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Market Wrap

Ouch!

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That's what a lot of bulls are saying right now. They've received a whoopin' from the bears the past two days and the bears may not be finished yet. While today looked somewhat capitulatory it wasn't to an extreme that has typically marked major bottoms. This looked more like people just couldn't get out the narrow door fast enough. If you look at the chart above you can see that volume was strong at 5.1B shares and down volume swamped up volume about 8:1. Declining issues handily beat advancing issues not quite half that at about 3.5:1.

Fear is clearly rising again--VIX shot higher by nearly 23% today. New 52-week lows dumped all over new highs by a 5:1 margin. These kinds of numbers typically warn of selling that has been overdone. And the equity only put/call ratio has been higher than normal the past couple of days, coming in at 0.84 today, and this also is usually a warning that too many are piling into the short boat which then capsizes.

The danger for the market is that sometimes hard selling like the past two days begets more selling. One reason is the hedge funds and the number of sold puts out there. They are of course hoping the market stays above support levels where they sold their puts. As long as the market stays above those levels into options expiration (July 21st) they get to keep their entire premium.

If the market drops below their sold strike level they must either buy the puts back (and buying puts is bearish and may be one of the reasons we're seeing the high put/call ratio) or they short the index/stock to hedge their short put position. This of course exacerbates the selling pressure as those who were feeling the most bullish are now forced to short the market. Kind of ironic actually.

Geopolitical concerns got the blame for rising oil and as a consequence for sinking equities. Usually news, at best, is a catalyst that starts something that was going to happen anyway. News does not make the market; the market makes the news. But the news people have to have a reason for why the market does what it does so they go for the easy to understand answers.

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I won't rehash the geopolitical news since we've heard it multiple times on multiple stations but with the rising tensions around the world it's obviously not conducive to bullish behavior. If anything people would prefer to sell first and ask questions later. But we all know of many many instances where the market has rallied strong on really bad news. The London bombings was a great example--it led to one of the strongest rallies this market has seen. So don't always believe the news as far as its effect on the markets.

One interesting development though is what's happening now that is in many ways reminiscent of the 1970's. When the Middle East oil producers got tired of us strongly supporting Israel during its conflicts at the time, we faced an oil embargo which of course plunged us into a recession. The 1970's was also marked by a stock market that basically went flat. There were huge price swings during that time and even after a new price high in the market in 1973 the market then plunged to new lows in 1974-75. It then rallied back up to the old highs in 1976 before getting a very large pullback into 1978.

It was a real yo-yo time in the market and I wouldn't be the least bit surprised if we see something similar this decade. That would mean the October 2002 lows will get taken out and then we'll rally back up to DOW 11K before heading back down in another big correction. Each cycle could take a couple of years as it did in the 70's. For a reminder, here's what it looked like back then. Got your seatbelts fastened? What this would mean of course is that buy and hold will not work. You'll want to trade this market, as difficult as that is.

DOW chart, 1960-1988, courtesy stockcharts.com

Without getting into the nitty gritty details of wave counts I'll just say that there are a lot of similarities between the market today and the market at the highs in 1972-73. I'll let you decide what you'd like to do with your long holdings.

In economic news it was a quiet day. Unemployment claims rose by 19K to 332K, making it the highest since the end of May. The 4-week average rose by 8,750 to 317,250. Continuing claims dropped by 18K to 2.4M while its 4-week average rose by 2K to 2.4M so it's been pretty steady but lower than year-ago levels (2.6M).

This afternoon we had the Treasury Budget numbers released for June and it showed receipts up a strong 13% to a record $264.4B. Must be from all those profits the executives received from their ill-gotten stock options that they're all being forced to re-price to what it should have been when the options were granted. Just more shenanigans by those entrusted to run our companies. Budget outlays were also up a record 15% to $243.9B. The good news is that the budget deficit is improving--at $206.5B year-to-date it's down 17% from a year ago. We ran a budget surplus for June at $20.5B vs. $19B expected. Maybe Congress needs to go on vacation early before they spend it.

