Many of you have probably been hiking and while climbing a hill you kept looking for the ridge line. As you finally neared the top of the hill and crested it you saw yet another higher hill so you headed for it. My wife never believes me anymore when I tell her the top of the mountain is just up ahead. You can probably relate this to the current market. Every time we think the top is right there, we find out there is yet another hill to crest. This looks like a topping process we're in but we can't see the top of the mountain yet since we're in the thick of the trees. It makes for a difficult time to see and trade.
The market started the day quietly and was actually pretty boring to watch all morning. It began the day slightly in the red and tried several times to get a bounce going but there were either not enough buyers or too many sellers. I attribute it to the topping process--a hand off of stock inventory from the Commercial players to the Speculators. The Speculators include the retail crowd and many mutual and hedge fund managers. The Speculators are the ones who are left holding the bag at the top and who disgorge themselves of stock at the bottom. The Commercials are the smart players and we need to watch them and trade with them.
It's always a challenge of course figuring out what the Commercials are doing since they hide their actions extremely well. Some measurements I like to use are the internal breadth measures as these will give a heads up as to what's going on under the hood. Watch the number of new 52-week highs vs. lows, advancing issues vs. declining issues and momentum indicators such as MACD and McClellan oscillators. Negative divergences in many of the oscillators such as RSI are good indications of a slowing in momentum which usually signals a turn coming. On Tuesday I showed a chart of the Nasdaq and the advance/decline issues on the Naz which showed a negative divergence against new price highs. I show a chart below of NYSE and the percent of stocks over their 50 and 200-day moving averages. Again, it shows we're at a potential turning point in the market, i.e., a high should be very close now.
Looking at today, we got the latest jobless claim data which showed initial claims rising 17K to 309K. The 4-week average initial claims fell 5,500 to 311,500 while continuing claims rose 12K to 2.7M.
Trade balance numbers were released and came in better than expected with a trade deficit that was down 5.8% at $64.2B which was below consensus of $66.2B. The import price index for December fell -0.2% vs. a +0.1% rise that had been expected. This is the 2nd straight drop in this index and is attributed primarily to the drop in crude oil prices. Excluding crude oil, import prices were unchanged in December. If all petroleum products are excluded, we had an increase of +0.2%. Imported natural gas prices fell -4.7% and we've certainly seen that in the chart of natural gas. Export prices were up +0.1% in December and which doesn't change if agricultural products are excluded. There was a record level of exports of goods and services and this helped narrow the trade gap.
Trade Securities Products:
Trade Futures Products:
Our trade gap with China was $18.5B vs. $16.7B a year earlier. Did you catch the news last night (NBC) about China introducing their Geely (pronounced jeeley) car? GM's Chairman and CEO, Richard Wagoner, said he's not worried about China for the next 10 years. And we wonder why GM is in such trouble. Japan took the longest to get their cars accepted by Americans and the time has been significantly reduced as each Asian country has introduced their cars into this country. China will make fast headway. Their Geely car, while acknowledged to be currently lower quality than most Americans will be willing to accept, will be introduced at less than $10K and it looks like the size of a Toyota Corolla with lots of seating room apparently. I can tell you that my son (a starving musician with a college degree), who drives a 1986 Acura Integra which is on its last legs, would gladly pay only $10K for such a car. Our trade gap with China will not likely be reduced anytime soon.
Interestingly though, our trade gap with China narrowed in December for the first time in 7 months. Wal-Mart had reported lower growth in sales for the month as well. The reduction in sales growth in WMT may be reflective of a slowing in spending my the lower income groups who are being hardest hit by the increase in energy costs. This trend will likely continue.
Before our market opened, the European Central Bank (ECB) announced they were going to keep their key interest rate steady at 2.25%, which was expected. They had raised it from 2.0% in December, the first increase in 5 years, but did not see the need to raise it yet again. They discussed their concern about inflation but want to see the effect of the December move before taking further action. Seems our Fed could learn a thing or two from our European friends in that regard.
We're at a potentially important inflection point as of the highs puts in thus far this week. Yesterday's high might have been THE high, especially as I look at the techs and small caps. They reached some important resistance levels and may be signaling they're done. Today's drop may also be signaling the same. But I don't trust the drop. It's too easy for the bears for the market to fail here and I don't trust it when it's too easy. The market is not going to ring the bell so that bulls can get up from the table and hold the door so that bears can sit down and enjoy a lovely meal. Another rally leg, or two, will completely frustrate the bears and convince many bulls that the January rally will turn into an up year.
