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Market Wrap

Another Top

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How about another call for a top? It's been, oh, a good week and half since I've called one (wink). With today's decline there is some evidence that the bounce against the decline from the February high may have finished. I will of course lay out my reasons why in the charts below but there definitely seems to be some cracks developing in the bull dike. With all the bullish talk out there I thought it would be worthwhile to hear the other argument--I'll show with charts why I'm bearish this market (and with that many of you will close this and never read any further, which of course is your prerogative but you might miss out on some things that will make you at least think about your positions).

As expected, the bullish sentiment during the bounce from the March low has hit extremes. I say as expected because I've been saying it would be typical for that to happen, especially after the first real scare in a decline that broke a longer term uptrend, as happened to the uptrend lines from last summer. Not only that but that decline occurred with huge and record down vs. up volume. I think it was the kickoff to the new bear market. Strong rallies, even with good breadth, are the hallmark of bear market rallies. Now that the indices are back up and knocking on the door to new highs (new highs for some like the NYSE), the bullish analysts have been out in force declaring their brilliance in telling everyone to buy the dips. They of course could be right and again I feel like the lone wolf howling at the moon (or Chicken Little with another episode of the "sky is falling").

With a market rally the past few days into the FOMC minutes (or held up is probably the better way to put it) there was a good chance for disappointment. We already had a good feel for what was in the minutes as the Fed heads have been out in force the past week ensuring that we knew what was in the minutes. But the market preferred to turn a deaf ear and the bullishness has been holding the market up.

I could get into lots of reasons why the market will struggle this year, including the housing market (today's news included more trouble for the home builders after KB Home announced they don't see a bottom in sight yet, mortgage applications continue to drop, and home prices are expected to fall this year for the first time in 38 years) but I've beat that horse to death. Credit standards continue to tighten (at a very fast pace) and this will cause a significant slowing in capital growth. Credit contraction is what causes recessions (or worse). But tonight I'm going to focus on several technical readings and show why the above is important for the longer term but as traders we need to watch what's right in front of us.


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The big news today, and really the only market moving news, was the FOMC minutes released at 2:00 PM. The market had already sold off from the open but it was getting a nice bounce into the afternoon. The release of the minutes sent the markets to new lows. Bonds also sold off today and that spiked interest rates back up. Speaking of rates, here's the updated chart for the 10-year yield:

10-year Yield (TNX) chart, Daily

The 10-year yield made it up to its 200-dma near 4.74% and backed off. But today it got a bounce back up near its recent high. It could press a little higher to its downtrend line from June 2006 but it looks ready for a pullback soon. It could stay trapped a little longer in a sideways triangle but I think after pulling back some it will then break higher and head for a Fib projection and longer term downtrend line near 5% (closer to the Fed rate of 5.25%). Fed funds futures are pricing in 5.25% through at least the summer now.

So we have interest rates working higher (making borrowing costs higher), credit standards tightening (making it more difficult to borrow funds for spending, investments, etc.) and now the Fed appears to have taken their printing press off line for some preventive maintenance:

Calculated M3 Money Supply, Weekly, courtesy nowandfutures.com

Note the fast drop in the rate of change. This tells me the Fed has become increasingly concerned about the inflationary pressures as a result of their easy money policies. They desperately need the bond market to sell off and ratchet up interest rates so that they don't have to. They know that they will psychologically kill the market with another rate increase. They'll avoid that like the plague. And they know they can't continue to stoke the economic fires with free money. In my opinion the slowing of money growth will have negative ramifications in the stock market because of the lack of new capital being injected into the monetary system through the stock and bond markets (through their primary dealer mega banks' trading teams).

I see a lot transpiring against the Fed right now and have been stating since last summer that the Fed will find itself painted into a corner--they can't raise rates for fear of killing the economy but they can't lower them for fear of fanning inflation. And now they can't keep their printing presses operating for fear of the inflation monster. What's a Fed to do? I suspect they're doing lots of nail biting right now. My take on this is that the stock and bond markets will start to get it and when they do they'll sell off.

