The Market got what it wanted yesterday (a pass by the Fed) but sold off today anyway. Just another sell-the-news event. The trouble this time is that a sell-the-news event could lead to something a lot more drastic. That's because the market has everything priced to perfection at this point and any disappointing news will not be taken well. But so far there have been no major hiccups. Well, except for that minor little problem with Amaranth losing $5B. But what's a few billion amongst friends. There's plenty more where that came from.
The jubilation at the news the Fed was going to hold at the current interest rate turned to fear today that perhaps that means the economy is slowing. The release of the Philly Fed survey and leading economic indicators today only added to fears that a hard landing may not be avoidable after all. And once again I'll mention the facts about the stock market vs. the Fed's rate changes. With very few exceptions the stock market was down 6 and 12 months After the Fed stopped raising rates. Why so many talk about the market being a good time to buy once the Fed stops raising rates is beyond me. I'm thinking it's smart money who keeps that rumor alive so that they have plenty of sheep to sell to while smart money unloads their inventory.
From a technical perspective several of the market's major indices are perched at the top of bearish ascending wedges in which they have cornered themselves. They must break to the upside with gusto otherwise even a normal pullback will be a break down from the wedges. Once a break down occurs it will be difficult to stem the blood-letting since these wedges typically retrace quickly all the way back to their origin; in this case that's the July low.
But that's the downside risk. For now the equity market is holding up remarkably well. The low VIX says no one is worried about a Sept/Oct correction (strong hint--put options are real cheap right now). I hate to sound like a bear since I know many of our readers do not like hearing anything other than bullish things and prefer to only buy and not sell. Buying calls is good; buying puts means youre a pessimist. But those who have followed me for a couple of years now know that I call it as I see it. As Fleckenstein often says, I'm often wrong but I'm always confident in what I say. So while I may sound confident in the setups I see tonight, understand that I'm just one analyst of many that you should be following (even here at OIN or on the Market Monitor) so as to form your own opinion. After all, it is your money.
If you don't like bearish reports you can stop reading here. But I see a bearish setup in this market the likes of which I haven't seen since 2000. Playing the short side is more difficult than playing the long side and it has a lot to do with bear market rallies that stops many shorts out of their positions only to reverse hard to the downside again. You don't see that kind of price action in a bull market. But the setup I see in front of us could make shorts more money in a year than bulls have made in the past 4 years. If you don't like playing the short side of this market then at least go into profit protection mode and move to cash soon, as in very soon. As I mentioned above, buying some put options for insurance against your portfolio's losses has never been cheaper. Some December puts should work very nicely.
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There are many who are speculating that the market will be held up into the elections. I have to say I've been surprised at the inability for this market to sell off. Bearish divergences have been on the charts since, well, since 2004 but it's getting noticeably weaker lately. The advancing-declining volume and issues shows less and less participation at each new high. The semis are simply not in the game. And when the semis are heading south while the big caps are chugging higher that says smart money is not buying into the new highs, literally.
But the effort to hold the market up could continue for several more weeks. Just getting close to the election would be good enough since not enough damage could occur by election (maybe). As a follower of Elliott Wave patterns there's a way for me to consider the possibility of a strong rally tomorrow. And if that happens I firmly believe we'll see a rally last at least into the end of this month, perhaps as a choppy rally, with SPX 1345 as an upside target. But if we get a bounce followed by new lows below today's then let the bell toll for those bulls who refuse to get out of their long positions.
Before getting to the charts to show what I'm looking at, let's review today's economic reports. The weekly unemployment numbers showed a rise of 7K to 318K. The 4-week average of new claims stayed steady at 315K. The number of continuing claims fell by 29K to 2.4M and the 4-week average dropped to 2.47M which puts it back down to the level seen at the beginning of the month.
The Leading Economic Indicators (LEI) fell -0.2% in August, making it the 4th time in the past 5 months to have fallen. It also fell in July. This suggests sluggish growth at best into the end of the year. Of the 10 indicators that make up the LEI, 3 were up--stock prices, money supply (gee, I wonder who could be doing that) and orders for consumer goods. Thank goodness for the mighty consumer still. But consumer expectations, building permits and the factory workweek dropped the biggest. The rest were down slightly--interest rate spread, jobless claims, vendor performance and orders for capital goods.
