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Market Wrap

Market Wrap

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As can be seen in the above table this past week was basically flat in the major indices while a couple of sectors had a good week.

No surprise, Friday's trading volume was very light, as was most of the week. The internals reflected the kind of day it was.

U.S. Dollar Takes It on the Chin

I (Keene Little) will be filling in for Jim this weekend. He will return to full duty this coming week. The holiday week was marked by low volume and trendless trading. The equity and bond markets have been marking time rather than busting a move in any particular direction. The past week has tended to be a bullish week as sellers more than buyers seem to be the ones who take the holiday seriously. But this past week was lethargic with no sense of direction. U.S. traders were then surprised to wake up on Friday to see the equity futures so far down in the red.

By about 6:00 AM the S&P 500 futures down about 8 points from Wednesday's close and the DOW futures were down about 50 points. The DOW futures then dropped another 20 points before the cash open and it was looking pretty ugly. It was certainly a bigger move than we had seen all week and it was in the opposite direction to what most traders were thinking for the week.

The reason for the equity market tanking overnight was blamed on the Euro/USD which I'll cover in more detail later (by the US dollar chart below). But the flight to the Euro and the dumping of the US dollar scared the equity market. This is an indication of what's to come, whether it comes now or a little later, so it was a good heads up for what to watch in the relationship between the value of the dollar and equities (and of course gold).

There was no major economic news to further influence the market Friday morning so it was left on its own to deal with this new "crisis". But was it alone? As soon as the cash markets opened it was nothing but rally for 1-1/2 hours until 11:00 AM. The futures were driven back up to, if not above, the point where they had sold off on the currency news in our overnight trading session. The techs even managed a new high for this rally leg.

But it appeared that the rally had been engineered to allow some big money that had been caught by the overnight surprise to be able to get out at a better price. For the next two hours into the early 1:00 PM close the market gave up most of the morning's gains and left most indices in the red for the day. I was left with a bearish taste in my mouth as the day ended.

But there is a possibility that the bounce off Friday's opening low may have been the start of the next leg up to the "one more new high". In other words the spike down on Friday morning might actually have been the completion of the consolidation pattern that we've been in for the past week. The challenge here is that it's very difficult to get a sense of market direction in a very light volume holiday-trading environment. Therefore I'll lay out two potential scenarios for Monday that should help us get a sense of where this market is going next.

The VIX will clearly be important to watch here. Friday's jump in the VIX may have been a knee jerk reaction to the drop at the opening and never settled back down even when the stock market rallied back up in the morning. Sniff, sniff, is that fear I smell?

VIX chart, Daily

I don't like to take away anything from Friday's price action, including the VIX, because of the low volume holiday trading. But disregarding that, this chart is giving us a heads up that something is about to change, maybe. After sliding down on top of its descending wedge, and hitting the bottom of the wedge with a record low, Friday's move higher says the bottom might be in. That would signify a top for equities. But it could be premature so it bears watching--any rally over 12 could mean we're seeing equities breaking their up trends.

My feeling is that we are now very close to putting in the top for this rally. Calling tops has been hazardous to bears' health and clearly the trend is still up. Sticking with the trend has been the smartest trading strategy, period. But I now consider, again, the long side to be high risk. As of Friday's close I had mentioned on the Market Monitor that even though there is the possibility that we'll see a continuation higher Monday/Tuesday I can not in good conscience recommend a long play from here. Unless you have the ability to watch the market on an intraday basis, or at least lay in stops not far below, I believe surprises now will be of the nasty variety and could cause some very fast selling.

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You can see in the intraday pattern in the DOW and SPX what's happening here--choppy rise, quick sell, choppy rise, quick sell--and this is a distribution pattern. The stock is being handed off to the sheeple and when the Boyz are done they'll let it drop and not worry about trying to prop it back up. They'll figure let it drop so that they can take the inventory back from the sheeple at a much lower price.

I appears foreigners are voicing a little more loudly their concerns about our debt levels and about the excessive money creation that's depressing the value of the dollar. This is a tricky game the Fed must play. They must produce enough money to maintain liquidity and easier credit in our economy to help prop it up (especially in light of the collapse in the home builders market and the negative impact that will continue to have) while at the same time holding back on money creation so as not to create too much inflation and scare away one of our lifelines--foreign purchases. Twinkle toes Bernanke is on the high wire across the canyon and the winds are starting to pick up speed.