That's sort of bigger picture stuff. The charts show a shorter term view that the supports the idea that we're on the verge of the recognition wave down--the one that makes most understand that buying the dips will have to be done much more carefully and that the bull market may in fact have finished its cycle.

Continuing with the FOMC minutes, the released minutes showed that the board members agreed that more rate increases might be needed in order to get inflation back in check. They acknowledged the potential weakening in the economy (probably due primarily to the housing market) and said they have many other tools to use other than raising interest rates. This would typically mean using their BPP-HDS (Ben's Printing Press and Helicopter Delivery System) but as the M3 chart above shows, they have not fully deployed that system recently.

The FOMC minutes showed the bankers were presented a worst-case scenario to chew on--simultaneous immediate slowing in the economy with accelerating inflation. This would of course be any Fed chairman's worst nightmare. Paul Volker, back in 1979, was the last to deal with a bad case of stagflation and he hammered the economy with brutally high interest rates to once and for all kill inflation. I remember buying my first house with a 13% mortgage and thinking I was lucky. When I refinanced at 9.5% (sub-10) you would have thought I'd won the lottery. The 1970s was a tough period for the economy and the stock market, with some huge swings high to low. Taking out the October 2002 low and then swinging back up to these highs in the course of 3 years would match what was happening back then. BTW, I think that's what we could see in front of us.

So the market's decline today may have been a result of sniffing out the bad odor in all this. We'll soon know for sure. The rally from the March lows has been petering out so we're due at least a pullback (even if it's from a minor new high this week first). If we get a corrective pullback that then leads to new highs it will be bullish. But that's not what I see happening. I believe the bounce is now over and we're preparing for another strong decline. I'll show both possibilities and key levels on the charts.

DOW chart, Daily

Today's pullback didn't even test the uptrend line from March 14th and this looks like a very bullish chart. Certainly the old adage about trading with the trend holds here--until and unless the DOW breaks below 12400, this chart says keep buying the dips. But daily oscillators caution that today's dip could get a little deeper and of course if that happens then both the 50-dma and uptrend line will be broken. A rally back up through 12600 is needed to keep the bulls alive here. A drop below 12242 would leave the bounce as a confirmed 3-wave correction and signify that new lows are coming.

Not shown on the chart but something I'm going to watch for is the possibility we'll see a sideways coil develop over the next few months. This possibility is based on the longer term rally pattern. So if you're in longer term put options, expecting a big leg down, be aware of the possibility for a long consolidation that kills the time premium on any options. Spreaders would of course love nothing better.

DOW chart, 60-min

This is a closer view of price action as it nears the uptrend line from March 14th. By breaking below 12496, the first key level for the bears, the only thing they need now is a break below 12400 to confirm the rally leg from March 30th is finished. The negative divergences at the recent highs were warning us that a downside break was right around the corner. Now the bulls want to see this correction be the end of it and see a push back above 12600 (which is where bears should have their stops).

SPX chart, Daily

Like the DOW this is a bullish chart--the uptrend line from March 14th is still holding and the 50-dma hasn't even been tested yet. This is a steep uptrend line though so those are much riskier to depend on holding. The dark red a-b-c bounce off the March 14th low would be confirmed a correction with a drop below 1409. A push back above 1455 would suggest the bulls are firmly in control.

SPX chart, 60-min

The previous low near 1435, and the uptrend line at the same level, makes it an important level for the bulls to hold. If they can do that and push it back above 1455 then they'll be firmly in control. But like the DOW, the negative divergences suggest the bulls have simply run out of steam to continue to push this higher. A break below 1424 (1st wave high within the move up from March 30th) would say the chances are very good we'll see a quick move below 1410.

OEX chart, Daily

Because of the corrective way the decline has started, from the February high, I'm thinking the decline will happen in a much choppier fashion than the strong impulsive move down I had been showing a month or so ago. Think of the way the decline happened in 2000-2002 and I'm thinking we might see the same kind of thing. Some of the legs down can still get incredibly sharp but so too can the rallies. It will make trading very difficult and for spread traders as well. Unless you get the right timing and sell way OTM, you could find your positions being threatened, on both sides, in the same month. But for an idea what could occur from here, this daily chart shows my preferred wave count.