I have a lot of charts to review with you tonight so let's get right to them.

DOW chart, Daily

The two big red candles the past two days says it all. A hard drop after testing its 50-dma and slicing right through support at its 200-dma and March 2003 uptrend line like they weren't even there does not bode well for the bulls, maybe. Dropping below the June 28th low leaves the move up from the June low to the July high as a confirmed 3-wave bounce which defines a correction (vs. a 5-wave move which is impulsive and defines the primary trend). But now we have a 3-wave move down from the May high to the June low and a 3-wave bounce to the July high. This leaves us guessing as to what the heck is playing out longer term.

For those of you following my EW counts, the move up to the July high is currently labeled wave-A. That means the pullback will be wave-B and we'll then get another rally leg back up to new highs which will be wave-C. This wave count fits the "intermediate bullish" scenario that I've been tracking via the two weekly SPX charts at the end of my reports. We'll review those charts again tonight. When I said the intermediate bullish scenario would be a choppy summer rally I wasn't kidding. If the current pullback from the July high is part of the choppy rally you know there are thousands of traders getting whipped out of their long positions. If we start to rally back up soon then it will be the bears' turn to get whipped out of their short positions. For now the bulls need to see the June low hold.

SPX chart, Daily

The uptrend line from August 2004 is the important line. As you'll see in the weekly charts at the end of this report, that's the bottom of what looks like a multi-year ascending wedge (and why I'm longer term bearish the market). After briefly breaking below it in June and then rallying back above it, SPX is now heading back down towards it. A retest of the uptrend line and the June low would be at the same level--about 1237. This level has already been broken for the DOW so it may not hold for SPX. The critical level, like for the DOW, is the June low of 1219.

Differentiating this chart from the DOW, as far as the EW count goes, is a very bearish wave count on this one. It says the decline from the May high has now formed a 1-2, (i)-(ii) wave count which means a 3rd of a 3rd wave down is in progress. The way the market has dropped the past two days speaks volumes for this wave count since a 3rd of a 3rd wave is by far the strongest of them all--a very fast and strong move (down in this case) would be expected. This wave count says you do not want to be long the market. Confirmation will be a break below 1219 with a big heads up if 1237 gives way.

Nasdaq chart, Daily

I've got the same wave count on the COMP as I do for the SPX. But interestingly there's another wave count that has an equal chance in my mind (shown on the QQQQ below) and that alternative count says the current decline should be ending very soon and a much larger bounce will follow. This alternate count would support the DOW's wave count which suggests we've got another rally leg coming as part of our choppy summer rally. The way to tell will be if a new low (which was achieved today) continues to show bullish divergences, as it is currently. If the COMP can find support at or above its October 2005 low at 2025 and turns back up with a bullish divergence, there's a good chance we'll see at least a multi-week rally follow.

QQQQ chart, Daily

This chart shows clearly the bullish divergences I mentioned above. It also shows a wave count that calls the decline from April as the move that finishes a big A-B-C correction since January. This suggests a big rally is coming. I'm not sure I'm ready to believe the big rally (to new highs) yet but I've learned to never say never with this market. Today the Q's broke, and closed, below the July 2005 $37.15 low which obviously is bearish. The next price level support is not until the April 2005 lows around $34.50. But there's another potential support level in between those two.

QQQQ chart, Weekly

Expanding our view here's a weekly chart of the Q's. It shows the horizontal price support broken at $37.15 and the next support level near $34.50. Also in that area is the 38% retracement of the 2002-2006 rally so that is clearly a strong support level. But before it gets there we could see support come in around $35.90 which is the bottom of a potential parallel up-channel for price action since January 2004. This would be a "measured move" within that channel and is very common to see. The weekly chart is oversold and the daily chart is showing bullish divergences. Be careful chasing this one to the short side since it may come back up and bite you.

SMH index, Weekly chart

The Philly exchange has apparently started charging for real-time data on sector indexes such as the SOX and QCharts has therefore stopped reporting price updates. Until that's settled (they will be moving to delayed price updates some time in the fall with their 6.0 upgrade) I'll use the SMH as a proxy for the SOX.

