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Market Wrap

Are We There Yet?

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Just maybe we saw the market high today (as the crowd groans while muttering "not again, not another call for a top"). On the Market Monitor I've been watching this week's rally leg very carefully and using the small caps (RUT), which has had a very clean rally pattern, since it looked like an ideal, almost picture perfect setup for a short play. I'll lay out what I was seeing with the RUT charts below. Whether it turns into THE top or just a pullback can't be known yet but there are enough pieces in place now to make another call for a top to this rally.

For the past few weeks I've been calling for new market highs because the last setup for a high around the end of April was busted. As I've often stated here, this market is overcooked to the upside so it's a matter of when and not if we're going to see a hard fall from the spike up, particularly from the March low, but since the end of April I've been looking for the rally to complete a 5-wave move up from that March low.

After a 5-wave move there will always be a correction of that move so I'm expecting at least a pullback correction once the rally from March completes the move. And the move up from March is the 5th wave of the move up from July so in fact we need to correct that rally. But the move up from July is the 5th wave of the move up from October 2005 so in fact we need to correct that rally. But the move up from October 2005 is the 3rd wave up from the October 2002/March 2003 low and that should finish the bear market rally which means the completion of this rally will start the next bear market leg down. Hence the importance of the top that I'm attempting to find.

As always we'll take it one leg at a time to see how the price pattern unfolds but clearly we're at a potentially very significant point in this rally and the risk, in my opinion, has completely shifted over to the bulls' side of the equation. It's time to get shorty and use today's highs as your stop levels. We should get a bounce tomorrow and that will be a good setup for a short play, or exit longs, giving us a nice nearby stop at today's highs.

If you're long the market and just holding on for further gains, you've done very well with that strategy. It's now time to seriously consider taking some profits off the table. Chasing this market higher for maybe another 2% (5%?) doesn't make sense when the downside risk is much greater. We saw what happened in February and this time around could be much more and much faster.

Today's quick drop from the high was supposedly due to Greenspan's mentioning that the Chinese market is due for a fall, or in his words, a "dramatic contraction" in Chinese equities. Remembering what happened in our stock market the day after the Chinese market dropped hard spooked a few investors today. They can only imagine what might happen if the Chinese market takes a harder spill, which it's setting up for. Greenspan went on to say that the surge in the Chinese stock market is unsustainable. With their market up 56% just this year, on top of the parabolic climb last year, some are saying it could be a bubble over there. Do ya think?


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At today's high we had the completion of the 5-wave moves that I mentioned above. For that reason I was looking for a top this morning to get short. The market was ready to pull back so Greenspan's words were just the catalyst to something that was already going to happen. So he gets the blame but in reality if it wasn't him there would have been something else to spook the market. It's interesting though that Greenspan feels so free to talk the market down like that (he knew full well what the reaction in our stock market would be). I can't imagine Greenspan when he was the Fed Head, or Bernanke now, saying the Chinese market is ready to crash (my words).

I don't want to be cynical of Mr. Greenspan who is, as you all know, one of my favorite people (cough), but might his comments have been intended to help the bond market? He now works as a consultant to PIMCO, one of the largest bond funds which has been predicting a decline in yields, and with Greenspan's words of wisdom today we saw a simultaneous sell off in stocks and buying in the bonds (which dropped yields from today's highs). Sounds to me like the plan worked with Mr. Greenspan. After all, he did speak the truth--I'm in complete agreement with his statements made today.

The mania we're seeing in our own stock market is reflected in the amount of LBO (leveraged buyout) and M&A (merger and acquisition) activity which is reaching unprecedented proportions. It's gotten so bad that now people are coming out and saying the stock market rally has a long way to go because there are fewer stocks available (meaning the law of supply and demand will drive the remaining stock prices higher). I have news for these people--the exact same thing was said in the spring and summer of 1929. Each time there was more news about more LBO and M&A activity in 1929 the stock market shot higher, until it didn't.

Even Bernanke was forced to admit that he's "starting to look into" this phenomenon. The reason he's becoming concerned is because of all the debt that's being used to complete these deals. I've talked at length before about the amount of credit that has been created over the past few years (the driver behind the excess liquidity sloshing around the world) and with private equity buyouts using leverage on the equity in order to finance the deals then you know we have a problem.

