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Market Wrap

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The jam job over the past two days has made for an interesting setup from an EW, Fib and trend line perspective. As you've seen in the past couple of Market Wraps I've set up both bullish and bearish "road maps" so that we can have some key levels for the market to tell us which direction the market is likely headed. Today's strong rally (ho hum, new all-time highs for the DOW) busted to the upside through some key levels that I had on last night's charts and therefore that puts us on a bullish path. Or does it? The move up from Monday's low has been impulsive and that actually opens the door to the possibility that it was an ending move and not the start of something bigger to the upside.

And with that the bulls just did a collective groan with a "Oh great, here he goes again with some bearish call for tonight. Doesn't he ever give up?" So, time to hear me out again as to why, this time, really really, today's high might have been the end of the run. I'll lay it out on the charts and let you be the judge. I'll also continue to show both bullish and bearish road maps so that we can let price make the final ruling. All I can do is give an opinion as to where I think price will head next. But price being the final arbiter, it will let me know which wave count we need to follow.

I've mentioned more than once in the past a pattern we've seen coming into opex. Typically, especially in the past year, we've seen the Thursday/Friday prior to opex get driven down hard only to be reversed into opex. My guess about this move is that first of all it's a head fake move. If the Boyz (my term for the mega banks' trading teams) can drive the market down they'll be able to suck in the shorts who are convinced the real selling is about to begin. Getting the shorts into the market then gives them the added fuel needed to spike the market up the following week by getting the shorts to scream for cover as the buy programs hit.

The other benefit to this maneuver is that the Boyz use the spike down just prior to opex week to load up on cheap front-month call options. Driving the DOW up 200+ points, or SPX +20, does wonders for those call options. To say they can make a few million on this trade alone would likely be a gross understatement. But how do they know they can get the market to rally? Ah, a little help from their friends, i.e., our Fed.

I've shown the M3 chart enough times for you to see how active the Fed has been in creating money, measured by M3 which they stopped reporting almost a year ago. Since that time they've gone hog wild with money creation. Bernanke is simply following through on what he promised he'd do--drop barrels of dollars into the money system to be sure we don't suffer any depreciation of assets. Could the collapse in the home builders and now the slowing in the housing market (and starting to see actual drop in prices year-over-year) be considered depreciation of assets? You bet.

Bernanke to the rescue! I'm sure he sees himself as the knight in shining armor on this issue with the great power of the U.S. banking system behind him. After all, the US dollar is the world's reserve currency and it's only fiat money anyway (not tied to a gold or any other standard), so we get to make as much as we want. As long as the rest of the world is happy to buy those cheaper and cheaper dollars Bernanke doesn't feel the need to be worried. He should be but that's a different story.

So back to the Boyz. With the Fed hyperinflating the money supply, and a ready channel to stuff it into the money system through their primary dealers (the mega banks) and into the markets, the Boyz know the money is coming (the Fed kindly lets them know). With the Fed's money coming in, and the banks' own appreciable trading capital now, moving the market higher is a piece of cake. And voila! We get rallies during opex like yesterday's and today's. Is it real buying? I would argue that it's not but then again I'm just a conspiracy theorist about all this.

But that's all speculation. I'd much rather go with the chart patterns and they're giving me some signals after the strong rally this week that it just might have been an ending move and that's what we'll review in a bit.

First, economic reports did not have that much influence over the market as futures barely rippled, even after a somewhat disappointing retails sales report. It was when Bernanke's talk was released that we saw the market shoot higher out of the gates. You would have thought he said something miraculous instead of something we've already heard time and again from the other Fed heads recently. There was absolutely nothing new in there and yet the market went nuts. Need I say more about the Fed goosing the market through their mega banks' trading teams?


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Retail Sales
U.S. retail sales were disappointing with big declines in auto sales and gasoline sales offsetting gains seen at the malls. The net result was a 0% change in overall sales. Excluding autos the sales number was +0.3% but still less than the +1.3% in December and half of what was expected. Sales have experienced their slowest year-over-year growth since April 2003. If you'll recall, that was right after a very nasty bear market and where the market started its bull run.