The January barometer is used by many to set their course for the year--an up January portends an up year. Of course what no one talks about is the fact that the mid-term year in a presidency, which 2006 is, doesn't follow that pattern. At any rate, if we get another rally leg and it scares the bears out of the market and pulls in the remaining bulls we'll have a perfect setup for a top. It's one of the reasons I don't trust today's decline. I think it could get reversed tomorrow and it might get reversed hard. Let's see what the charts look like.
DOW chart, Daily
If yesterday's high was THE high we'll get a bounce to correct the decline from yesterday's high and I would look to a 38-62% retracement for resistance. A rollover from that kind of retracement that then drops to a new low would signify a major high is in. Until that happens we might have had a leg down today that merely completed a correction to the rally and it will continue higher, either immediately tomorrow or after a brief pullback tomorrow morning to a minor new low. I think we're very close to getting our answer. The next bounce will tell bunches in this regard.
SPX chart, Daily
It's the same deal with the SPX (and the others as well)--if the pullback completed today, or with a minor new low tomorrow morning, we will get a bounce that should retrace 38-62% of the decline from yesterday's high. Any rollover from there to a new low is one that should be sold and sold hard since we likely will have been in a very significant high. Until that happens I'm thinking we could rally to yet another new high. There's still that 1304 target hanging up there.
Nasdaq chart, Daily
The techs and small caps continue to give me the most bearish feelings only because they are potentially closer to finishing their upside patterns but I've got a Fib projection, based on the leg up from October, at 2345 (note this is a correction to my previous chart as I had the wrong point picked for the end of wave-1 in the rally up from the October low). This gets it close to the Fib projection of 2355 which is based on two equal legs up from the April 2005 low. That's pretty good correlation and any resistance found there (assuming we'll rally up to there) should make an excellent long term short.
On Tuesday I had shown a chart of the Nasdaq and compared it to the advance-decline issues, pointing out the negative divergence between the two. This was to show that the new index price highs do not have the same level of participation by all the stocks in the index, usually a bearish sign of loss of momentum. It's the under-the-hood check to see if the internal breadth of the market supports new highs (or lows in a decline).
Looking at the larger NYSE index, the same kind of comparison shows the same kind of lack of breadth and continues to call into question the current rally. If you look at the number of stocks above their respective 50 and 200-day moving averages, any new price highs should be accompanied by a larger number of stocks moving above these important long term averages. When they start to diverge, it's time to be careful chasing the market any higher--bring up those stops and get ready to try the short side.
This NYSE weekly chart shows the new price highs being made since 2004:
NYSE index, Weekly chart
Before comparing to the next chart, look at where price is--right up against the trend line that runs along the highs from January 2004. Actually it's poking above the line which is common (throw-over) and if it then reverses back below the line, that's the first sell signal. At any rate, since 2004 this index has been making new highs. Now compare to the percentage of stocks that are above their 200-dmas:
NYSE % Above 200MA, Weekly chart, courtesy StockCharts.com
It's readily apparent that each new high in the NYSE has been met with fewer stocks participating. A lower percentage of stocks in this index have been above their 200-dma's as the rally has progressed. This is clearly not a market timing tool since this divergence has been in place for 2 years now. I show it to demonstrate that the rally we're in is NOT the start of a major bull market as so many are calling for. We are in an ending pattern. The EW pattern calls for an end to the rally, trend lines call for an end to the rally and negative divergences like this call for an end. Get your insurance policy up to date (that would be "long put" insurance such as LEAP puts).
Here's another chart showing why I'm calling the end of the rally:
NYSE % Above 50MA, Weekly chart, courtesy StockCharts.com
This is a similar chart to the above but it's looking at the percentage of stocks in the NYSE that are above their 50-dma. The thing to take away from this chart is the fact that each time the percentage has reached about 85% it has marked the top of the rally from which we got a deep retracement. If you look at a daily chart instead of the weekly shown here, you will see this starting to roll over and will it's leaving a bearish divergence on MACD.
All the signals are there for a top. It will pay dearly for you to heed this warning and protect profits on longs and look for ways to short the market. We could have a little more upside work to do but at this point playing for a few more points to the upside is risky business. The current move is very similar to the one we had in August-September 2000. Take a look at the daily chart to see what happened after September. It wasn't pretty--it was almost a 10% drop in NYSE and a 13% drop in SPX. Did you know we haven't had a 10% correction in over 4 years? I think we're due.
