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Market Wrap

Working Hard to Stay Still

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Unless you liked see-saws as a kid and enjoy the same thing in the market, this is turning into an extremely frustrating market to trade. I can tell from recent emails that readers are frustrated. Multiply this by the tens of thousands of active traders and you can just imagine the angst this market is creating right now. This forces traders to make hasty (bad?) decisions, rushed trades and rapid exits. The net result is what we're currently seeing--a market that is getting whipped around and taking traders with it. The only ones making money in a market like this are the brokers. As I mentioned on the Monitor today, this too shall pass. This is one of the worst market conditions to trade and I believe it's because we're in a major topping process.

Bottoms are usually cleaner than tops. They're a lot scarier but they usually end in a flash and then rally from there. Tops are pure ugly. There's a constant battle between the bulls and the bears and is usually marked by very choppy price action. Loss of momentum occurs gradually and very rarely do you get a clean finish marked by lots of selling after it. There's no ringing of the bell. The large funds usually try to hold the market up and then sell into it, push it back up, sell into it, rinse and repeat. The retail crowd is usually the last one to figure out we're topping and they're typically the ones buying the inventory from the Big Boyz. I think that's the current environment. If we're in a process of hammering out a top and getting ready for a multi-month (multi-year?) decline, we can expect the process to take months. I would say we've been in that process since last November/December. Tops are usually rounded over rather than sharp v-reversals. Even a head and shoulders top is a rounded top.

So understanding the market environment in which you're trading can be very helpful. There are good times to trade and there are bad times. Most traders give back what they made during the good times. Even Jesse Livermore mentioned that one of his secrets to success as a trader was knowing when not to trade. He would leave the market for months to let it set up the way he wanted it. Most of us here watch the market every day and probably would have major withdrawal symptoms if we even thought about being away from the market for two weeks let alone months. We're a sick bunch but you gotta love it. But in bad times, like now, we must learn to trade lightly and more quickly.

I liken it to running out of your mouse hole into the middle of the living room, while the dog and cat are distracted and creating a fur ball, stealing a piece of cheese and then scurrying back into your hole before you're noticed. You won't get fat that way but you also won't go hungry. In times like this market you're only trying to keep from going hungry. You will soon have an opportunity to pick up the whole chunk of cheese and cram it back into your hole. I know, some of you are thinking something else is getting crammed into, well, never mind.

It was a quiet morning as far as economic reports go, with only the release of the unemployment claims number. Initial claims were up 15K to 294K, a little higher than the 287K that was expected, but it makes this the 7th week in a row that the total has been below 300K, something it hasn't done since the summer of 2000. Didn't something bad happen after the summer of 2000? The 4-week average rose 5,250 to 287,250. The continuing claims number fell 2K to 2.486M which is the lowest it's been in 5 years. The 4-week average of continuing claims dropped 2,750 to 2.508M, also a 5-year low. I'll remind you again what happened following the last time it was this low in 2001 and it wasn't a pretty time for the stock market. The other good piece of news was from the outplacement firm Challenger Gray & Christmas. They reported corporate layoff announcements fell 15.5% to 87,437 in February.

So for now the news is good and hopefully people are finding replacement jobs that are equal to or better than their previous jobs and not a lower-paying one. The chart I showed last week of real hourly wages suggests otherwise and is a major reason why I believe we'll see a continuing slowdown in consumer spending as the housing market stalls and less equity is available for withdrawal.

Speaking of homes, the news earlier this week shows we have a problem. With existing and new home sales slowing, and yet builders are reporting record ground breaking, I wonder how many are worried about a glut of inventory, already at high not seen since November 1996, nearly 10 years. With spring approaching, which is when many homeowners wait until before they put their house on the market, I suspect we're going to see a spike up in inventory. That will clearly not help home prices and any further price pressure on homes will only have a depressive effect on homeowners. Consumer spending would likely take a major hit then.