I'll try to show on the charts how close I think we are.

DOW chart, Daily

The DOW is struggling. The inability for RSI to get back above its broken uptrend line, and the negative divergences at its new price highs, is showing us this index is tired. There is simply not the same level of participation in the rally as the earlier part. Those who wanted to be in for the year-end rally are already in, seat belts have been fastened, drinks have been served, the plane is full and now they're all waiting for take off. I would bet many of them have not read the emergency instructions for how to exit the aircraft in the event of a crash or fire.

I had mentioned above that I can't recommend a long play here. This is simply too close to being finished now. It's possible the rally is complete but ideally we'll get another minor new high before seeing a top. If you look at the move up from November 3rd you can see how "pretty" that leg would be with another move higher since it would give us a clear 5-wave move. And it would be the 5th of the 5th wave in the move up from July. That would be a strong sell signal and it's the one I'm waiting for. The danger here, and why I'm recommend staying flat rather than try to trade long, is that these final 5th waves have a habit of being a no-show. They can truncate (not make a new high) or they can extend much higher or anything in between. They tend to get reversed quickly. I still like the 12400 area if it manages to push up to there as a potential high for this rally. It's possible to see a manic push up to 12500 but I would interpret that kind of move as the final exhaustion push and it would be a gift to bears.

SPX chart, Daily

The little pullback in the past week is less obvious on SPX than on the DOW (and non-existent on the techs) but it too looks like it could use another push higher to finish. As I look at some Fib projections for the move up I'm getting 1415-1420 as targets for a potential high. That kind of move would be a nice little rally and certainly worth a try if you're nimble. But as I said the risk for this move is that it could fail at any time, including here, and beat feet to the downside in a hurry.

If the market will rally on Monday, which I'm not saying it will, here's how it will do it (I've asked ReganBooks for $3.5M and for News Corp. to cover this):

SPX chart, 60-min

The sharp move down on Friday morning may have been the completion of the consolidation since November 16th. If you're an EW (Elliott Wave) fan, I've got that consolidation labeled as an a-b-c-d-e triangle wave-4 on this chart. The quick spike down on Friday would be wave-e to finish it, which is often how e-waves finish. The move up off Friday's low would then be the start of wave-5 to finish the rally leg from November 3rd. That rally leg would finish the rally from July. The rally leg from July would finish the one from August 2004 and that rally leg would finish the A-B-C bounce off the October 2002 low. In other words, by this EW count we should be within days of making THE top to the bull market rally.

I know what you're thinking--"yea, yea, sure, I've heard it before". As I said before, the trend is your friend and those who have stuck with their friend have done very well the past couple of months. I like to pick tops and I'm picking one on this chart. There are many pieces coming together here and the EW count is just one of them. Trend lines, VIX, negative divergences, insider selling, Bradley Model turn date this week, my Aunt Mary, you name it, I've got too many signals for me to ignore here.

So, Monday will be telling--the short term bullish case as presented above needs to have a rally start immediately on Monday. Friday morning's low can not be violated otherwise at a minimum we're going to see a deeper pullback before another potential rally leg. If Friday's low is violated I will be very cautious about both sides until I see what develops next. SPX needs to drop below 1388 to confirm the likelihood that there will be no more upside and that we should be looking to short all rallies, and short big. If we get the rally leg on Monday/Tuesday I believe it will set up an outstanding shorting opportunity. Don't go hog wild but instead continue to slowly build your longer term short position.

Nasdaq chart, Daily

The COMP appears to have had what's referred to as a "running correction" in EW terminology. Instead of pulling back as the DOW did, the techs corrected in an upward sloping correction. These are relatively uncommon but not in a market that's not allowed to pull back. If this interpretation of the pattern over the past week is correct then it's set up like the SPX chart I showed above and we should see another push to new highs. The top of its up-channel is near 2500 and that makes for a great place to lie in ambush with your short play. One warning on this index is that the chopping higher over the past week could be a heads up that this one is very close to finishing its rally. This interpretation suggests a minor new high on Monday could finish it off and top out perhaps earlier than the big caps. This might be a result of money rotating into the safety of the big caps. Small caps and techs might suffer a little earlier.