The Philly Fed survey came out at 12:00 and the market started breaking down right after that. The Philly Fed diffusion index dropped significantly--down -0.4% vs. expectations for +14.4%. This was a drop from August's +18.5%. This was the first time this index went negative since April 2003 which of course was right after the bottom in the market (March 2003). Readings below zero indicate contraction and that's what started the "R" word to start spreading around again. Economic growth is slowing fast and inflation is hanging on. For those who were around in the 1970's and remember the painful times of stagflation, that's where we could be headed again. It's tough for the Fed to fight that one--they'd be stuck between a rock and a hard place.
The new orders index dropped to -1.3 from 15.7 and shipments dropped -6.8 from 22.3. Prices paid index dropped to 38.1 from 45.3 while the employment index rose slightly to 10.7 from 8.2.
DOW chart, Daily
The DOW continues to press against the top of its ascending wedge but not able to make more headway than that. And each new high is being met with less enthusiasm as measured by market breadth. The bearish divergences at new highs is usually a very good indicator that the bearish interpretation of this pattern is the correct one. The Elliott wave count that have for the internal structure shows it could be complete at today's high. There's also the possibility that today's pullback was just a deep correction to this week's rally off Tuesday's low. If that's the case then the market needs to rally hard tomorrow. If we've seen the high for this pattern then we should see a bounce (assuming we'll get one tomorrow) that then leads to new lows.
The DOW came down and touched its uptrend line from July today at 11500. That's the line the bulls need to defend. If the DOW breaks that and then breaks Tuesday's low (11480) then that will be confirmation of the break down from this pattern. Ascending wedges (and descending wedges) tend to retrace the wedge relatively quickly and that would mean a drop below July's low and it could happen in a matter of weeks vs. the 2 months it took to build this wedge. The bigger EW pattern tells me we're perched on the edge of a cliff. You'll recall the chart I showed a couple of weeks ago showing the relationship between the housing index vs. the S&P 500 (lagged 12 months). That chart and my EW count suggest we're in for a nasty decline very soon.
SPX chart, Daily
The SPX sports the exact same bearish ascending wedge as the DOW. A retest of the May high also occurred. Like the DOW, if today's pullback is followed by a strong thrust higher tomorrow (and it has to happen tomorrow) then we could see a push up to a Gann and Fib target of 1345. It might not happen in a quick move though but instead be a choppy ride higher. That would tell me it's the last leg up as smart money sells into it. By its wedge pattern, and previous highs and lows, SPX could find support around 1313 whereas the DOW will show a break down by that point. So there's enough of a difference to cause some question as to when we'd have a sell signal. A break below SPX 1308 would tell me to short every bounce in your favorite index.
Nasdaq chart, Daily
The COMP is struggling near the top of its steep parallel up-channel for price action since the August low. It's also at the broken uptrend line from August 2004 where it last failed a retest in late June. While this one could press higher as well, it's looking very vulnerable to a sell off here. The QQQQ chart looks exactly the same.
SMH index, Daily chart
The semis have been weaker during the whole summer rally and have now started to sell off before the rest of the market. That's usually very telling--they're the canary in the coal mine and I think the canary just fell off its perch. It's looking at me with sorrowful eyes while clutching its throat. I can't quite figure out if it was a bad seed or what. Bulls should heed the warning on this one if it breaks its uptrend line from July, currently just below where it closed today.
BIX banking index, Daily chart
The banks look almost bullish here, but only if it survives a retest of its broken downtrend line (closed on it today). If it drops back down below the line then it was just a bull trap head fake to the upside. A failed break out usually results in a whip to the downside as all the bulls scramble out the one narrow exit door. But if the banks turn around and head higher I would expect to see the same in the DOW and SPX and I would abandon attempts at the short side until at least the end of the month.
Securities broker index, Daily chart
The brokers also pushed higher than I thought they'd go, and there's not much in the way of bearish divergences to tell me I should be looking to short this index. It did however get near testing its broken uptrend line from May 2005. This index loves to test previously broken support and has been consistently doing that since the April high. This could be just another test before turning back lower. That's my expectation but we'll need price to turn back down now to give some clues in that regard.
U.S. Home Construction Index chart, DJUSHB, Daily
The housing index has been consolidating since its July low and it looks like a bear flag. My EW count says it is in fact a bear flag and that we should see this continue lower once it's done (and the last high in September should have been it). This should get down to, or below, 500 before another consolidation.