This is no different than the subprime mortgage problem where buyers were using no money down and borrowing more just to make payments. This whole asset pyramid we've built over the years has been built on credit and not hard assets. And yes I mean it's a pyramid scheme otherwise known as a Ponzi scheme and the stock market is the only place that it's legal, albeit just a dangerous. Hedge funds today are trading with upwards of 25:1 leverage (and even much much higher for some)--for every dollar they have in their account they've purchased $25 of other inflated assets. Those inflated assets are then used for additional leverage so that they can go out and buy more. It's not hard to understand why Buffet calls the derivative mess a financial WMD. The collapse of this credit bubble will be mind-numbingly fast.

So before getting to the charts there was only one economic report today which was crude inventories.

Crude Inventories
Crude supplies were up 2M barrels to 344.2M, making for a 5th week in a row for gains. Distillate stocks were up 500K barrels at 120.3M. Gasoline supplies outpaced usage and climbed for a 3rd week, up 1.5M barrels at 196.7M. Prices for oil products were flat to down on the day.

With that let's get to the charts, starting with the weekly chart of the DOW to remind you of the 40-week cycle which I still consider us to be in (through this week).

DOW chart, Weekly, 40-week cycles

First of all the 13493 level is the Fib projection where the DOW has two equal legs up from the March 2003 low. As a reminder, these "measured" moves are often important reversal points. The fact that price overshot this level doesn't concern me one bit. As a percent of the 7000+ point move up from March 2003 I'd say it's in the "noise" measurement. Weekly oscillators are as overbought as they've ever been and volume is down while price heads higher. This is a good setup for a reversal right around the current 40-week cycle.

DOW chart, Daily

The rally up from March has formed a tight ascending wedge and is showing clear negative divergence between the early May high (wave-3) and the current high (wave-5) which is what I expect to see between the 3rd and 5th waves. The 5th wave achieved 62% of the 1st wave at 12564 and this is the most common relationship between these two waves in an ascending wedge. And now with the shooting star candlestick for today, at resistance, this looks good for a top. This is a good place to short the DOW, especially with a bounce tomorrow to correct today's decline since you'll be able to lower your risk.

The 60-min chart focuses on the move up from May 10th which is the small 5th wave on the daily chart above.

DOW chart, 60-min

While I'm thinking today's high finished the rally I show the possibility, with the green wave count, for another new high before finding the top. That's why I say the DOW is a short against today's high. I don't favor that bullish wave count but knowing we're in a bullish period around the holiday I also discount the possibility. But the break of the uptrend line from April 12th was a sell signal and today's close was a retest of that trend line. We should get a correction of today's decline followed by new lows. If that happens then drop your stop on short plays to the high of the bounce.

SPX chart, Daily

SPX looks very similar to the DOW and has for this entire rally. This too has created a nice 5-wave move up in an ascending wedge with the bearish divergences that support this pattern. Three attempts to get a closing high above the March 2000 closing high of 1527.46 were all rejected with afternoon sell offs. It looked like classic distribution patterns. We've got 3 little shooting star candlesticks for the past 3 days with today's looking particularly bearish.

SPX chart, 60-min

Like the DOW again, the 60-min chart shows the rally leg from May 11th and the 5-wave count. The only question in my mind is whether today's pullback was the completion of a slightly larger 4th wave correction which would mean one final high to go. In that case the two upside targets are first to 1538 and then 1542-1545. If we do get a new high into early next week then again watch for additional negative divergences to help identify a potential high. I'll be doing the same on the Market Monitor.

For tomorrow I'm expecting a slightly lower low to find support at the uptrend line from March, a bounce to correct today's decline and then a continuation lower that breaks that uptrend line. That's the line the bulls need to hold and the bears to break, so play this accordingly.

Nasdaq-100 (NDX) chart, Daily

NDX did an over-throw above the trend line across the highs from November and then dropped sharply back down, leaving yet again another lower high on the RSI. This can't be viewed any other way than bearish. It takes a break below 1857, the May low, to put the bears in the driver's seat and it's a good short against today's high. Upside potential is to 1962 if this manages to turn around and higher again.