NYSE Composite index, Daily chart

Looking at the big index in an effort to gauge the broader market shows me the same potential as the others--a small pop higher could have it tagging resistance at the nice round number of 9000. In its EW count, with an extended 5th wave in the move up from June, a common Fib projection for that 5th wave is equality with the previous two impulsive waves (1 and 3) which is at 8968. Therefore between 8968 and 9000 I'm looking for a top in NYSE. Thursday's high was 8962 so close enough? If Friday's low is taken out right away on Monday and it drops below 8872, the November 7th high, then I'd say we've seen the top already.

SOX semiconductor index, Daily chart

The SOX continues to look somewhat bullish here. It managed to break above trend line resistance and is now consolidating under its 62% retracement resistance. A break higher could carry some. There is a lot of air above it for a run up to 530. Obviously it would need the help of a bullish climate and the broader market rallying and therein lies the problem in my opinion. I can see the possibility for a minor new high in this one as part of its choppy climb higher over the past week. Any drop back below 480 would be bearish.

BIX banking index, Daily chart

I've been saying the banks are one of our canaries in the coal mine. For those who aren't aware, canaries were used as gauges of proper oxygen and other gas levels in the air down in the mines (they now have "electronic canaries"). If the canary dropped off its perch the miners knew to get out of there. Well this bank canary is swirling around the drain. Lately any breaks below the 50-dma have been one-day affairs and then a quick recovery. With a closure below the 50-dma on Friday the banks will need to do the same here on Monday. But the fact that the banks have not been participating in the latest rally should be a concern to bulls.

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

The housing index is close now--just a little more push up to tag the top of its bear flag pattern and the top of a parallel down-channel for price action since the fall of 2005. The 200-dma slightly below the cross of those trend lines might hold this down and certainly the combination of these should serve as tough resistance, especially now with daily oscillators into overbought. The 720-730 area is the zone to watch for a reversal. This should be the setup for the next leg down to new lows thereby refuting all those who believe housing will have a soft landing, including some of our Federal Reserve Governors and our ex-Fed head Greenspan.

Oil chart, December contract, Daily

I'm about to put one of those emergency medical bracelets on oil so that it can call in "help, I've fallen and can't get up". My expectation for oil to rally out of this hole has not changed, even with that last pullback making a new low. I'm expecting a choppy rise back up to correct the July-October decline and it needs to get started from here. The next move should be above its 50-dma. If it instead heads back down for new lows then it becomes more bearish than I thought and I don't know yet where it could be headed (how low).

Oil Index chart, Daily

If oil can rally a bit and the broader market rallies then we should see this index make a new high for this leg up as well. I think it will only be a minor new high before rolling back over. It's possible we'll see a retest of the previous high near 660 but that could be a stretch. A drop back below 617, the November 17 low, would say we've seen the high for now.

Transportation Index chart, TRAN, Daily

A Fib projection for the leg up from November 3rd, at 4925, coincides nicely with the center of its up-channel for price action since September. Right now the Trannies are fighting the downtrend line from May. It takes a drop below 4750 to confirm we've seen the high.

The US dollar quandary
The US dollar is what spooked equity futures overnight and after the thin holiday trading on Friday it will be interesting to see if Friday's price action in the currencies was more an anomaly or the start of a bigger move. There were a lot traders who were short the Euro and/or long the dollar who got stopped out on the overnight run. In the light volume environment it's not known how much that may have been a factor.

There were a couple of other factors blamed for the quick plunge in the dollar, with the usual culprits at the forefront--China's desire to diversify away from the dollar, Europeans worrying about an increase in the difference between interest rates between countries, and yen carry trades.

China warned about the risk to Asian currency reserves from further dollar weakening (the market pressure here could force the Fed to back off a little on creating too many of the little greenbacks). If the dollar weakens China could start selling off some of their greenback inventory. If their threat to lighten up on the dollar causes the value to drop which then causes them to sell more which then causes a further drop, well you can see where it might lead in a hurry.

Europe has been notching up their interest rates and traders are getting nervous the Fed will lower U.S. interest rates--this would entice more people to flee the dollar in pursuit of higher interest rates on currencies such as the Euro.

The Yen carry trade is where people borrow the Yen at 1% rates and then invest the money in other higher yield currencies. The unwinding of these trades can have a very large influence on currency values.

The result was a dumping of dollars and buying of Euros, mostly during European trading hours. By the time most of us awakened the big move was over. The question now is whether their will be follow through when the rest of the world gets back to their trading desks or if instead we see a reversal of that big move. The dollar is down to the May low and even poked a couple pennies below it.