So the question now is why is retail sales growth so low after we've seen such a strong bull market? The answer of course is because the bull market has really been a bear market rally and even with the DOW and other indices at new all-time highs, we don't have the same underlying strength in the economy. And as Scott Hoyt, an economist for Moody's Economy.com, said, the report showed "a continuing trend of weakening growth in consumer spending." This is of course no surprise when you consider what's happening to the consumer's bank accounts and I suspect is only the start of a real slowdown in consumer spending that's coming.

Investors in retail stocks liked the news though as the retail index (RLX) hit an all-time high with the DOW today. With retail sales accounting for about half of consumer spending, and consumer spending accounting for about 2/3 of our GDP, we know the importance retail spending numbers have on our future health. But the chart of RLX, like the rest of the market, looks overbought on its monthly, weekly and daily charts. The move up from January looks like it could be forming an ascending wedge to finish off the rally from July. Sounds similar to the broader market and in fact is. Any sell off in this index will be a good indicator/confirmation that the broader market has also topped.

Business Inventories
U.S. businesses were able to reduce their inventories as a percent of sales in December, following a fairly sharp increase in the prior months. All those holiday sales helped clear the channel. Actual inventory levels remain unchanged but since sales increased +1.3% that lowered the inventory-to-sales ratio to 1.28 vs. 1.30 in November. This is the lowest ratio since August. In the past year business sales are up +4.4% but inventories are up +6.0% so that will need to be reversed in order to keep businesses from getting stuck with excess inventories (that they might have to then write down or offload at fire sale prices).

Crude Inventories
There were surprise declines in crude and gasoline supplies but the drop in distillates was less than had been expected. The net result was a nearly 2% decline in crude prices today, closing near $58, reversing yesterday's gains. The stocks of supplies were down lower than normally seen in February but it's primarily traders looking for some volatility around these numbers to trade. Overall it would appear the distillate inventory is holding up well considering the very cold weather much of the country has been experiencing recently. Refinery activity was at 86.6% of capacity, down from 87.3% the previous week.

Getting back to a review of the charts, I've been showing ascending wedges on the daily charts since November and the first thing to remember about these patterns is that they're ending patterns. The bearish divergences support this interpretation of what's going on here. Second, they're very difficult to figure out where the end is. This is true for finding bottoms in a descending wedge as well but let's stick with what we have here--an ascending wedge for the final move of the rally (very typical finish). Each time price pushes up to the top of the wedge, after what could be counted as a 5-wave move up from the start of the pattern, we should be looking for a potential high and that's what I've been doing.

Because of the choppy price action inside these wedges it becomes a challenge figuring out where each of those 5 waves begins and ends so it becomes a bit of guesswork (EW analysis is a great tool but like all tools it's still subject to interpretation) as the pattern nears its end. The high last week had the makings for an end to the pattern and I liked the impulsive finish to it from the January 26th low. So I called for a top last Wednesday.

Calling for a top last week was obviously was a bit premature but that's OK. I'm very confident that we're close and I think it's worth probing for a top each time price presses back to the top of the wedge, as it's done again today. After testing for a top I then watch to see what kind of drop we get. After last Wednesday's high we got a 3-wave pullback to this past Monday's low and another impulsive rally to today's high. That 3-wave pullback was a heads up that the market may not be finished rallying and the levels I identified on yesterday's charts showed where the bearish wave count, as I had them labeled, was no longer a valid count.

The natural thought then is that we should therefore be on a bullish wave count and that's entirely possible, and I continue to show that possibility in tonight's charts. But the fact that we rallied so hard and impulsively up to today's high, again at the top of the ascending wedges, suddenly makes the pattern bearish again. Sounds strange I know so let's see if I can do an adequate job with the charts.

Unless there were any significant changes to the charts I normally update, especially with them updated as of yesterday, I'll just focus tonight on those that could tell us the longer term pattern.

DOW chart, Daily

Today's spike up, following the one on Tuesday, changes the wave counts just enough to go over them again. First of all, on the DOW daily chart the important level to look at is 12733.50. That's where the 5th wave in the rally from July is equal to the 1st wave, one of the most common relationships between these two waves. The challenge has been figuring out where wave-4 ended and wave-5 began. The choppy overlapping price action since November makes that a bit challenging but the count as shown on this chart is my best interpretation of the pattern and compares favorably between indices.