The 5th wave of the rally from March is the move up from the May low and is shown closer in this 60-min chart:

Nasdaq-100 (NDX) chart, 60-min

Counting waves is sometimes as easy as drawing a parallel channel. Once price broke down from the parallel up-channel from the May 16th low, that confirmed the end of the 5-wave move as labeled in dark red. I show the possibility for a larger 4th wave (in green) with the need for a new high but that's not my preferred count here. But proof is needed with a drop below the wave-(i) high at 1892. By that time it should also be breaking the uptrend line from March and confirm that that 5-wave move is also done. This market has done some amazing things in turning itself around and heading higher again so keep your stop tight at a new high above today's if you're short or want to get short.

Russell-2000 (RUT) chart, Daily

The daily pattern was leaving a lot to be desired in trying to figure out what it was doing but then the move from the late April high started to become much clearer and once the bounce from the mid-May low started it became almost crystal clear what was going on. I focused on it in the Market Monitor because I felt it would do the best job in identifying the top of this rally. It did not disappoint. Stopping at the trend line along the highs from May 2006, with bearish divergences and another shooting star (with a little larger red body than normal), after a clean wave count makes this one easy to call a top. I could be wrong on that call (it's been known to happen) but this is one of those setups where I pound the table on a short play setup. You should be short this index against today's high, period.

The move up from the mid-May low was a picture-perfect 5-wave move and even if it isn't to be THE top, all 5-wave moves will be followed by at least a correction of that move.

Russell-2000 (RUT) chart, 60-min

Labeled in green as waves (i) through (v), the move up is very clear. I placed a Fib projection off the bottom of wave-(iv) to show where the 5th wave would be equal to wave-(i) and 162% of wave-(i). The upper Fib target at 846.07 was missed today by 11 cents. The sharp drop back below the trend line along the highs from April 25th is a sell signal. The new high was accompanied by negative divergences. The setups just don't get sweeter than this one. It will be very disappointing if this doesn't follow through to the downside but that's what stops are for.

Because the setup coming into today was so clear I followed it closely by posting 5 and 10-min charts of the leg up from Monday's low. As the final 5th wave it too needed to be a 5-wave move and that's what I show on this 10-min chart:

Russell-2000 (RUT) chart, 10-min

The end of the 4th wave (green wave-(iv) on the 60-min chart) is labeled as wave-4 on this chart at the bottom left. From there you can see a clean 5-wave move up to today's high which again left bearish divergences against the 3rd wave high. And then the 5th of the 5th wave, the move up this morning was also a clean 5-wave move (labeled in bold waves i through v). The wave count nailed today's high at the 846 Fib projection. Following that high is a clean 5-wave decline and that tells us the trend has reversed. It being a 5-wave move down means we'll get a bounce tomorrow, perhaps up to about 840-841, to be followed by another decline. A 5-wave move down like this will not stand by itself but instead will be followed by at least one more. Then we'll get to see if the larger 3-wave decline sets up another rally leg of just a small 4th wave correction but at least for now look to short tomorrow's bounce and use today's high as your stop--nice tight risk.

NYSE (NYA) vs. New 52-week highs, Daily

The ascending wedge for the NYSE over the past several months is confirmed by the negative breadth as shown with the number of new 52-week highs as compared to new price highs. The last time we saw this kind of divergence was at the February high. Just remember that the next decline could make that February decline look puny.

Not shown but if I plotted the new 52-week lows against price you would see them trending higher. So not only are fewer stocks participating in the NYSE's new price highs but more and more stocks are actually heading the other way and making new lows. Just more negative divergence.

NYSE (NYA) vs. Advance-Decline line, Daily

Another internal breadth measurement is the a-d line for the NYSE, which as you can see is diverging against new price highs. And I failed to mention that shooting star on the daily chart at resistance by the trend line. This is something bears can drool over. Will it mean anything this time? Who knows but I sure like the setup.

Semiconductor holder (SMH), Daily chart

After breaking the downtrend line from January 2004 the semis have broken back down below that trend line. Not bullish. In fact it's a sell signal. The move up from March met the minimum projection out of this pattern and I believe it's done. Confirmation will be with a break back below 35.70 and until then this could always just give us a pullback and then launch higher again.