The techs were seeing a lot of selling pressure before the broader market got hit. Consequently I think any bounce will be led by the techs. SMH is oversold on this weekly chart at the same time it's reaching a potentially strong support level. Also like the Q's I'm seeing lots of bullish divergences at the new lows. A Fib projection for the 2nd leg down at 162% of the 1st leg down from its January 2006 high is at $29.40. The January and April 2005 lows are near $29.80. This makes for a potentially strong support level just below $30. Like the Q's I'd be careful chasing this one much lower.

BIX banking index, Daily chart

The banking index wasn't even able to touch the 50-dma and has now pulled sharply away. This looks very bearish but there's still potential support at either its 200-ema (closed on it today) or its 200-sma a little lower (just under 366). The daily oscillators rolling over doesn't make one feel particularly bullish here. The banks deserve careful monitoring as a proxy for the broader market. Even more bearish in my mind is the XBD.

Securities brokers index (XBD), Daily chart

The securities broker index gave us a great warning back in May when it failed the retest of its broken uptrend line and fell sharply away. Repeat performance? After retesting its second uptrend line (slightly breaking back above) and its broken 50-dma, this index has reacted sharply to the downside. As long as this index is bearish I don't think you want to be thinking long the market. Now we'll have to watch the techs to see if they give us some bullish signals soon and this index to see if it maintains a very bearish chart. We could of course see them diverge but then that's not what bulls want to see either.

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

The short waiting to happen happened. The picture perfect bear flag off the June low has seen follow through to the downside. I don't know if it will drop hard from here or instead chop its way lower (as part of the last wave within the decline from January) but this one appears to be headed for potential support in the 510-530 area.

Oil chart, August contract, Daily

Oil didn't even make it back for retest of its short term downtrend line from its early May high or its 50-dma. That's bullish price action and now it's made new highs. In fact they're new all-time highs for a front month contract. This one should be headed to $80 before we see any appreciably pullback. The overnight futures tonight already show oil above $78.

Oil Index chart, Daily

The oil stocks haven't followed oil higher the past few days and it looks to me like it's going to do some consolidation near the highs which should be followed by another leg higher. From wherever the pullback finishes tack on 35 points (that's the size of the 1st wave up off the June low) and that's your upside target for the 5th wave up. I'd take some money off the table at that point since it will be due for a deeper pullback after that. It's possible the high out of this will be the last one for a long time. But for now stay long.

Transportation Index chart, TRAN, Daily

The Trannies almost made it up to retest its broken uptrend line but missed it. This looks like a classic double top with a minor bearish divergence at that last high. This should continue lower and the first downside target is its 200-dma near 4350. And speaking of double-tops, when you get a chance take a look at the weekly chart of the DOW. Doesn't the double-top in the DOW look suspiciously like the daily double-top in the Trannies? Using DOW Theory we have a bearish setup in place even though it could take many months before we see it play out bearishly.

U.S. Dollar chart, Daily

The US dollar should continue lower and between the H&S price objective near $83 and a Fib projection (for the 5th wave to equal the 1st wave) at $82.25 should provide both a target and support where I expect the dollar to then get a bigger multi-month bounce back up to perhaps the $88 area.

Gold chart, August contract, Daily

If the dollar continues to drop that should be good for gold (and other commodities) but that relationship is not reliable enough to confidently trade. Gold looks ready for another pullback soon. A little higher and it will tag its 62% retracement of the May-June decline. I don't know if gold will continue higher after a pullback or if it instead will get another leg down to match the May-June move. In any case if you're a gold trader I'd watch for a shorting opportunity right around the corner. At a minimum I would expect gold to pullback to the $630 area.

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

Tomorrow will be a busy day for economic reports. There are a number of reports there that could move the market. Whether the initial futures move will carry through to the cash markets is very difficult to say. Many times the initial futures reaction gets reversed 10 minutes after the cash open. Maybe manipulation of the futures market? Nah, we know that stuff doesn't happen.

