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Market Wrap

More Credit for the Weary

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The title of tonight's report will make more sense when you read the discussion further below (before the chart of the banks) where I discuss the situation we find ourselves today with the amount of credit that's out there. In short, the amount of credit created in the past few years is mind boggling and not something we've ever seen before. We don't really know how well the system has truly benefitted from all the liquidity in the system (Greenspan says it's good so I feel better now) and what's more we don't know how well the system will withstand a shock to the system. The financial markets have not had a shock since 2001 and there's been such a mushroom in the debt markets since that time so it's causing much speculation in the financial markets. I thought it worthy of discussion and passing along.

Today was another snoozer. After yesterday's 1-hour wonder rally it went flat for the rest of the day. The rally was essentially without news and has many scratching their heads wondering where and why it happened. Need we a reason for the market to move? Well, yes, if you're a Cheerleading Network reporter or analyst trying to explain every move in the market. But in the end it doesn't really matter since we follow price and try to figure out what price is doing rather than what Iran's president is up to. He's a shrewd one don't you think? If anyone knows how to play the political game I've got to hand it to that guy--he's got it nailed down.

Yesterday's and today's sideways consolidation is normally a win for the bulls and so far that's the way it's looking. I expect we'll see a resolution higher out of this but the real question is how much higher. I'll show some projections in tonight's charts but since there are multiple upside targets it may be better to wait for uptrend lines to start breaking. The trend is your friend and your friend is long the market. But I'd follow behind your friend and keep watching out for th sneak attack.

The bounce from the March low has morphed into a larger correction and has clearly delayed the next leg down. That has changed all the charts from last week where I showed projections into the summer. By turning around and rallying back up, the bullish key price levels I had on the charts were hit. That negated the immediately bearish wave counts on several of the charts and therefore changes the projections. Once the current bounce finishes I'll then be able to make new projections for both the bullish and bearish scenarios.

Right now the bounce still appears to be a correction of the initial leg down from the February high. But now that the bounce is extending it is changing the pattern to one that is equally bearish in the short term but could make for a choppier decline in the longer term. Bear markets (something I believe we're starting) are difficult to trade and now it looks like it will become a choppy one to boot (instead of a sharper impulsive move down that I had been showing). It's still very early in the game and lots can change but I wanted to mention that up front because of the possibility this market could drag out any moves. That would of course help all you spread traders out there. But the potential for a hard decline is still very much alive so in the short term I would continue to be cautious about bull put spreads.

As I've been doing on the charts, I show both bullish and bearish scenarios, with the key levels to help identify when one takes preference over the other. While I'm bearish the stock market I don't want to get caught fighting the current. The hard sell off from the February high was a key moment for the market and I think it marked the end of the bull market. But if I'm wrong on that and we see strong rallies to new highs then there's a good possibility we'll see the market tack on at least another 1000 points on the DOW (which is why I'm not going to allow myself to get caught fighting that strong of a current). While I don't believe that will happen I do have to consider the possibility, especially from an EW (Elliott Wave) perspective.

Again, I'll show the latest updates and projections in tonight's charts. But first let's review today's economic reports.


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Economic reports
Today's economic reports did little to the market so we'll cover them briefly.

Factory Orders
Orders climbed +1.0% in February, a 2-month high thanks to a surge in non-defense aircraft orders. Talk about wild swings! New civilian aircraft orders had dropped -60.4% in January and were up +88.4% in February. It's all in the date of closing of the orders. Excluding those aircraft orders left factory orders down -0.4% so that was disappointing.

Shipments declined -0.5%. This is one reason the Trannies are struggling. Core capital goods (a sign of companies willing to bet on the future) dropped -2.4% so that's not a good sign for economic growth in the future. Inventories were flat in February but the lower shipments number increased the inventory-to-shipments ratio to 1.25 from 1.24. Unfilled orders rose +0.9%, the highest since December.

ISM Services
The ISM number should have depressed the market but it was ignored. Since services make up the bulk of our economy now, any slowdown here is a negative for economic growth. And slow down it did--while still above 50 it dropped from 54.3% to 52.4% which is the weakest pace in 4 years (April 2003). Both the factory order slowdown and ISM slowdown surprised economists who had expected upticks (why am I not surprised that they were surprised).