The DOW achieved that Fib projection, and then some, and that has my attention to a potential high based simply on that level. At the same time the DOW is again banging its head at the top of its ascending wedge with a wave pattern that could be called complete at today's high. Whether or not this high turns out to be any longer lasting than last week's high will only be known in hindsight. But right now, the setup is there to call today's high as the top and that's what I'm doing.

It certainly is not unreasonable to expect a pullback. If we don't get a pullback on Thursday then we'll be n bonafide breakout mode in which case we should see DOW 13K in a hurry. We'll also know that quickly on Thursday as well. But assuming we get a pullback started then we'll just watch it again to see how it develops. If we start getting a nice clean impulse down (a 5-wave move with no overlap in the dips and bounces) then we'll know we've got something the bears can hold onto. if we instead get only a 3-wave pullback again, like last week's, and start to head higher again you can be sure we'll see more new highs and that's depicted in green on the chart above. The pullback should hold above Monday's 12536 low but it takes a drop below the 12431 low on January 26 to put the bears in the driver's seat.

DOW chart, 60-min

If you look at the pullback from last Wednesday's high you can see it's only a 3-wave move. Once the DOW rallied back above 12675, last Friday's high, that told us we can probably expect new highs. That's why that level had been identified as a key level. The bearish count calls the move up from Monday as wave-c of an a-b-c move up from January 29th, which would be the final 5th wave inside the ascending wedge. As I mentioned above, it's a challenge figuring out which move up is the leg that's finishing the pattern. I was confident about calling a high last Wednesday because of the impulsive leg up from January 29th. The fact that price did not make it up to the top of the wedge was a little concerning but nothing surprising (considering the weakening rally. Today's touch of the top of the wedge (actually a tiny little throw-over) is classic. I like it.

Again, if it rallies tomorrow then take all bearish bets off the table as we should see it rocket higher in that case. But assuming we'll get a pullback which will lead to another push higher in an extension of this ending diagonal, then watch for support around the 12650 area (in a 3-wave pullback which could go deeper or shallower) followed by a continuation higher. For this kind of move (not the rocket ride out of here tomorrow) there are some Fib projections in the 12804-12845 area that I'd watch and the next turn window is mid March.

SPX chart, Daily

Once again the SPX chart looks very similar to the DOW. They've been on essentially the same path since July. The little throw-over above its ending diagonal pattern is apparent on this chart and price closed right at the top of the pattern. By rallying above 1453 it changed the wave count but that not so obviously on the daily chart. I did put a key level at 1458 which is just above today's high. Since I'm calling for a market top today then any continuation of the rally on Thursday obviously says that's wrong and we're on a bullish path. I show a pullback even for the bullish wave count so a pullback tomorrow/Friday will not necessarily mean the top is in. It takes a break of the trend line along the lows (bottom of the ascending wedge) with a break below 1417 to confirm the bearish wave count is correct. But that's a long ways down and I'm trying to identify levels where we can at least get a heads up that something is changing.

SPX chart, 60-min

Also similar to the DOW chart, this 60-min chart shows a closer view of price action around the top of the ascending wedge--a throw-over and close below. That's a sell signal and one of the reasons I'm expecting to see at least a pullback. As long as the pullback finds support above Monday's 1431 low then there is the possibility for a continuation higher, as shown by the bullish green count. A break of the bottom of the wedge, with confirmation by a break below 1431, will put us in the bearish wave count. Proof positive for the bears will be a break below the January 26 low near 1417.

The bulls will want to see a corrective pullback (3-wave move down or a choppy sideways move down). It could pull back as far as the bottom of the pattern again, like it did to Monday's low, so stay aware of that possibility. But then it should head north again in another strong impulsive rally. Upside Fib targets in that case are in the 1475 area.

One other note on Fibs and where both the SPX and OEX closed today--I've shown on the weekly SPX chart the Fib projection at 1455.32 which is where the rally from October 2002 has two equal legs up (it's a big A-B-C correction to the 2000-2002 decline). OEX has been relatively weaker than SPX and first of all, that's a little worrisome since you never want to see your generals getting nervous and holding back. Sending the troops out front to get shot is not market friendly. I'd rather hang with the generals since they're probably a little smarter in survival skills. So the OEX has not made it up to the Fib projection for two equal legs up at 704.31. But the OEX has stopped, for the 3rd time in 3 weeks right at the level where it has retraced 62% of the 2000-2002 decline, which is at 670.13. This is either preparing to bust through Fib resistance here and run higher or else smart money is distributing stock up here. Until proven otherwise I'd trade with smart money.