This week we also saw that business activity is slowing, as measured by Chicago purchasing managers index (dropped to 54.9 from 58.5), the GDP was raised a whopping 0.5% from 1.1% to 1.6% (was that what Secretary Snow meant last month when he said the GDP number was bogus and that it would be raised sharply higher?), personal incomes rose less than spending (and savings remains negative 8 months out of 10 now) and retail sales slowed (they had the smallest gain in 9 months). Or as analyst Jharonne Martis at Thomson Financial said, "So far, the results look mixed. It's not that consumers have stopped shopping; it is just that they're slowing down." And to think he probably gets paid big bucks for that kind of analysis. On top of all this, borrowing costs are rising. This is not the picture of health that I would expect to see in order to support those who say we're going to have a strong economy and stock market. I'm thinking exactly the opposite but maybe I'm missing something.

But the cheerleaders of CNBC are out there every day beating the bushes for new buyers for their corporate clients. You do know they're not watching out for your best interests, right? I stopped watching them years ago since I find I get more help from Jerry Springer. At least he's entertaining. I trust the charts, although I must admit even they are a challenge at the moment. But let's see what have to say this week.

DOW chart, Daily

I posted this chart on the Monitor on Wednesday to show a potential ascending wedge that might be playing out from October's low. Price recently tested the top of the pattern and has since pulled back. My best guess is that we're going to see choppy price action has the DOW stays in a tight range and works its way over to the uptrend line from October. That trend line is currently down near 10870 so that's the downside potential if we get a hard drop to it. But if we do more of a sideways/down affair we could spend the month of March in the kind of price action we've seen the past 2 weeks. And then a rally up to a new high, as I depict on the chart, may not be a smooth ride either so we could be looking at 2 months of this, um, stinky brown stuff. At least that's what I would mentally prepare for so that you keep your frustration level under control and don't go stupid on us. Keep your trading account whole by trading light and trading fast; take your profits quickly and let the base hits add up in your account. If and when we break down, you'll have ample opportunity to feast on some juicy steaks.

SPX chart, Daily

Like the DOW, SPX is battling up against a trend line and finding it to be resistance. The bullish interpretation here is that it's consolidating right underneath resistance and is getting ready to blast to the upside. If we do see a break above this resistance, watch the Fib target at 1312.72. But it will have to fight against negative divergences and overbought stochastics in order to get there. Instead I'm thinking it will do like the DOW and chop its way lower to the uptrend line from October. That line currently sits just above 1270. The intersection of the downtrend line from January's high and the October uptrend line is at 1272 next Monday. That would make for an interesting downside target to get long.

Nasdaq chart, Daily

The COMP is fighting a different kind of trendline--its broken uptrend line from October. So while the DOW and SPX may work their way down to their October uptrend lines, the COMP is finding it to be resistance currently. And the way the COMP is rising off its February low tells me it's not long for this world. It's a choppy corrective rise and that tells me the bounce will fail and price will head for new lows. Even MACD during the latest bounce hasn't been able to get enthused about the rally attempt. But if the bulls can put something together here, I like the upside Fib target of 2355. It's possible that we'll see the same kind of choppy price action as the COMP fights its way upward, as it's been doing since the February low.

SOX index, Daily chart

Somebody lit a fire under the SOX yesterday and it blasted higher, saving itself from breaking its uptrend line from October. But it stopped at the downtrend line from January, which is currently at 550 so watch this level if we get a little more bounce tomorrow. Any break above 550 should be considered bullish, for the whole market for that matter. It's interesting to see that MACD has bounced back up to the bottom of the trend line along its previous lows. I don't tend to draw a lot of trend lines on these indicators but it will be interesting to see if that's where MACD rolls back over.

BKX banking index, Daily chart

After looking at the potential ascending wedges for the DOW and SPX it made sense to consider one for the banks as well. So I drew the trend line across the two highs in November and December and that's essentially where the latest rally stopped. If the pullback continues, as the oscillators suggest it will, watch for support at the October uptrend line currently just below 104. A break below 103 would be bearish, confirmed by a break below the February low, but until that happens I'm thinking this could chop its way higher with the broader averages.

U.S. Home Construction Index chart, DJUSHB, Daily

The home builders bounced up to their 50-dma but couldn't make it up to the 200-dma. That's actually more bearish since the 50 has crossed down through the 200. So I'm starting a new parallel down-channel and we'll see if guides price lower. I would expect to see support at the uptrend line from March 2003 and the potential H&S neckline, both of which are near 830. MACD bouncing up to the zero line and rolling back over is a bearish signal. Anytime you see MACD make it back to the zero line and then reverse, that's usually a good trade signal. Notice the past instances of this on this chart and try it with the symbols you trade.