Not helping in the stagflation department, the price index jumped from 53.8% to 63.3% due to higher costs for fuel and other petroleum products. This is the highest number since last August. New orders fell to 53.8% from 54.8% and the employment index also dropped to 50.8% from 52.2%. The good news in the report was the jump in the backlog order index from 47.0% to 52.5%.

Crude Inventories
The crude and distillate inventories saw very minor changes, as did the percent utilization (87.03% vs. 87.01% the week before). Total distillates and crude dropped marginally. Heating oil and natural gas prices were up marginally today while crude dropped a few cents. It was just as quiet a day in that market as the stock market.

ADP Job Growth
While not an economic report this report gives us a heads up for what the employment numbers will look like. ADP showed an increase in private-sector employment of 106K. Adding in 24K from government and we get 130K. This is a little less than the 168K that economists are looking for, following the 97K gain in February. Depending on the numbers that come out Friday it could have an impact on what the Fed will want to do next with interest rates. With a slowing economy and persistent inflation there's not a lot they'll be able to do yet. They've done a fine job painting themselves into a corner. No matter what Bernanke does here he's going to get paint on himself.

Now let's take a look at the charts to see what has changed over the past week.

DOW chart, Daily

There are a few upside targets and that's the reason for the multiple projections before price turns back down. First of all, the change from last week shows the move down to the March 14th low as wave-A (3-wave move down from the February high. I had counted that new low as wave-b of an a-b-c bounce from March 5th. That worked well until we got the new highs this week. It's possible that the 3-wave decline into the March 14th low, which is a corrective pattern, means the DOW will rally to new all-time highs and that's shown in the green wave count. A push up above 13K is a very good possibility by the bullish wave count.

While I don't believe the bullish wave count is correct I'll let price let me know. The first upside Fib target is where the 2nd leg up in the bounce from March 14th will equal 62% of the 1st leg up (labeled a-b-c in dark red). That's at 12596 and the dark red arrow from there shows the first bearish potential. The 2nd upside target is at 12814 which is where the two legs up have equality. The light red price projection is for that scenario.

There is the possibility that the DOW won't even rally as high as 12596 (shown in the 60-min chart below) so if at any time the DOW breaks below 12242, the last pullback low, then the pattern turns more immediately bearish. A heads up on that would be a break of the uptrend line from March 14th.

Note the potential for the DOW to make a double top before it rolls over. Certainly a rally up to the 12800 area would have a lot of people bullish. Keep an eye on RSI as well--it's back up to the declining trend line along its highs since October.

DOW chart, 60-min

All the possible price projections makes for a messy looking chart so I apologize for the multitude of lines. As I mentioned above, the first upside Fib target is 12596, with the top of a potential ascending wedge just above that level. Also mentioned above, a break of the uptrend line from March 14th would suggest the bounce is over. Right now that would be a break below 12350. The light red projection shows the potential to rally up to 12814 before finishing the bounce (a minor new high would not negate this being a corrective bounce since b-waves can fully retrace, and then some, the prior move). The more bullish scenario would likely see a pullback soon, shown in green, before continuing to press higher. Here again the uptrend line from March 14th should hold in that case.

DOW chart, 30-min

I wanted to zoom in a little closer to show why even the 12596 upside target might not be met (shown here in light red). The move up from last Friday, March 30th, needs to be a 5-wave move to finish wave-C of the A-B-C rally from March 13th. As shown with the dark red wave count, it's possible we're seeing a very small ascending wedge for the 5th wave. This says a very minor down-up sequence on Thursday could finish the move up. It's a little tricky here but if price moves a little higher in this fashion and then breaks below 12496, Wednesday's low, then that would be the time to try the short side. Confirmation for the bears wouldn't come until the 1st wave high at 12391 was violated.

SPX chart, Daily

The SPX charts have essentially the same setup as the DOW so I won't cover this in the same detail as I covered for the DOW. Resistance is layered above--the top of the parallel up-channel from 2004 is near 1450, the first upside Fib projection is at 1455 and the upper projection is just under 1484. Needless to say that would be one heck of a rally to 1484 and should hardly be called bearish. I only call it bearish because it could still be part of a larger bearish pattern. Any rally above 1455 would have me bullish for at least the short term. As the bullish scenario depicts (the same one that would drive the DOW above 13K), we could see at least a test of the 2000 high in relatively short order.