U.S. Dollar chart, Daily

After a slight break of its uptrend line from January 2005 on Wednesday, Friday's break down made it decisive. The dollar found support at May's low so if Friday's light-volume trading was "excessive" then we should see a bounce on Monday. For dollar bulls they'll need to not only see a bounce but Friday's low needs to hold on any pullback. A bounce followed by another break down would confirm a new leg down in the dollar is probably already well on its way.

But if the dollar can get a bounce back above its broken uptrend line then it stands a good chance of getting back up to the top of its multi-month consolidation. I'm feeling that's a low probability at this point.

If you're wondering why you should even care or worry about the dollar I'll try to explain why we equity traders care. Many of the past market "dislocations" (nice term for market crash) have resulted from currency failures somewhere in the world that caused a domino effect through the financial industry. Clearly the US dollar has one of the biggest effects on the world's currencies. Global liquidity and credit availability has a lot to do with U.S. policies related to the dollar. And the explosion in the number and amount of credit default swaps and derivatives is a house of cards, or as Warren Buffet calls them, Weapons of Mass Destruction in the financial world.

The importance to equity traders is that the decline in the dollar from here will spell trouble for the equity market. Selling the dollar will further depress its value and selling will beget more selling. If foreigners start dumping the dollar we will lose potential support in our markets, including the equity and bond markets. If the bond market loses foreign support the Fed would be in a tough spot. First of all a sinking dollar raises the risk for inflation. That would force the Fed to raise interest rates. If the Fed needs to entice foreign money back to bonds they may be forced to raise rates to make our bonds more competitive. After all, this was one of the reasons given for the flight to the Euro on Friday--heading for better rates there or out of fear of dropping rates in the U.S.

Most economists are coming out with reports lately about why they believe the Fed is close to dropping rates. This has the stock market believing it too and believing that action will then help prime the pump and keep economic growth alive, and that companies' earnings will continue to grow and life will be wonderful. My opinion is that this expectation by so many is what will set up the hard landing as these people suddenly, and collectively, come to recognize it's not going to happen. The Fed is more concerned about rising inflation than a slowing economy and it really is that simple. What the Fed is doing with the dollar boxes them into a corner and gives them no wiggle room for rate reductions.

Bottom line is that the Fed would be under a lot of pressure to raise rates regardless of what's happening to our economy and that would obviously kill stocks. The stock market would also not like the prospect of inflation as it would hurt earnings growth prospects. If a rate increase is required then our economy would feel the negative impact from that, again not good for stocks. From this very brief description of the interconnectedness of these markets you can see the intricate web we weave. Quite frankly I don't see a good way out of this problem and it's all part of the domino setup that will be hard to stop.

With the U.S. dollar getting hit to the down side in overnight trading it was no surprise to see gold up. What was a surprise to long time gold traders was the fact that gold was even trading. It was the first time that gold was trading on the electronic CBOT exchange while the Comex division of Nymex was closed for trading. One more trading pit that is in trouble.

I don't see the same upside "break" for gold to match the potential break down for the dollar. That could be telling us something and bears watching next week. A quick reversal in both trades would say Friday's action may have been an anomaly. At best though a recovery for the dollar and a pullback in gold will be just a delay of the inevitable--what we saw today will continue either now or within the next couple of months.

Gold chart, December contract, Daily

Gold's broken uptrend line from August 2005 has not been recaptured yet. In fact gold didn't even make it back up to the line on Friday, currently at 642.50. That means gold could easily pull back within its multi-month consolidation pattern. But a new high for gold actually gives it a bullish look with what looks like a 5-wave move up from its October low. That kind of a move suggests we'll see a pullback (perhaps to the 50-dma) followed by a continuation higher. This kind of move might follow the dollar's bounce back up to test its broken uptrend line and then a continuation lower.

Next week's economic reports include the following:

Next week is a busy week for potentially market-moving economic reports. We have nothing on Monday but come Tuesday, when there's the potential to see a market high, it could be interesting to see what happens around Tuesday's reports. The Durable Goods number is expected to be bad, as in -6.0% after September's +8.3%. The market has been rallying in the face of this bad news. And if it comes out worse than that? Say goodbye to the growth expectations component of the P/E ratios that everyone has been saying is just fine. Of course then there will be those who say a bad number is a good number since it will mean the Fed will have to reduce rates. That's not going to happen.