OOil chart, November contract, Daily
I've been saying for a while now that I expected oil prices to decline based on my belief that we'll see an economic slowdown on a global basis. This was based on EW analysis that calls for a deep retracement in the stock market which happens to be the best reflection of social mood that we have. With a downturn in social mood (which we're seeing) we'll see a downturn in the economy. Lack of demand for oil will result in a drop in oil prices. This has nothing to do with the fundamentals about oil which I know next to nothing about (although thanks to Jim and his superb research and analysis I'm far more educated this year). It has everything to do with EW analysis and it tells me oil has further to go to the downside before finding firmer support. I could be all washed up on this but this is how I'm calling it. And if we get the 5-wave move down as I've depicted it will mean we've seen the high in oil for a long time (a few years anyway).
Oil Index chart, Daily
The oil index is mirroring the oil price. The break of the 200-dma followed by a failed retest of it looks bearish. We might have completed the 3rd wave down which would call for a sideways/up consolidation and the short term charts are starting to show bullish divergences so we might not be far from a bounce. It's not one I'd want to buy but I wouldn't want to short this index from here, not yet anyway.
Transportation Index chart, TRAN, Daily
A retest of the May high for DOW and SPX is not being accompanied by a test of the high for the TRAN. That's bearish non-confirmation. The Trannies struggled with the confluence of its 50, 100 and 200 moving averages and now looks ready to pullback after a failed test of that resistance. It looks like another bear flag about to break down.
U.S. Dollar chart, Daily
The US dollar chart is starting to give me bigger bearish feelings here. For a while I though a brief consolidation would be followed by a move to minor new low--targeting around $83--to be followed by a bigger bounce. Now I'm getting the impression that the sideways coil is the continuation pattern for the move down from November 2005. Two equal legs down from last year's high would take the dollar down to around $77. That should theoretically be very good for gold. But so far I'm not seeing that much I like bullish about gold.
Gold chart, December contract, Daily
I view the current small consolidation as bearish and am looking for lower prices for gold. Using Fib projections I see a downside target of $506. I've drawn in a trend line across the lows in March and June of this year and if I squint I can see a H&S pattern there (albeit with a rather large right shoulder, so it's a humpback H&S). The downside price target from that is closer to $400 and that matches a Fib projection for the 2nd leg down to be 162% of the 1st leg down (common, especially in commodities). I don't know if that will happen from here but without considering the US dollar or any of the economic fundamentals that should drive gold higher, my opinion on gold is bearish for now.
Results of today's economic reports include the following:
This chart (from Yahoo's economic calendar) doesn't show any significant economic reports tomorrow. Jane reported on the Market Monitor at the end of the day that we'll have the August Chicago Fed National Activity Index (Previous: -0.12).
After the close JDSU (2.15 -0.03) announced its approval for a 1-for-8 reverse stock split. That would get their stock price back up to $17.20 based on today's closing price. Of course stock holders would have one-eighth of the number of shares they currently have. Expect many many more tech companies to do this in the next year, especially those that were hammered down during 2000-2002 and haven't really recovered much since then.
Taking a look at my weekly SPX chart to see how it's doing, again there's not much change.
SPX chart, Weekly, More Immediately Bearish
The market is stubbornly holding onto its highs but not making much headway on a weekly basis. The weekly oscillators into overbought and/or curling offers more evidence that the bearish ascending wedges will likely result in a significant price correction. For those who like to play the short side we should have a good opportunity right around the corner. But the real money maker for short players will be next year after a bounce into the new year.
For now I'd play it carefully tomorrow and into next week. The bearish setup is there but we'll have to see a bounce followed by a move to new lows below today's. That would be a strong sell signal for me and I'd be looking to short the bounces after that. But if tomorrow reverses today's losses then I'd be inclined to scalp the long side and watching carefully for the end of the run.
I say scalping long plays because I believe the risks are now on the bulls' side. Surprises are likely to be to the downside now. With the market priced to perfection it won't take much to see a fast exit and the exit door gets mighty narrow when that happens. For those of you who have traded fast markets you know about the terrible fills you can get. If you want out quickly don't even hesitate to use a market order. If you want in, use a limit order. It's a time to be very careful and if you can't watch the market intraday, and you're long the market, be sure you're using some protection. Nobody likes nasty surprises when you don't use protection.
Good luck and I'll see you next Thursday and on the Market Monitor tomorrow.