Something I've often discussed is the amount of money being injected into our monetary system as measured by M-3. M-0, M-1 and M-2 measure the amount of money in physical currency, demand accounts (savings and checking), money market accounts and certificates of deposit. M-3 adds deposits of Euros and Fed repurchase agreements to this total. It is through these repurchase agreements that the Fed is able to add or withdraw money to or from our monetary system and for that reason M-3 has always been an important measurement of the Fed's activities. Watching the correlation between M-3 and the stock market shows when liquidity levels are high (massive injections of new money) we see the market rise. When the liquidity is removed the market settles back down or flattens out.

We know there is a Working Group that consists of the Chairman of the Federal Reserve, the Secretary of the Treasury, the Head of the SEC and some heads of large Wall Street firms. This working group was created in 1988 to provide stability to the markets in times of crisis. The group has come to be known as the Plunge Protection Team (PPT). Market participants have been feeling that they have protection in the form of the Greenspan Put but now that we have Bernanke at the helm we'll have to call it something else, maybe the Bernanke Bounce. The speculation now is that the PPT is becoming more aggressive in their intervention and that they're intervening more often. They're doing more preemptive strikes so to speak.

Practically under the cover of darkness, and with little fanfare, the Fed announced back in November that they would no longer report M-3 after March 23, 2006. The Federal Reserve was set up originally to provide stability to our currency and economy and M-3 was a measurement of their activity. They will soon begin to go stealth on us and hide what they're doing. And they're doing it at a time when great changes may be coming about. With large sums of electronically created money the PPT is able to do just about anything they want in the market and when they want to. Fed Vice Chairman Roger Ferguson unexpectedly announced his resignation last week. One has to wonder why the relatively high turnover rate at the Federal Reserve in the past two years. These are powerful positions and giving them up could mean these people are not comfortable with where the Federal Reserve is headed.

We've often seen, especially since about 1998, the market found sudden buying interest at a time when the market seemed most vulnerable. In the past year whenever bad news was hitting the market we got a strong rally instead of the normal sell off from fear. The London bombings a few months ago and the sudden magical levitation that began in the pre-market futures was probably the most obvious intervention. The market rallied hard that day as shorts ran for cover. It didn't seem natural each time it happened. Those instances had the finger prints of the PPT all over it.

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Sudden buying out of the blue has made life for shorts miserable. Greenspan let it be known on numerous occasions he despised shorts and probably derived great satisfaction out of frying them. But ironically the short interest is the power behind the PPT-induced rally. Without short covering to get things started it would be much more difficult, and expensive, to get strong rallies off the ground. Therefore the Fed needs two key ingredients--large money supply to inject into the markets (which is easy since they just create it out of thin air) and a high short interest ratio.

As we head into March we have a market that is probably at a higher risk level than it's been for a while. Jim did a great job outlining the risk as seen in the month of March in previous years. We have many technical indicators warning of a potential high. We have waning momentum, we're at or near key resistance levels, we see bearish non-confirmation between indices, overbought indicators, we're heading into a period known for its cyclical risks (the "turn month") and we have several political instabilities, any one of which could blow up badly. We can see all this and the PPT can see this. They know the market is currently vulnerable to a sell off and they don't want to see it happen. And now as we head into March we soon won't have M-3 reported to us. In other words the Fed (PPT) will be able to do anything they want without warning. We used to at least have large increases in M-3 as a heads up that we could soon find buying support in the market.

Iran has reported that they're going to start selling their oil in Euros beginning March 20th (and the Fed stops reporting M-3 on March, 23rd--how convenient as the Church Lady would say). Iran has essentially declared war on the US dollar. The last country to do that was Iraq and we attacked them. One of the first things we did was change the oil currency back to US dollars. Selling oil in Euros could cause many foreign banks to pull money out of the US and exchange them for Euros to buy their oil. Notice the two components that are added to the money supply measurements for M-3--Euro deposits and Fed repurchase agreements. I don't know much about the Fed's activities and money supply but I sure smell something fishy in the timing of all this.