Speaking of manipulation, er I mean, a change in reporting of the data, the NYSE has decided to change the way it reports program trading volume. As we all know, program trading volume has been increasing over the years and has gotten to the point that it's become a very difficult game to play when we little people are trading against billions of dollars being moved by program trades. Thanks to Joe for forwarding me this information, the NYSE has decided to change the number of trades reported as program trades. Obviously it doesn't look good for traders if they know they're fighting the robots and so the folks at NYSE are trying to figure out how to lie, er I mean report things different so as not to scare us away.

After reporting program trades the same way for the past 20 years they've now decided to count exactly half of them. Total share volume traded on the NYSE is counted as both the buy and the sell (need a buyer for every seller) and that's the way the program trades were counted as well, which of course makes sense. But with program trading volume regularly exceeding 65% they decided that they'd count only the program trade and not the other side of the trade and then divide that number by total volume which they continue to track as two trades for each transaction.

So last week's program trading volume was reported at just 34.2% of the total when in reality it was 68.4%. Not only are just a few key member banks controlling most of the program trading (and have the profits to prove they're controlling the market) but now they're outright lying to us about the volume of program trading going on. It just seems to be getting worse instead of better in the lying and deceitful practices going on in the market. The arrogance by those in power did not go away with the collapse of Enron. Far from it. If you track program trading volume just double it to get the real number.

Finishing up today's look, sector action was red across the board. Some of the sectors I don't have numbers for (due to QCharts not reporting the Philly exchange indices) but the leaders to the downside on my list were the Transports, gold and silver, cyclicals, securities brokers, disk drives, computer hardware and biotechs. Doing the best in a down day, but still red, were the oil stocks, software, banks, retail and healthcare.

Futures are currently pointing to a continuation lower tomorrow. At best, for the short term, it looks like we should get some consolidations followed by new lows, so in other words a stair-stepping lower for another couple of days. I could be wrong but I think the hard selling is over for now. We might see an early morning flush as some try to exit their positions first thing tomorrow morning but then watch for a consolidation near the lows. It's probably too early to be thinking about catching falling knives but shorting from here should only be done if you can watch the market intraday. We could get some surprise short covering (even covering of the short hedges that many may have put on to protect their short put positions) and I think it's probably a little dicey to short the market from here.

For a little longer term perspective let's review the weekly SPX charts. Nothing has changed yet since we haven't broken down to the point where we have our answer as to which scenario is playing out. But if the current decline keeps smokin' lower then we'll have our answer sooner rather than later.

SPX chart, Weekly, More Immediately Bearish

As a reminder, this "immediately bearish" scenario says the May high was the end of the 2002-2006 rally which ended in an ascending wedge. The wave count, as reviewed in the SPX chart near the beginning of this report, says we're about to get hammered to the downside in a 3rd of a 3rd wave down in which case the June low won't even act as a speed bump. One thing about wedges like this one--they tend to get retraced quickly. So while it took two years to build this ascending wedge we could see it completely retraced in just a few months. A break below 1219 that stays below will say this scenario gets the nod.

SPX chart, Weekly, Intermediate Bullish

Ascending wedges are filled with lots of corrective (3-wave) price action (as are all triangle patterns) and it's why they're so hard to trade--they're full of chop and whipsaws. If you've had trouble trading the past couple of years, this is why. The wedge may not be finished yet and the pullback to the June low may have set up the last (choppy) rally leg to a new market high which will Then set up the big decline. For this scenario to play out the current pullback must find support at or above the June low and then we'll get another rally leg that takes us above the July high and quite possibly to new market highs as depicted here. No answers to the question yet but we're getting very close now.

Tomorrow is a summer Friday and we just completed two hard down days. Both of these tell us we can probably expect consolidation tomorrow. Sounds like a good time to keep your browser window closed and enjoy something else. Good luck if you trade and I'll see you here next week, and on the Market Monitor tomorrow for those who follow it.
 

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