total Return Index have risen somewhat since the end of May. With that in mind, it is interesting to note that this Index is approaching a test of key trend line resistance now sitting at the 283 level. A break above it, if it occurs, would tend to raise hopes that demand for commodities is strengthening, and in turn hint that final demand and the economy are improving as well.

Nevertheless, the employment numbers due out at the end of this week will be key in sizing up whether employment and wage stability are at risk. Those factors, as well as the direction of commodity prices, are crucial to the “inflation versus deflation” debate.

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Just when it appeared the equity markets might be forced into an extended period of “the summer doldrums” (typical of the season), the S & P 500 Index broke above key downtrend resistance on weekly bar charts forcing investors to take another look.

Thus far, earnings have been, by and large, better than expected. In addition, this week’s economic numbers out of Europe were refreshingly pleasing, highlighted by a survey of German business confidence that posted a sharp rise. Upbeat news on the French service sector and a surprise increase in British GDP added to the reverie.

In addition, some uncertainties that had shrouded the marketplace did get a bit of resolve last week. The SEC’s securities fraud case against Goldman Sachs was settled and the European bank stress test results were viewed as largely benign.

Notions of reduced consumer credit in the U.S., fiscal austerity initiatives in Europe, and continued worries over the soundness of many U.S. State and municipal balance sheets, nevertheless, have not gone away. Because of this, last week’s turn-around in equity prices initially triggered a round of short-covering. Mild mutual fund allocation shifts away from either cash or low yielding or money market funds and into stocks were also noticed.

Although none of the current economic concerns are likely to go away any time soon, the S & P 500 index (SPX) did manage to break above key resistance with oversold conditions still present on the weekly time frame. This technical set-up suggests that further upside gains are likely to emerge over the intermediate term despite the economic gloom that still looms.

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Technicians are always looking for the birth of a trend, the maturing of a trend, or the end of one. When a series of conflicting chart elements are present however, corrective price action usually results. Such is the case for the S&P 500 Index (SPX) right now. Oversold conditions are currently present, which suggests that buying on weakness is a viable strategy. Bearish technical divergences, like the bearish MACD “non-confirmation” divergence that is now visible on weekly charts, on the other hand, suggests that bullish momentum is still on the wane.

During the past week, the S&P 500 Index (SPX) failed to break above key downtrend resistance at 1,100, but instead reversed quickly lower. Over the next few weeks, oversold conditions could persist with sellers capable of sending the S&P 500 Index (SPX) down to key support now sitting near 1,007. Worse, an eventual test of “channel bottom” support currently at 970 could well occur.

That said, an eventual break above key trend line resistance at 1,100 would likely catch a healthy number of investors off guard, which could fuel an unexpected rally in an otherwise skeptical market environment. Time will tell, but lower price action could prevail for a while until buyers sense that equity prices have been discounted enough.

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Last week’s 511 point surge in the Dow Jones Industrial Average (DJIA) as well as the S&P 500 Index’s (SPX) 55 point gain caused both of those key barometers to close back above their respective “mid-channel” resistance levels. At the same time, bullish technical divergences were registered on each, suggesting more upside gains are likely heading into July’s “earnings season”.

What appears to be a leader in this surprising turn-around are bank stocks. The Keefe, Bruyette & Woods U.S. Bank Index (BKX) staged an impressive rally last week characterized by similar bullish technical divergences as well as a test of key downtrend resistance. Interestingly, both the DJIA and the SPX are now approaching similar downtrend tests.

Given that most analysts believe that a legitimate turn-around in both the stock market and in the economy requires a healthy banking system, one might surmise that a “breakout” to the upside in the Keefe, Bruyette & Woods U.S. Bank Index (BKX) would trigger similar upside “breaks” for both the DJIA and the SPX. The “breakout” level for the BKX sits very close by at 49.50. The DJIA and SPX “breakout” points sit a bit further above at 10,350 and 1,098 respectively.

It is important to point out, however, that all observations are based daily bar charts, which are short-term viewpoints by definition. Nevertheless, they all suggest that the current “summer rally”, if that is what it is, has a lot more pep left in it which might add a bit more sunshine to the upcoming earnings season.

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After the release of a host of worrisome economic data, the Dow Jones Industrial Average (DJIA) closed below both “cross” trend line and “mid-channel” supports located at the 9,885 level last week. Housing sales and starts were disappointing. Consumer spending was tepid. Manufacturing ISM posted its weakest reading since November. Initial jobless claims rose unexpectedly by 18K last week with Friday’s monthly employment report showing a mere 83K increase in private sector jobs during June.

As a result, a typical pre-holiday long-weekend “short-covering” rally never materialized on Friday with the DJIA falling by 46 points instead. Dollar weakness also played a roll in tempering any investor enthusiasm.

Weekly bar charts currently suggest that the “risk” of a possible move down to key “channel bottom” support now at 8,780 over the near-term is a reasonable expectation. Weekly technical studies are not yet in an oversold condition, but should be by the time “channel bottom” support is reached, if this scenario plays out.

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