For those who don't believe the market could possibly rally that high in such a short period of time (I'm one of them), I will mention that a very similar price pattern played out in 1987. After a pullback earlier in the year (about 8%) it went on to rally about 20% in only a couple of months. Unfortunately for the bulls that was a blow-off top since it was immediately followed by the crash of '87. Will the same thing play out this year? Stranger things have happened.

The key level for the bears is a break below its last pullback low at 1409. But like with the DOW, a break of its uptrend line from March 14th would be a heads up that the bounce is probably over.

SPX chart, 60-min

Again, pretty much the same as for the DOW so I won't go into the same detail. It's possible we'll get only a minor new high on Thursday (keep an eye on 1442-1443 for that potential) before rolling over. A break of its uptrend line would be at about 1425 currently. If the bulls can keep the rally alive into Monday then 1455 is the first upside Fib target. We'll have to catch OBL or something to get it to rally up to 1484.

OEX chart, Daily

The OEX is of course looking very similar to the DOW and SPX but I wanted to show a potential price projection into the summer since I know many of you trade spreads such as Mike Parnos' Iron Condors. A break from the current bounce should see some swift selling and some Fib projections and retracements point to the 590 area by May. This is not much of a change from what I showed last week. But from there we could get a higher bounce (wave-B on the chart) than what I had been showing and then an even harder decline following that. In other words it could get pretty wild this year. Volatility would likely be very high and it's going to cause some heartburn for spread traders. Have your Maalox handy if it plays out this way (unless you're able to sell way OTM).

Nasdaq-100 (NDX) chart, Daily

The techs and small caps differ just enough from the large caps to have some slightly different price projections. As shown more clearly on the 60-min chart below, the first upside Fib projection is at 1812. The trend line along the lows since November is near 1820. This trend line acted as resistance on the last test at the March high. Another retest and failure would be bearish.

The bullish price projection, in green, shows an ascending wedge to complete the 5th wave of the rally from last summer. That makes for an ugly wave count (huge 4th wave relative to other waves) but it doesn't violate any rules. It too would essentially look like a double top against the February high.

Nasdaq-100 (NDX) chart, 60-min

Within the larger ascending wedge, shown on the daily chart, there could be a small ascending wedge playing out since last Friday's low. Unless a minor new high tomorrow, similar to what I discussed for the DOW chart, finishes this off, I see the possibility for NDX to push up to 1812 if not 1820 before the bounce is finished.

Russell-2000 (RUT) chart, Daily

Because the March 14th low was not lower than March 5th, and there's no overlap between the highs and lows with the bounce, it's possible the small caps, like NDX, are finishing up a 5th wave for the rally from last summer. I don't like that interpretation but it's possible. The upside Fib projections are 822 and 841. The uptrend line from August is also near 822 so that level holds some real potential to be tagged and to be resistance. I'd definitely be interested in shorting it there if the setup looked good (completed 5-wave move up from last Friday and short term bearish divergences accompanying the high).

The key level for the bulls is a move above 824 but watch out for the February high. The key level for the bears is 791, the previous pullback low. The uptrend line from March 14th is also very close and a break of that line, currently near 805, would be a heads up that the bounce could be finished.

I know many traders use the RUT for their spread trades and as I mentioned for the OEX, be careful about the downside (bull put spreads) since we could get a sharp move down to the 730 area by early May.

Russell-2000 (RUT)chart, 60-min

The closer view shows a small parallel up-channel for price action since last Friday's low. Another push higher to the top of that channel, and to the top of its ascending wedge from the March 5th low, could have it tagging the 822 area (or closing the gap from February 26th at 823.79). Then it could pull back and find support at its uptrend line from March 14th and shoot higher, or it will break down. I'd try a short around the 822 area and/or a break of its uptrend line. In the meantime run with the bulls.

NYSE (NYA) chart, Daily

The NYSE is nearing both its previous high and the top of the parallel up-channel from 2004. You can see how price respected this line in December and January. At 9427 on Thursday (only 30 points higher than its closing price), watch for resistance there.

Before continuing with the rest of the charts I wanted to discuss the money/credit situation that I believe is going to be difficult to correct. The banks (the next chart after this) are giving us a heads up that something not-market-friendly could happen soon and this is of course important to us traders/investors.