SOX index, Daily chart
The pattern of the rally from Jan 3rd looks like it could be complete at yesterday's high and gives me the most bearish feeling here. If I were to judge the entire market on this index I would say get short now in a big way. Because I'm not quite sure about the others I'm reluctant to call a top. But I would say protect profits in the semi's now.
BKX banking index, Daily chart
I showed a weekly chart of the banks on Tuesday so this daily chart is simply a little closer view. Price has been hammering at the top of the weekly parallel channel (purple line on the chart) since November and as it has made marginal new highs it has been leaving negative divergences on MACD. This looks very bearish. But, the flip side of interpreting MACD here is that it has worked off its overbought conditions while price has gone sideways. With MACD back down to the zero line while price has consolidated under resistance, this could actually be very bullish. I mention it because of the possibility and a rally in the banks above this resistance (for more than a head fake move) should be taken seriously but it's not something I'm expecting based on the other indices.
U.S. Home Construction Index chart, DJUSHB, Daily
The housing index pulled back sharply today after nearing the top of its parallel up-channel which looks like a bear flag. It too could be done with its rally and is ready to roll back over. But if it is able to rally a little higher, watch the 1050-1060 area for resistance to short the home builders.
More than a few homeowners might be able to breathe a little easier than had been feared before the winter started. The natural gas inventories were reported today and as of January 6, 2006 there was a decline of only 20 bcf from last week's 2,641 bcf, making it only 2 bcf less than last year at this time. This week's 2,621 bcf is 276 above the 5-year average of 2,345 bcf. The price of natural gas took a beating today--down -3.2% to $8.95/mbtu, a level not seen since the lows of last July just before price shot higher into the end of the year. The price of natural gas is now down 43% from its December high of $15.78 (February contract).
Oil's recent rise is being attributed to the scare that's going on in Iran. It's looking like Iran has decided to play tough rather than politics. Their new hard-nosed ignoramus of a president, Mahmoud Ahmadinejad, has decided he'd rather have nukes than the blessing of other countries and if the U.N Security Council were to institute sanctions against the country, we can kiss their oil goodbye. Shock and surprise, even France and Germany are now recommending the U.N. get involved. Will wonders never cease. Obviously any sanctions placed on Iran would have a significant impact on oil prices. Hence oil's rally. However, if this is a game of blinksmanship and Ahmadinejad blinks first, oil could see a precipitous drop. It's a dicey time for oil traders and one of the few times technical analysis could be trumped by news.
Oil chart, February contract, Daily
News out of Iran will continue to have an effect on the price of oil but at this point we don't know if all the bad news is priced into oil or not. New highs in oil are being met with negative divergences so the rally appears to be finishing, and at its 50% retracement. I'm still counting the bounce up from the November low as a 3-wave correction to the Aug-Nov decline which means we should get another leg down to new lows. If we get a pullback we should see at least a drop down to its 200-dma and broken downtrend line just above $60.
Oil Index chart, Daily
If the quick drop in this index marks the top of its rally, which I'm currently thinking, this could be telling us the price of oil will soon follow it back down. Price pressed up against resistance today (see 60-min chart below) and then fell off sharply. Whether or not it can make it up to the top of its bear flag pattern is doubtful but still possible (up near 580). Today's daily candlestick is a shooting star and is a fairly reliable reversal signal. It needs a red candle following it to confirm.
Oil Index chart, 60-min
A close up view of the rally off the December 27th low shows the last part of the rally formed a parallel up-channel. Price rallied up to the top of today and then got slammed. It broke below the channel and that's why I'm thinking the rally is over. The new highs were leaving negative divergences in their wake. In the Monitor around noon as the index climbed above 572 I showed this chart and mentioned it was hitting resistance which ended up being a great short play. The setup was just too nice to ignore.
Transportation Index chart, TRAN, Daily
The Trannies continue to look like they've found a top. Watch to see if the 50-dma at 4115 provides support. This could still make an attempt at another high, or a test of the highs. The pullback looks corrective and leads me to believe it could make another run to the upside which leaves me guessing on this index here. The negative divergences on MACD suggest a big sell off coming.
U.S. Dollar chart, Daily
The US dollar bounced off its 200-ema and back up to its broken uptrend line. From a short term perspective I see the possibility that it could drop down to its 200-sma which is close to where it would achieve two equal legs down in its pullback from the November high, which would be at $88.36. The 200-dma has been slowly climbing and could coincide with that level in the next day or two. I would expect the dollar to find firm support there and start the next rally leg, either from here or slightly lower around that $88.36 level.