Nasdaq-100 (NDX) chart, Daily

Rather than a parallel up-channel, as I showed for the DOW and SPX, I've got an ascending wedge for the NDX. This is just an idea but it's based on some of the corrective wave structures I'm seeing--it's either a bounce that's correcting the initial move down from the February high, or it's part of the ascending wedge to a new high. The push to a new high would likely be choppy and full of whipsaws. If it holds above its 50-dma at 1783 then the bulls have a chance to run this back up. A break below that support would also be a break of its uptrend line. The bears need to push this below 1753 to leave the bounce from March 14th confirmed as a corrective 3-wave bounce.

Nasdaq-100 (NDX) chart, 60-min

In addition to support at 1783 by its 50-dma, it's also the high on March 30th (the 1st wave in the rally from the March 30 low) and any break below that level would confirm that rally leg is finished.

It's often helpful to compare one stock vs. another or vs. an index so that you can determine relative strength. You'd prefer to be long the relatively strong stocks/sectors and short the weak ones. The thing to remember about relative strength (not to be confused here with RSI) is that the chart can be pointing down or up but it doesn't mean price is doing that. It only shows you how the stock/index is performing compared to the other.

NDX relative to SPX chart, Monthly

The above monthly chart compares the Nasdaq-100 (NDX) to the S&P 500 (SPX). Not surprisingly it shows the tech stocks significantly underperformed the broader market from 2000 to 2002. After a quick and relatively stronger jump off the market low in 2002, the techs have traded more or less in synch since 2003 with the broader market. If anything they've been losing a little as compared to SPX during the last 3-1/2 years.

And herein lies the problem for the market--when the market is bullish the techs and small caps (higher-beta stocks) typically outperform the larger caps. That's because fund managers feel bullish about the stock market and want to get more bang for their invested buck. When the large caps start to outperform the small caps it's generally considered a defensive posture.

I drew a line across the lows since 2004 and other than the brief break lower in 2006, that line is supporting the current decline in relative strength. If that line breaks then it should be significant because it will tell us that the tech stocks are underperforming the broader market at a time when analysts are feeling most bullish. While analysts are being bullish and telling you that you should be buying the dips, fund managers are quietly liquidating their tech holdings and getting more defensive. Keep this chart handy on your computer and keep it updated--you'll want to know when smart money has left the building.

Russell-2000 (RUT) chart, Daily

I have a similar ascending wedge drawn on the daily chart as I showed for NDX, and for the same reason. If this continues to press higher then it might be a very choppy ride to relatively minor new highs. Today the RUT broke its uptrend line from March 14th and the lower line I have on the chart is just an assumption right now based on the RUT finding support around its 50-dma just above 800. A break below 800 would likely have 791 being tested quickly and if that breaks then a 3-wave bounce will be left in its path and new lows are likely on the way.

Russell-2000 (RUT)chart, 60-min

I show a key level at 804, which was nearly broken today, as it is the 1st wave for the move up from March 30th. A break below that would say that rally leg is finished. Then 800 would need to hold but in reality a break of 804 would tell me 800 will also.

NYSE (NYA) chart, Daily

Lots of people got all excited about the new all-time high in the NYSE yesterday, even though it was by mere points. But a new high is a new high and the bulls are by no means finished here, yet. As I wrote on the char, it looks like a good setup for a double top for this index. Double tops separated by at least a month are more significant than ones only a week or so apart. As being more representative of the broader market, a double top here would obviously be bearish. After a minor push back above the top of its parallel up-channel from 2004, price fell back below it today. It also broke its uptrend line from March 14th.