There has been a lot of discussion about the excess liquidity sloshing about in the global markets. I've been known to make a comment or two about it and I've suggested the Fed is behind much of it in this country with their easy money policy and their magic printing press. What I haven't discussed much is the easy credit and its impact on the whole liquidity issue. Almost every country is doing it and certainly Japan has been doing it for a very long time with their ZIRP (zero interest rate policy). They've made it almost too easy to borrow yen to invest elsewhere. The easy credit policies of the various countries have literally exploded the total value of credit, creating a credit bubble the likes of which we've never seen before. This has significantly increased total liquidity.

The reason this is important to investors is because the increase in asset values over the past several years, be it stocks, commodities, real estate or collectibles, has been significantly aided by the enormous increase in liquidity through credit. We've had credit hyper-inflation. The easing of banking lending standards paved the way to the shambles we now see in the subprime market. When pets can get mortgages for their dog houses you know we'll soon be joining the dog in his house. As many analysts point out, where there's one cockroach there are usually many more hiding in the cracks. The subprime problem is but one cockroach.

The important thing to remember, even though it can go on for a long time, is that credit is not money. While inflation can continue for a very long time in currency, it's not the same for credit. Credit inflation is always followed by a credit collapse as demand for credit dries up and lending standards tighten up. Credit inflation is only the illusion of money and along the line it means a lot of people owe a lot of money. The negative savings rate for 2+ years and over-the-top debt levels (personal, corporate, government) tells us this is exactly what's happening.

This excess credit has created asset bubbles. As asset values have increased people have been borrowing more money against those assets (think home equity loans). You can see how this will quickly inflate assets as more money becomes available to buy more inflated assets. This is a Ponzi scheme on a national (actually global) level that has been fully aided and abetted by our Fed. And then when credit dries up, as it will in any down cycle, the popping of the credit bubble will cause a collapse in asset values, and that means all asset values.

The argument that certain assets will rise, such as gold in an inflationary environment, may not hold true this time. Perhaps it will over the long term but over the next year or two or three we could see a sudden downwash in everything non-cash. Those who were buying stuff with cash will likely soon be buying cash with their stuff (meaning they'll be selling their stuff and socking the cash into savings or more likely paying off their debts).

Credit expansions typically implode and we've never seen the kind of credit expansion as we've had over the past few years. The "correction" will likely not be fun for a lot of people, or corporations or governments. Do you have money in municipal bonds for the tax benefits? I'd rethink that strategy right now. When debtors start defaulting on their loans it will likely ripple throughout the banking system before it's all finished. Have you seen the banks leading the charge to the downside recently? There's a reason for that.

The no-doc ("liar") loans that have caused major headaches for the subprime lenders are not isolated to the least credit-worthy home buyers. The reason we haven't seen much trouble from the corporate debt market yet is because banks have been lowering their lending standards to companies. Consider the "covenant lite" bank loans to corporations now. When a business borrows from a bank they need to maintain certain standards, referred to as covenants, in order to satisfy the lender that the business is still sound and their money is safe. If accounts receivable gets too high or old, or if inventory too high orprofits too low, etc., it may violate the bank's covenants and they'll call the loan.

So now the banks have created these "covenant lite" loans, essentially meaning lower lending standards for the companies. Think subprime here. If a company violates any of these covenants they get a do-over, called a "covenant holiday". They can make believe that bad quarter didn't happen and press on. If the company then has another bad quarter? They get another covenant holiday. Corporate accountants and CEO's are literally laughing about this. They know how crazy it is for the banks to do this.

If companies start having some bad quarters in an economic slowdown, the banks won't realize they're in trouble until it's too late. Normally they'd take reserves for bad loans (which takes money off the bottom line) but they won't be doing that until all of a sudden they realize their offered holidays turn into a longer term vacation--for their money. S&P analyst Steven Miller said the debt markets "have reached a point where we can't go any further." He went on to say "Some of the deals introduced into the market [this year] felt like they were at the edge of a cliff, leaning over, with someone holding their belt loops." I sure hope those belt loops are sewn on nice and tight.

Where there's one cockroach there are many. Keep this in mind as you see the banks underperforming the market right now. Smart money knows what's happening and you can bet they're lightening their load during these rallies. The stock market remains in lala land and while the longer term, and intermediate term, trends are up (therefore trade with the trend), understand the underlying risks facing the market now, and the cracks that are developing. The poor little Dutch boy has his finger plugging the hole in the dike (which never happened by the way) and is calling for help. The rest of the stock market participants are whistling Dixie as they run off to buy more tulips.