Gold chart, February contract, Daily
I'm beginning to think this leg up from its steep pullback may be the final 5th wave instead of as I've labeled it for the December high. Short term the upside looks like it could be forming a small ascending wedge and gives me the impression it's putting the final touches on its rally from July. Whether this is the end of that rally or part of a larger correction from its December high is somewhat irrelevant--both suggest another steep pullback is right around the corner. If you're long gold, time to protect positions again. If you didn't get out last time (and you're doing shorter term trading in gold rather than holding for longer term), you have another opportunity here.
Results of today's economic reports and tomorrow's reports include the following:
Tomorrow will be a little busier for economic reports and some have the potential to move the market prior to the cash open. Futures rallied a bit right after the cash close today and it makes me wonder if some results didn't leak out prematurely. I know that never happens but some players are really prescient. Trying to gauge the market's response to these reports is an exercise in frustration. It all depends on the market's mood and they often just wait for the report to get out of the way so they can do what they planned to do anyway.
The leader to the downside in the DOW today was General Motors (GM 20.96 -0.90). After hitting its 50-dma on Tuesday at $22.60 I suggested shorting this stock. I didn't personally take that one but wish now that I had. Watch its 20-dma at $20.38 for potential support but I see this one just continuing to make new lows. I guess it all depends on how well management listens to Kerkorian. I think he's a little frustrated that his purchase at $30 hasn't done that well. Happens to the best of us.
Sector action was mostly in the red today, led to the downside by the airlines, oil service, cyclicals, biotechs, networkers, SOX and Transports. The only green sectors in my list were the disk drive, healthcare, computer hardware and utilities.
The Fed came out today and talked some more about inflated asset values. Fed Governor Geithner said low risk premiums for assets complicates their outlook, saying that doubts about asset values necessitates a widening of the neutral range for Fed rates as they take into account these [inflated] asset values. I added the word "inflated" even though the Fed didn't say that. If you read between the lines that's exactly what they're saying. Geithner also said the US current account deficit poses a growth risk. Growth to the economy that is. They have no problem growing the money supply.
In fact Greenspan mentioned the very same thing in his major speech at Jackson Hole last year. He said "Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."
Reread the last 3 sentences. Greenspan could not have made it any clearer what the risks are. The fact that so many expect a continuation of the good times is also a warning flag. Even Greenspan has noted that "One of the most impressive pictures of the epic public faith in the rising trend is a look at personal savings rates over the last 40 years, which depicts a rising sense of fearlessness." The bull market in stocks and then in real estate has clearly caused this. It's interesting to note that the savings rate peaked in August 1982, the exact month of the low in stocks, and the rate has plunged with every major advance of the bull market. Tthe monthly saving rate fell below zero for the first time in 1999 which of course was a forerunner to the steep correction that began in 2000. Here we are again with a negative savings rate. Do you think the public really learns from past history? I think not. The willingness to bet on the future instead of conserving has been a warning about almost every important stock market high since 1970.
The Fed is saying they are concerned about the over-inflated values of assets, primarily real estate but stocks as well. They are scared to death about the housing bubble and are going to be trying very hard to let the air out slowly. They say they don't change policy to take care of asset bubbles but that's a bunch of baloney. They created the bubble in real estate with easy money policies, they know it, and now they're trying to figure out how to deflate the values. I don't hold out much hope they'll be successful in their letting air out slowly. I'll cover this topic a little more in depth next week with some more information about why I think the housing bubble is a much bigger problem for us this time. Past real estate bubbles were regional whereas this one is a national problem. The last time this happened was in the 1920's (gulp).
Speaking of inflated assets, UBS lifted their S&P 500 target to 1400 by the end of the year, citing its "new belief that this level of profitability is much more sustainable than not." If we can get a few more firms to come out with bullish statements like that I'll know we're nearing a top. Check under the hood guys--our little engine that could is running low on steam pressure.
Tomorrow morning could get a little volatile if we make new lows first. If we instead gap up I'd be tempted to buy it since we may be offered few pullbacks. But the upside is very risky at this point. In fact trading is risky at this point. The topping process is full of whipsaws and lack of follow through, making holding onto positions very difficult. Don't be bashful about sitting on the sidelines and letting the dust settle, which should be soon. Keep your powder dry and if you like playing the short side, you'll have some wonderful opportunities soon. If you only like the long side, don't let this move much further down since a top could be followed by a swift decline as new longs realize they got swindled and start to bail in a hurry.
Good luck and I'll see you on the Monitor tomorrow. Look for a relatively light volume day as traders leave early to start their long weekend (Monday is a holiday).