BIX banking index, Daily chart

The banks are close to finishing their a-b-c bounce off the March low, if it didn't complete it today. A break of Tuesday's low would be a sell signal.

XBD broker index, Daily chart

The brokers have been stronger than the banks and we've got a clean 5-wave move up from March. The 5th wave is still a little small but truncated 5th waves are common (and it would be failing at the mid line of the up-channel, also very common). And if it fails here it will be a double top, or really a triple top, with bearish divergence. Confirmation of the end of the rally comes with a drop back below the wave-4 low just under 250.

Before looking at the home builders chart, Treasury Secretary Paulson mentioned this week that he felt we're near the bottom in the housing market and that the subprime mortgage problem would not have any further impact on the banking/mortgage industry. Oh really? I guess time will tell but I think he's mistaken. First of all the housing market has much to do to work out the excesses in the system. Highly inflated values combined with harder-to-get mortgages makes for a tough combination that has already significantly slowed down home buying interest. The excess inventory problem as a result of foreclosures, speculators abandoning the market (vacant homes are a big nut out there right now), people selling in order to avoid mortgage resets, etc., continues to increase the total inventory of unsold homes.

Those who say the subprime mortgage problem will be self contained are either deluding themselves or making political statements in hopes of keeping people positive and in a home-buying mood. The tightening in lending standards, which is continuing to work its way through more and more banks, will be the real problem and this is a result of the subprime bomb. As banks make it harder to get a loan for over-inflated homes, there will simply be fewer buyers qualified to buy.

The changes have soured the buyer's moods which is reflected in the latest surveys showing there is low buyer traffic through homes for sale--the measurement was 23 in May which was down from 27 in April which was down from 28 in March which was down from 29 in February. The Single Family Sales readings in May continue a downward trend--the index was 31 in May, down from 33 in April which was down from 36 in March which was down from 40 in February. Notice a pattern here? Do you see a bottom in those numbers? And the May figure was sharply lower than the reading of 50 in 2006 (and as comparison it reached a high of 78 in December 2004 and now at 23 it's the lowest it's been since 1991).

This can't be blamed on the weather either as May was a nice month to go house hunting, especially as compared to February which was miserable. Housing is still headed for the dumpster which makes the rally in the home builders all the more amazing, and a good short. Even the CEOs of the home builders don't see a bottom. I'll still go with the CEOs instead of Secretary Paulson's opinion knowing his statement is probably far more political than fact.

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

Last week I mentioned the decline from late April was looking corrective and I thought we'd get another rally leg back up that could test the 200-dma. We got that and then some with today's rally smoking up through the 200-sma and getting just above the 200-ema. But it dropped sharply back down and closed below both 200 moving averages. Ruh roh. Another shooting star with RSI overbought. So it looks ready to reverse back down but if it can manage a little more rally then the Fib projection at 692 is right on top of a 50% retracement of the decline from February, and is at the top of a parallel up-channel. I thought that's where it was headed until today's sharp reversal. Now I'm not so sure about that happening. Reality could set back in with tomorrow's New Home Sales number out at 10:00 AM.

Oil chart, ETF (USO), Daily

I can't quite figure out if oil is getting ready to break its downtrend or drop back down in its new down-channel. Price action has been corrective looking in both directions with gives me the impression it's going to head higher and a break above 52 would confirm that. A break below 47.39 would say the bears are running the show for a little longer.

Oil Index chart, Daily

Another nice 5-wave rally looks ready to come to an end. Price stalled at the top of its up-channel with a move above the top of a larger parallel up-channel from 2005. But with oscillators as overbought as they've ever been, at resistance, after a 5-wave move, I don't think it'll head any higher, certainly not appreciably so. Therefore a drop back below 725, back inside the larger channel, would be a sell signal. A break below 680 would confirm the rally is complete.

Signs of a weakening economy are often reflected in the Trannies because fewer goods to ship is an indication that manufacturing is slowing down. It doesn't matter if we're losing manufacturing over time it's still a good measure month-to-month to see how shipments are doing. For 2007 year-to-date railcar loadings are down -4.3% when compared to the same period in 2006. The first week of May was down -4.9% y/y. Trucking tonnage has declined in 4 of the past 5 quarters. So the negative divergence between the Transports and the DOW is very likely to translate into a move lower by the DOW very soon. DOW Theory is alive and well no matter how many out there say "it's different this time because we're a service economy now". I beg to differ.