And that brings us to the chart of the banks:

BIX banking index, Daily chart

While the broader market is doing a decent job correcting the decline from the February high, the banks are ready to test the March low, and are already below the March 5th low. This is a huge bearish divergence for the broader market and for no other reason has me bearish. While I show some pretty significant rally potential as per the bullish EW counts I don't for a minute believe they will happen as long as the banks look like this. Follow the money has never been truer and right now the money is fleeing the market. Don't get caught in another downside surprise like the one in late February since I don't think market participants will be nearly as lucky the next time around in getting a big recovery bounce, at least not without lots of damage first.

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

I thought the hype about the spring market was going to give the home builders a lift, and it still might. It's possible we're going to see another leg up for the bounce that started mid March. But with each day that this drops lower than that mid-March low, the greater the likelihood that this is getting ready to really let go to the downside in wave-3.

Oil chart, May contract, Daily

Oil is being held down by the 200-dma and the previously broken uptrend line. Other than the wild spike last week it now appears oil is topping for now. It will be important for oil bulls to see the new uptrend line hold on a test if it gets down there--currently nearing $61.

Oil Index chart, Daily

Ideally the oil stocks will consolidate briefly and then push a little higher to give us a 5-wave move up from the March low. That would then set up at least a pullback to correct that 5-wave move or more likely in my opinion a turn back down to new lows, breaking its uptrend line from last year.

Transportation Index chart, TRAN, Daily

The Trannies are messing around the 50-dma and uptrend line from September but the bounce since the February decline looks corrective. Like the broader market I'm expecting this to roll over and head for new lows, breaking its uptrend line from March 2003 in the process.

U.S. Dollar chart, Daily

I think I can, I think I can... The dollar looks like it's trying to bounce but obviously still meeting selling pressure. I expect it to be a choppy bounce/consolidation before continuing lower but if at any time the dollar is able to rally above its downtrend line from November 2005 then that would be clearly more bullish for the dollar.

Gold chart, June contract, Daily

The bullish scenario for gold is that the US dollar continues to drop and inflation fears continue to drive people into owning the shiny metal. Getting through the downtrend line near 686 will be an important step in that regard. Based on the EW pattern for gold, and my belief that all assets will suffer selling pressure, I think gold will not rally out of this. Instead I think gold will break down and head at least to the low $600's. Depending on what pattern is playing out in the longer term, gold could eventually drop to $500 or lower. The key level for gold bears (of which there are very few) is 615 although a break of its uptrend line from October would be a heads up that something more bearish has already begun.

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

It'll be very quiet tomorrow in more ways than one. There's only one economic report and other than a big swing one way or the other, there shouldn't be much impact to the market. With an expected light-volume day before the holiday, it could be another snoozer of a day. Be careful of the market getting easily pushed around. Friday will be a busy day for economic reports but we'll have to wait until Monday to see if the market cares.

SPX chart, Weekly, More Immediately Bearish

SPX is still struggling to move above the top of its parallel up-channel and I suspect it will be held down. The weekly oscillators are threatening to turn back up but any retest of the February high followed by a turn back down would leave rather significant bearish divergences. Something to watch for anyway.

Be careful about downside surprises. That's my #1 caution to traders right now. Just as the market was caught by surprise by the decline from the February high, I think that's going to be the way of the market right now. Almost everyone is back on the bullish side of the boat and when it tips over again, there will be much gnashing of teeth and wringing of hands. People will again try to buy the dips, convinced after this last episode that it's the right thing to do. That's what makes the next leg down (in my preferred EW count) so strong--it's the reverse of short covering.

For tomorrow expect a relatively quiet day which could either continue to consolidate sideways, pull back a little more or chop a little higher. Chopping higher actually makes it more bearish as it would likely be finishing a small ascending wedge. I would look to short that pattern. But if it continues sideways or pulls back only marginally then we should get another leg up to finish the bounce, maybe even into next Monday.

Good luck and I'll be back here next Wednesday and on the Market Monitor tomorrow. This market has been a challenge with the current bounce but I still think we're close to finding the top of it and will attempt once again to position short for the next leg down.

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