NYSE (NYA) chart, 60-min

A couple of internal Fib projections for the move up from March 14th pointed to the same Fib area (9456) as the big one on the weekly chart (9455 is where a move above the 2000 high was equal to the move below it to the 2002 low). When I see this kind of Fib correlation I really take notice since it's probably not a fluke or coincidence. Now with the turn back down, following negative divergences at the highs, and a break of its uptrend line from March 14th, I'm calling a top to this one. I could be a bit early since really it's only a minor break--it could easily recover tomorrow. But lots of things line up for this double top on NYSE and I'm short the stock market against new highs for this index--keeps stops very tight and your risk is small.

They say you should always follow the money. In fact, digressing just a little, you've probably heard the trouble Don Imus is in for his crude and not-so-funny comments about the Rutgers female basketball players who made it to the NCAA final game. After a week of simmering behind the scenes all of a sudden advertisers, including P&G and Staples, have said they're pulling all of their ads from Imus' radio show if they don't do the right thing (fire Imus). All of a sudden with the lack of money coming in it's getting all kinds of media and network attention.

But I digress. Follow the money, and with the stock market that means look at volume associated with a move. A move with big volume is to be trusted and you should join it (except for capitulation events) but a move with dying volume means interest in the move is dropping and you should prepare for a reversal. With that, look at the NYSE and total volume:

NYSE and Total Volume (NYA) chart, Daily

I lined up the charts as best I could to show the big burst in volume (bottom chart) as the NYSE got hammered lower from its February high. Since that time, and during the rally back up to that high look at what volume has done--it has steadily dropped off where each new high was on lower volume. This is classic for a correction and does not support those bullish analysts saying we're at the start of the next major leg higher. Oh yea? Then where are the participants? Now on today's drop look at the volume--it broke the downtrend line. Other than the banks, shown below, this chart screams to get short the market.

BIX banking index, Daily chart

I said last week that with all the bullish scenarios I show on the charts (the bullish wave counts) my preferred counts are the bearish ones. The reason is the banks. Again, follow the money. If the banks aren't getting any I don't think anyone else is going to either. If Momma doesn't have any, you're not getting any either. The banks have had a funky pattern the past week and I keep thinking they're going to bounce. So far nothing but I still see that possibility. If they do get a bounce (maybe up to the 200-dma) then the broader market will probably bounce and I think it would be a better shorting opportunity. As long as the banks look weak I'd prefer to be short the market.

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

Like the banks I kept waiting for another bounce leg in the home builders. Every time they looked ready to bounce another home builders would come out with dismal earnings AND a dismal outlook. This is now looking like the next big wave down is about ready to kick into gear. After a very weak corrective bounce in March this one could get ugly in a hurry. But that bullish divergence keeps me thinking there just might be a bounce coming...

Oil chart, May contract, Daily

Oil found support at its 50-dma and uptrend line from January. Support needs to hold here otherwise a break below $61 would likely mean the last low at $58.80 is in danger of being taken out. And if that happens then the bounce from the January low will be left confirmed as a 3-wave correction to the impulsive drop from July. An impulsive drop followed by a corrective bounce will lead to another impulsive drop. That would mean a drop well below its last low near $52. I don't have to understand why it would do that but only go by what the chart tells could happen. If you're long the oil stocks and oil drops below $58 I'd rethink my strategy of being long, funnymentals be damned in that case.

Oil Index chart, Daily

I show a bearish resolution here for the oil stocks if for no other reason I'm bearish the broader stock market and a receding tide lowers all boats. The current bounce from the March low looks close to completing and that means at least a pullback is coming. I have it completing an a-b-c bounce off the January low (same as oil). This is why I'm saying if oil drops below $58 I'd exit any long plays in these stocks. It takes a break below 630 to generate a stronger sell signal in this index.

Transportation Index chart, TRAN, Daily

The Trannies have a very similar pattern here to the DOW and SPX. No DOW Theory divergence here. If the a-b-c count for the move up from March 14th is correct we should get a quick decline to a new low where the uptrend line from March 2003 will be tested. It would surely provide a bounce but a drop to there would likely break it soon after the bounce.