Nasdaq-100 (NDX) chart, Daily

The daily chart shows only small changes from yesterday. Sharp-eyed readers will notice that I changed the key level for the bullish count (green target) to 1822 from 1820. That's because of the move the past 2 days and the possibility that it's a c-wave in a complex correction from the low on January 22nd. I show why a little more clearly in the charts below. But for now I still like the bearish count as my preferred count and the next move down should be a strong decline that quickly drops through the key level for the bears at 1763. But any continuation higher than 1822, even if we first get a pullback, would likely have us on the bullish green path. In that case a rally into mid March, perhaps as late as April, is a possibility.

I show two 120-min charts below to highlight two different wave counts--one for the bears and one for the bulls. This is what I've been showing and updating on a daily basis on the Market Monitor in an effort to keep up with this yo-yo market. The pattern in the techs in particular over the past 3 weeks has been very choppy and difficult to get a handle on. So we're watching both counts to see if the bullish count should become the preferred count.

Nasdaq-100 (NDX) chart, 120-min bearish wave count

Since the bearish count is my preferred count at the moment, we'll start with that one. One of the reasons I like the bearish count is because of all the choppy price action since January 22nd. After the sharp drop from mid January this corrective price action is bearish, or at least that's the higher odds interpretation. So I've price action enclosed in what looks like a bear flag. I show a Fib projection for this week's leg up at 1822.31 but I'm not sure it will get there. That would have been the top of its flag pattern today and would have made a picture-perfect finish. If it pushes up to there tomorrow morning watch for a potential high to form there. It takes a break below 1763 to confirm the bearish wave pattern.

Nasdaq-100 (NDX) chart, 120-min bullish wave count

If the NDX is on a more bullish path it's probably at the early stages of an ascending wedge (based on the how corrective price action is looking). This bullish wave count shows how that might look. So any rally above 1823 would place the bullish count at a higher probability. With a potential turn window in mid March this price pattern fits well.

Russell-2000 (RUT) chart, Daily

I had pointed out the potential importance of 816 for the RUT and once again it was unable to hold it today even though it rallied above it. So I'm keeping the key level at that Fib level. As with the other indices it's possible the move up to a new high today was actually the finishing touches to its rally. If so then we'll see the red bearish count on this chart become the primary count. A break below 798 would confirm the bears are in control. But a pullback will not necessarily be bearish since it could lead to yet another push to new highs. In that case there are upside Fib targets near 824 and then 845 above that.

Russell-2000 (RUT) chart, 120-min bearish wave count

The 802 low on Monday is the key level for the bears since a break below that level would at least be the start they'll need to know that something more bearish is happening. A break below the top of the consolidation during December and January, essentially at 800, and the uptrend line from the January low, currently near 794, would be better confirmation but a break below 802 would be the first heads up (down). There's a slightly different way to label the wave count for the move up from the January low but the result would be the same--we're either topping here or after a slight push higher to 821.

Russell-2000 (RUT) chart, 120-min bullish wave count

One other alternate wave count suggests we'll see another pullback or sideways correction before getting the final high into March. The upside Fib targets of 824, possibly as high as 845 (I have my doubts about that one), would then be in play. We'll know better about that possibility if the coming pullback looks corrective. And that's why a break below the uptrend line from August is required before the bulls are in trouble.

I'll leave at that for charts tonight so that I can get this out in time. It took a bit of work to figure out what the rally the past two days has done to the charts and after today's rally in particular the charts suddenly turned potentially bearish based on the wave count and the impulsive finish again (like last week).

I did want to briefly discuss Bernanke's discussion since that's supposedly the reason for today's rally (cough). I'll say it again--the rally had nothing to do with his talk since the market already knew exactly what he was going to say and he offered nothing new. It was a large influx of money and manipulation to help their main man look good. That's obviously my opinion only but I haven't seen anything to tell me I'm way off base.

The FOMC has trimmed the forecast for real GDP growth in 2007 to 2.5% from its earlier estimate of 3.0%-3.25%. Sounds like a reason to rally! Bernanke mentioned housing several times and said the key downside risk to their growth forecast is the housing market. He said "We don't want to jump to conclusions. It will helpful to see what happens when the spring selling season begins and see how strong demand is at that time." He also said the recent distress in the subprime mortgage market was a "significant concern" but offered that it wouldn't damage the overall economy. Sounds like a bit of double-speak to me--there's downside risk but it won't hurt the overall economy. Well Mr. Bernanke, which one is it?