So the market is set up for a potential turn to the downside and we have the possibility that foreign investments will begin to dry up. Sounds like the Fed might have to get busy cranking out more dollars and the easiest way to get it into the monetary system is through the equity and bond markets, especially when they can put the monetary injection to "good use", i.e., to prop up the markets. They probably think they're geniuses. Once M-3 is not reported we need to come up with another warning system that the Fed/PPT is getting ready to do their thing again.

I had mentioned that the PPT needs a higher level of short interest in order to help them get a rally started. A fellow EW analyst came up with some interesting data I'll share with you. Dr. Robert D. McHugh who has his own newsletter, studies these things and he put together a chart that correlates the CBOE put options to the chart of the DOW. But he smoothes the data by graphing the ratio of the 10-day moving average of the put options to the 30-day moving average. As this chart shows, the peaks in this 10-dma/30-dma ratio tend to correlate with market bottoms.

DOW vs. CBOE Put Options, courtesy Dr. Robert D. McHugh, Ph.D.

If the PPT needs short covering to help them lift the market, we know we need to be careful (when trying to short the market) when the short interest is high. This has always been true but now with the PPT becoming more active in the market, the out-of-the-blue rallies must be respected. We've seen time and again rallies take off for no apparent reason, or in the face of really bad news, and then just keep going. As can be seen in the above chart, we currently do not have a large short interest ratio and that makes the PPT a non-threat to bears right now.

But if the market drops into the end of March and Iran starts selling oil in Euros and the Fed stops reporting M-3, and if the short interest ratio as shown on the chart begins to climb above 1.18 (the horizontal red line), the risk becomes greater for bears. In other words when the 10-dma is 18% over the 30-dma, it's time to protect profits on short positions, and even think about watching to grab a long play (which will be difficult to think about in a sell off). It's unfortunate that we have to plan for Fed intervention into the "free" market and into our trading plan, but sometimes reality sucks and we still need to deal with it and change our tactics to accommodate the changes. This will be an interesting chart to keep an eye on over the next month or so.

I try not to be a conspiracy theorist and I'm not a Bush basher by any means but something is starting to smell fishy in what's coming out of the White House. I'll mention this as food for thought since again it could have negative ramifications for our market (and perhaps another reason the Fed wants to stop reporting the measurement of their activities). We just learned that the business of running six of our vital seaports is being sold to a state-owned business in the United Arab Emirates, Dubois Ports. My first reaction was horror but then I thought about the fact that we (Coast Guard, FBI) are responsible for security and President Bush's argument about not discriminating against our ally made sense.

But here's the what-if and questions I have. Saying he just recently learned of the deal, why has President Bush been so adamant about this deal? He came out with stronger support for this than many other ideas, and for the very first time threatened to veto Congress if they attempted to block him. This is important to him and he made that abundantly clear. But why? Take a look at the map and see where the United Arab Emirates is located in relation to Iran and the Strait of Hormuz. Might the seaport deal be in exchange for them allowing us to stage more of our military in their country? It sounds like we're getting ready to defend tanker flow through the Strait and who knows what else militarily. Makes one wonder what's really going on behind closed doors and what we're not being told. I don't like being lied to--tell us the truth, I think we can handle it.

If we stage our military in and around the Strait of Hormuz, there will be a lot of uncertainty about what's coming next. The market will not like this one bit. As the market struggles to hold onto its highs, and chops its way higher, which already looks like a battle between the bulls and the bears, the bulls will be easily spooked causing them to grab their profits and run, and run fast. The exit doors might not be wide enough when someone yells "Fire!" and I don't mean the burning kind. Just a heads up.

OK, enough speculation. Let's get back to the charts and take a look at oil since that's what might cause the next (and the next, and the next...) conflict. As I had mentioned last week, it looks like oil is consolidating and potentially forming a right shoulder of a H&S pattern. A break of its neckline and drop in price would suggest things are quieting down on the world's stage and that would be a good thing. Let's all hope for a price break down in oil, for more reasons than one.

Oil chart, April contract, Daily

The potential neckline of the H&S pattern is near $60 so the psychologically important $60 level is important for a couple of reasons. If that and the February low gives way the next level of support would be the longer uptrend line from January 2004 currently near $56. The choppiness of the current bounce off the February low tells me to expect lower once the bounce is finished. It's a bit premature to speculate on the downside but the H&S pattern projects a price drop to about $50 which matches the Fib projection for the next leg down (to be 162% of the 1st leg down).