Transportation Index chart, TRAN, Daily

The move up from the end of April looks funky (that's a technical term meaning I'm not sure how to count it). My first impression is that it's a short ascending wedge for the final 5th wave of wave-5 on the chart. The bearish divergences support this view and therefore it's either already topped or it will top with a minor new high perhaps up to the trend line along the highs from May 2006, currently just below 5300. A break below yesterday's low, confirmed with a break below 5100, would suggest we've seen the high in the Transports. Find your favorite (weak) stock and short it.

U.S. Dollar chart, Daily

The US dollar has made a bigger bounce than all of its bounces since the January high. The form of the bounce leaves much to be desired and looks more like a bear flag than the start of an impulsive climb up. So there's the possibility that the bounce will fail and we'll see the dollar head for a new low and perhaps tag its Fib projection at 81.03 and the bottom of its wedge one more time. But as long as it stays within its up-channel the dollar remains bullish and should break out of its descending wedge.

Gold chart, StreetTrack Gold ETF (GLD), Daily

Each leg down in gold (GLD) has been followed by a choppy bounce, including the current bounce, and that says look for lower lows in gold still. I'm looking for GLD to drop down to its uptrend line from July 2005, consolidate and then break that support which should then become resistance. Gold should work its way lower to at least 50 ($500 on the metal) over the next many months. But if the US dollar drops back down as I pointed out above, then we could see gold get one more bounce back up near its recent highs. That's not my preferred wave count at the moment but a possibility. Watch the dollar (and the euro as it's tracking gold well) if you're trading gold.

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

After today's quiet day for economic reports, tomorrow is not much better. But durable goods orders, considering how much it's been slowing down lately, could move the market, especially pre-market. Then the new home sales data could have an impact but as always it's hard to judge the reaction of the market to the news. I'll stick with the EW pattern. I'm looking for a slight decline in the morning and then a bounce into the afternoon (staying below today's high) and then another sell off into the close.

SPX chart, Weekly, More Immediately Bearish

We don't have anything telling on the weekly SPX chart yet. There's a heads up right now with the candlestick pattern at the top of its parallel up-channel from last July's low. If it were to finish as a gravestone doji at resistance with overbought oscillators then a red candle for next week would be bearish confirmation of the potential reversal signal. We'll watch for it.

As we get closer to the holiday weekend we'll see lower and lower volume (today's was average) with Friday likely to be a snoozer. But be aware that we could have a volatile day tomorrow if we get the bounce into mid day, maybe the afternoon, followed by another sell off which would likelybe faster and stronger than today's. Depending on how early and quickly we were to get the selling that could then set up Friday for a consolidation day and then more selling next week. But that's speculation based on what I see in the pattern as of today's close.

With lower volume, maybe, it might aggravate any moves so be a little careful about your positions. If you're day trading then use crisp entries and tight stops--it'll be good practice for summer time trading.

As I mentioned for several of the charts, I'm hoping to see a minor new low tomorrow morning that sets up a corrective bounce (3-wave move or something a little more complex) that retraces 38%-62% of the decline from today's high. That should set up a very good short play since you'll be able to keep your stop tight against today's high. That might be a little wide for futures traders but an excellent play for put options. Buy a few and then wait to see if it works. A bounce followed by a move to a new low will be a good time to add a few more. Then we'll just follow it down to see whether we get just a 3-wave decline or if it instead turns into a 5-wave decline. Keep an eye on the RUT for now since it's giving us some very clear patterns.

Good luck the rest of this week and enjoy your 3-day holiday. I'll be back on Wednesday and I'll be with some of you on the Market Monitor where I'll be watching very carefully for evidence of a true market turn vs. just a pullback. I think we could be approaching the time where it will be very good to be a bear. For all the bulls who don't like playing the short side simply identify how much of a pullback you're will to take and set your stops. Cash is a wonderful position and one where you'll be able to relax and enjoy your summer.

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