U.S. Dollar chart, Daily

Some bullish divergences continue to suggest the US dollar is going to bounce any day now. The bearish sentiment on the dollar is thick enough to cut with a knife. Nobody believes in the dollar and that usually sets up a rally as the bears run for cover. What kind of bounce we get is still debatable--some believe it's ready to rally and break its downtrend line from March 2006. I think it will bounce but then drop to a new low before a stronger rally develops. The $81 area is very strong support going back to December 1998 before the big rally in the dollar, and then again in December 2004. While that level could break (which would be bullish for commodities, especially the metals), the bullish divergences on the monthly chart suggest that's not going to happen.

Gold chart, June contract (GC07M), Daily

Gold looks ready for at least a pullback. It hit the downtrend line from May 2006 and the mid line of its current parallel up-channel for price action since October. A pullback to its uptrend line (as a guess) followed by new highs would also be a break of its downtrend line and I'd be very bullish the shiny metal at that point. Keep an eye on what the dollar is doing in that case. But I'm bearish gold (at which point you're asking, geesh, is this guy bullish on anything? To which I answer yes--cash). Most assets have appreciated under an easy-credit environment and therefore most will depreciate during a credit contraction.

I think gold is completing, perhaps just completed, a correction to the leg down from the February high. That February high should have completed the correction to the decline from May 2006. In other words we should now be set up for a strong decline in gold (and probably stronger in silver). I like trading the metals because they can move very fast, in both directions, and you can make a lot of money. Right now, as I called out on the Market Monitor yesterday morning, I like the potential on the short side with a stop just above 687. Tight stop and big potential--my kind of trade. You can trade the gold futures contract or the gold ETF (GLD). Or you can trade options on the gold stocks (XAU).

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

Tomorrow will be another snoozer for economic reports. Missing on the list is the unemployment report at 8:30. It's a lagging indicator and means nothing for the stock market. Friday's reports will be potentially market moving with the PPI numbers. The market now knows without question the Fed is seriously considering raising rates, which they'll be forced to do unless they can jawbone the bond market into doing it for them. If China carries through on their threat to stop investing in the U.S. then reduced demand for treasuries will drop their price, boosting yield. Come to think of it, maybe that's why we filed charges against them at the WTO--we want China to stop buying so much of our debt and let the bond prices settle back down some. We're truly in a global market so who knows.

SPX chart, Weekly, More Immediately Bearish

This is a little closer view of the regular weekly chart in order to show the candles a little more clearly. Weekly stochastics has cycled back up near overbought (fast setting on that) while MACD has barely been able to lift its head. A roll back over in MACD would likely take MACD into negative territory and a trip back down to the bottom of SPX's parallel up-channel would likely be next on the agenda. That's down near 1300 and it could happen in May. It could even happen this month but I never like to bet on very fast moves. This market has the ability to stretch things out which is the reason I always suggest buying much more time than you think you'll need if you're buying long options. Spread traders of course want front month if they can get enough premium.

The Thursday prior to opex week has become known as the head fake day. This was first pointed out to me over a year ago and it has worked nearly every month since. Therefore we'll watch to see if we get the same setup. Right now it looks to me a like a brief bounce in the morning should lead to another sell off and then another consolidation followed by more selling probably into Friday. That scenario suggests the PPI numbers on Friday morning will be the excuse du jour for more market selling and then we'll put in some kind of temporary low.

That would then set us up for a rally into opex week to correct whatever decline we get this week (assuming we get it). The bounce would probably last into Wednesday, maybe Thursday, and then start another stronger leg down.

But if we get a rally tomorrow then the bullish wave count could be in play and we might rally into the end of this week. That would set up a down week next week. By the looks of what I see so far I think this Thursday/Friday will once again be the head fake day. If you want to play with the big boyz, buy a few lottery front month options and see if we get the opposite move next week to cash in. I say lottery because it's the kind of play you don't use a stop on--it either works and you're a hero or it doesn't and you're the goat.

Good luck in the next week and I'll be back next Wednesday. As always we'll try to nail down the turns with the daily roadmap updates on the Market Monitor. See you there.

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