Oil chart, 30-min

This is what I mean when I say the choppiness of the bounce. This is the pattern since the February low and shows something like an ascending wedge forming. This is one of the EW triangle patterns and as such should have 5 internal waves, labeled a-b-c-d-e as I've done on the chart. The last wave, wave-e, often does a throw-over above the top of the pattern before dropping back down (or throw-under below the bottom of the pattern if in a decline). That's what I'm watching now to see if we get that--any rally up near $64 that then fails to hold and drops back down below $63.50 would be a sell signal for oil.

Oil index chart, Daily

The oil stocks look like they could bounce a little higher before it's done. I have trend lines and Fibs pointing to about 578-580 for a potential high although motoring sideways instead is just as likely. MACD in negative territory is not bullish but it could work its way back up to the zero line before it's ready to roll back over.

Transportation Index chart, Daily

Where oh where did the Trannie top go... Talk about a choppy rise higher! This is a classic ending pattern and there's no doubt in my mind that this sucker is finishing up very very soon. It's just a matter of where and when but I don't think it's much higher.

Transportation Index chart, 60-min

Zooming in on the final move higher (as I'm interpreting it) shows an overlapping corrective climb to new highs. I've got it counted as complete at Wednesday's high but this kind of pattern can morph into a larger one and continue so it's a tough pattern to trade. It could be done now but confirmation doesn't come until the TRAN breaks below 4400.

U.S. Dollar chart, Daily

The pullback in the US dollar was expected and now I'm waiting to see if support holds or not. The 50-dma did not hold so next up (down) is the 200-dma at $89.33. It is currently just shy of a 50% retracement of the rally off the January low ($89.48) and a 62% retracement would take it down to $89.11, just under the 200-dma. Any deeper retracement than that and I would begin to think more seriously about a break down in the dollar right around the corner. But so far I'm thinking this is just a corrective pullback before it launches on a strong rally, and this fits my current thinking on gold as well.

Gold chart, April contract, Daily

The bounce has made it up to the upper band that I thought would be reached. I was thinking $570 on the high side and so far the high is $572.50. Trend lines and Fibs point to this area as a potential high and if it instead continues rallying (and the US dollar continues to drop) I would say we've got new highs in gold coming. But I'm thinking the bounce will top out very near here and we'll start the next leg down. It's possible gold will trade sideways in a large triangle pattern but I won't have a feel for that until the decline gets underway. My first thought is that we'll see another sharp price drop so once again protect profits if you're long and consider shorting gold if you're a trader (through an ETF, futures, or options on XAU).

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's lonely economic reports are the Michigan Sentiment and ISM. There are no surprises expected but these have the power to move the market if they do surprise. Both will be released after the market opens.

As can be seen in the table at the top of this report, the internals matched the day. Down volume and declining issues were the winners today but not by much. What is surprising, and perhaps telling, is the continuation of more new 52-week highs vs. lows. This looks like accumulation going on behind closed doors and doesn't suggest we have an imminent sell off coming.

Sector action was also mixed with a slightly negative bias. Leaders to the downside were the airliners, retail, Transports, cyclicals and banks. The leaders in the green were gold and silver and energy.

Tomorrow is a bit of crap shoot when it comes to figuring out the immediate direction. I could easily make an argument for the market moving in either direction. That tells me to stay out and wait for a clearer setup. I know Type-A traders don't want to hear that. They want, no they Need to trade, and they want to know which direction to place their bets. If held at gunpoint and told to trade, I'd trade long tomorrow morning only because it looks like we need to finish the 2nd leg up of a bounce that started from Tuesday's low. That might take SPX back up for another test of its recent highs and be part of its sideways journey over to its October uptrend line.

But I see an equal chance for the market to continue its decline after today's attempt at a recovery off this morning's sharp drop. A sharp drop followed by a choppy rise usually leads to another sharp drop. So if I were forced to trade I'd go long but as soon as the gunman took his eyes off me I'd get my money off the table as fast as I could. Wait for a better setup and we'll do the best we can on the Monitor to help you in and out of trades. Good luck and I'll see you there.
 

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