When asked about the inverted yield curve would hurt the banks Bernanke said he felt it was a problem for some banks but overall "I don't see the banking sector as being under tremendous pressure in terms of its profits and assets quality." In effect Bernanke is saying an inverted yield curve is not important anymore. Banks got a big rally today and look like they could be headed to new highs as many investors apparently truly believe it's different this time. This is the hallmark of a blow-off top--when everyone believes the trend is sustainable as far as the eye can see and they start changing the rules to fit that view.

Bernanke sits before the House Financial Services Committee tomorrow and they're not known to be as Fed-friendly so I'm sure the market will be listening carefully for any foot-in-mouth statements.

The housing index got a good bounce today but the daily chart shows price stalled at its 10 and 20-dma's which are now resistance after price dropped below these averages last week.

I've got some very interesting data I had hoped to share tonight on the housing market and what it has meant for our homeowners. The huge ramp up in home prices should have greatly improved the "balance sheet" when looking at assets vs. liabilities. Unfortunately that's not the case. Our savings rate is the lowest (negative) it's been since 1932-1933. We know why people were dipping into savings back then, but why now at the peak of economic performance. And I just found out my nephew and his fiance just contracted on a house in New York for no money down, 100% financing. Think banks are getting desperate to do something with all that money the Fed is cramming into the monetary system? Scary. Pretty soon they'll be pushing on a string when demand dries up and can't sop up all that liquidity. At any rate I'll have to save all that for next week.

The only other sector worth mentioning is the Transports. They got a huge lift today and it's looking like a breakout above the May high. Today's close at 5117 is more than 100 points higher than that resistance level which now needs to act as support on any pullback. For upside potential the top of a parallel up-channel for price action since September is currently near 5200 so there's some upside potential there.

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

It will be a busy morning tomorrow with economic reports. The NY Empire Index and Industrial Production have the ability to move the market but I think the market may be more focused on what Bernanke will say in front of Congress. The Philly Fed number that comes out at noon could also move the market. Friday will be the more important day as far as economic reports go. With a market holiday next Monday it will be interesting to see how this week finishes up. A bullish opex week may not follow through next week. A down Friday could set up a nasty surprise for the bulls next week and therefore I'd be reluctant to be long if that sets up.

SPX chart, Weekly, More Immediately Bearish

I'll close with the SPX weekly chart, shown yesterday and obviously not much different from then, just to keep things in perspective here. I don't show the monthly chart but like just about all equity charts it shows overbought. So we've got monthly, weekly and daily charts overbought. Would I recommend a long here? Not unless you like momentum trading and are hoping to see this upside momentum continue. I would do that only if I could watch the market like a hawk during the day.

The upside pattern, with the ascending wedges on the daily charts, suggests the break down, when it starts, will be fast. Months of gains will probably be wiped out in days. That's typical. It is the risk of that happening as the reason why I can't recommend going long here. The upside potential is not worth the risk of the downside damage if you can't get out quickly.

Good luck trying the short side if you want to give it a try with me. I think it's worth another try. Small losses are well worth the effort here since a short that sticks will pay handsomely. Just stay disciplined and don't let the market move much against you. The past two days have shown how painful that would have been for anyone who shorted the break down only to watch it fly up against them. It's the reason I like to pick tops--I can keep my risk much tighter.

So if we get a small pop tomorrow morning I think it'll be a good setup to try the short side. We may not get it the pop if today's high was it. If you're waiting for an opportunity to do a swing trade on the short side, and you can't watch the market intraday then wait. We'll know when the short side is the better bet and it'll then be a good time to wait for a bounce to get short. The downside potential is rather large so catching the tippy top is not necessary.

I've shown some levels on the charts above where we'll want to switch to bear mode. For the rest of us who like catching tops (and have the bandages to stop the bleeding when those rising knives cut us), look at tomorrow as your opportunity. Good luck and we'll review how well that effort went at this time next week. For those who follow the Market Monitor I'll keep those road maps updated and we'll try to stay on top of this move each step of the way.

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