The rest of this coming week has some potential stink bombs mixed in there as well so it could be a bit of a land mine trying to trade around these things and of course the morning reaction to the news doesn't necessarily mean much as to how the rest of the day will trade. Just continue to exercise caution because I think we will have a lot of fund managers now more nervous about holding onto their profits rather than trying to make more. A little hiccup and they'll all be running for the exit door faster, and with equal results, as if someone yelled "fire!" in a crowded theater.

An end of week update to the weekly SPX chart shows an interesting development from a candlestick perspective. It's hard to see on this chart but this week's candle is a doji at resistance. A doji means indecision or hesitation. It's when traders stare at each other to see who will blink first. A doji at resistance has more of a reversal potential tied to it and it's a heads up for a potential trend change about to occur. It doesn't mean we will see a reversal and it doesn't mean we can't see new highs followed by a reversal but it does give us a heads up. A red candle for the following week would be confirmation that we've probably had a trend change.

SPX chart, Weekly, More Immediately Bearish

I've mentioned several times in the past how well parallel channels work in evaluating where support and resistance will be found. It has to do with "measured moves" in the market. We react to moves in the market without necessarily thinking about it and these measured moves are part of the cyclical nature of the market. These work on all time frames and happen to be one of my favorite tools. On a weekly basis, especially with weekly oscillators in overbought now, this channel should be very effective in identifying resistance and this is just another item in the "bear" column as I evaluate the market for longer term trades. This past week's doji at resistance is a big warning to me.

Monday's game plan is relatively easy--go long if the market starts higher right away and use Friday afternoon's pullback low as your stop level. Rallying from Friday's pullback is the requirement in the short term bullish scenario I laid out, especially in the SPX 60-min chart above. If Friday's pullback low is violated, the important low is Friday morning's low and if that breaks then you'll want to short the bounces. I'm not sure what a deeper pullback would mean until SPX 1388 breaks--a break of that level would tell me that we've likely already seen the high for the rally. In that case get short on the bounces and start building your longer term short portfolio.

There are a lot of people expecting an end-of-year rally and will be buying the dips with gusto. The deeper the dip the more buyers will step in, thinking they got a heck of a good deal on the price. Shoppers are already in that frame of mind so why not with stocks too. The Boyz will know this and they'll use those buyers and shorts for all they're worth--the buy programs in a down market will light off the market like California's hill sides after a dry summer.

And as soon as all that dry grass finishes burning the fire extinguishes and down will come the market. If you like playing the short side you will need to accommodate this kind of market action. You'll need to be either very quick and take your money on a down flush or you'll need to establish a position and let it occasionally flare up against you. For that reason I like to try to pick tops--I prefer to let the market flail around underneath me and wait for a target to exit my trades. If I'm feeling confident about the short side (hard to do), I'll add to my position each time it flares up with short covering and new buyers.

I'll finish with one more chart that I got from this link.

Insider Selling, courtesy insider.thomsonfn.com, data as of Nov 18, 2006

This chart is from the link above (thanks to Joe E. for sending it to me) and shows insider selling in the form of sell/buy ratios. As can be seen in the big jump in November inside selling has jumped significantly. A low ratio means insiders are buying more and obviously feeling confident about the prospects for their own stock. A high ratio indicates fear amongst the insiders and worry about the value of their stock. They are in effect saying that don't believe the high price will be sustainable and they're taking their money and running. It's always smart to follow the insiders. This would be called legal insider trading if you were to follow their advice.

Hopefully by Thursday when I'll be back with you for the Market Wrap I'll have some good signals for what the market is doing. If it's still chopping its way higher by Thursday then we'll know the uptrend still rules and that's what you should be following if you're currently long. If you're currently flat then new long positions are highly risky. If the market has dropped below some support levels or levels that indicate to me a top is in, then we'll look for some short entry ideas.

If this ends up being a trend change week then it could be volatile. Very rarely does it go up in a nice smooth move and then simply reverse in a smooth ride back down. The bears and bulls duke it out for control and those stuck in the middle become punching bags. Flat is a good position while we wait to see what sets up. Longer term players should be thinking about legging into longer term short positions this week. Short term traders will need to watch the market carefully for moves in both directions. Good luck and I'll see you on the Market Monitor Monday morning and back here on Thursday.
 

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