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Market Wrap

Tick Tock, Flip Flop

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The market is getting twitchy. That's a technical term for choppy whipsaw price action. Seen any of that lately? One look at most daily charts over the past month will show some big red candles followed by another rally to a marginal new high followed by another red candle and then another rally. Yesterday and today we got the red candles so I guess that means we're due the next rally leg.

In actuality the market is set up for the next rally leg, as I'll point out in the charts, and it could even be a strong rally into opex but it can't waste any time on Thursday starting it. As has been pointed out many times in the past, the Thursday prior to opex has been the head fake day. What has worked very well for well over a year is to fade the Thursday move. Last month's Thursday move had me faked out a little because it made a quick low in the morning and then rallied for the rest of the day. That had me thinking bearishly about opex week (fading the Thursday rally). Silly me. The quick low was the head fake and it was all rally from there.

We now have the same potential setup coming into the June opex--a quick low tomorrow morning followed by the resumption of the rally. But I'll provide some key levels to help guide us as to what is happening, both bullishly as well as bearishly.

As most of you are acutely aware of by now, I'm bearish the market longer term. We all have our longer term opinions and at this point I'm clearly in the minority with a bearish opinion and that's more than OK with me. It's hard being a contrarian and I can't say it's been terribly helpful picking a top in a market that is in a blow off top (my opinion). These are rare events and you can't plan on it nor can you easily figure out where it will end.

I recently read an interview with a market analyst, Walter Deemer, who has been advising fund managers for half a century (literally). He commented that if he offers a market opinion that most everyone in the room agrees with then he goes back to the office to figure out what he did wrong. It's when everyone disagrees with him that he knows he's right. As he said, being a market technician means being a contrarian and always fighting the urge to join the crowd, and taking heat because you're offering a not-popular opinion. The hate mail, calling me a permabear, tells me I'm probably more right than wrong. As Deemer pointed out, the hard part is the timing. I'd have to wholeheartedly agree with that statement.

But just because I'm bearish longer term doesn't mean I can't find the bullish trading opportunities and that's why I've worked hard to identify key levels, both bullish and bearish, on the charts to help identify the key moments for the market--punch up through the bullish key level and I go with the bullish count and vice versa. But each time we've made what I think is a potentially important high (based primarily on the EW (Elliott Wave) count, I test it by shorting the market against that high. As has happened many times, including the multiple highs into February, the market will prove me wrong with another run higher and I'll take either a small loss or more often than not a minor profit (or out at even) since I lower my stop as quickly as I can and let the market then prove to me it hasn't made THE top.

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I don't think this week's (or last Friday's) high is THE high. That of course increases the likelihood that it was in fact THE high (painful grin). The reason for my opinion on that is because of the corrective new high this week. It appears we have a pullback pattern that is similar to previous pullbacks, including the hard sell offs which have been nothing more than bear traps. It's possible this week's sell off is another bear trap and that's what I'll review in tonight's charts, of which I have many so I'll try to work through them quickly.

First a quick review of some economic reports.

Economic reports
It was another quiet day for economic reports although the news out of Europe with their rate increase caused some selling in our overnight futures which carried into today's selling. Our two reports included Productivity and Crude Inventories.

European Central Bank rate increase
While not an economic report per se, the increase in interest rates in Europe to 4% from 3.75% has an impact on our country because most realize we're all connected at the hip. The same concerns by the European bankers are shared by our Fed. Therefore a rate increase by ECB sparks fears that our Fed may have to do the same. The productivity numbers (see below) didn't help alleviate those concerns). The ECB raised rates even though their consumer-level inflation has been running below their target rate of 2% or below. May's CPI was 1.9%. Our CPI data has been running higher than that.

The U.S. bond rates have been ratcheting higher as the bond market starts to sniff out the higher inflation rates as well, and the potential for the Fed to raise our rates sooner rather than later.

10-year Yield (TNX) chart, Daily

The 10-year yield is close to hitting resistance at its downtrend line from January 2000, currently near above 5.0%. I believe we'll see rates pull back a little (which could support a rally in stocks as money rotates back into bonds--a rally in bonds would cause a drop in rates) but as depicted by the bullish price path (for yield) I think rates will break above 5.0%. I read recently that many analysts don't believe bonds will be competitive with stocks until they reach 5.5%. I think stocks will have a problem with TNX over 5% and I think that would cause more and more fund managers to rotate into the safety of bonds over a hyper-inflated stocks market.

Productivity (Rev)
Productivity slowed a lot more than had been expected, coming in at +1.0% for the 1st quarter. This was revised down from last month's initial estimate of +1.7%. Over the past year productivity is up only +1.0%. At the same time labor costs were revised higher to +1.8% annualized vs. the +0.6% initial estimate. This is a double whammy for the Fed and their concern about inflation. Higher productivity helps absorb higher costs to business, including the higher labor costs, and without the improved productivity they're either forced to pass along their costs (resulting in higher inflation) or they eat the costs (resulting in lower earnings). Either case is not market friendly.

Crude Inventories reports caused some commotion in the pits today as traders scrambled to make sense of the data and the lack of impact from Cyclone Gonu in the Mideast. This is the strongest tropical storm to hit the area since 1977 and it was expected by many oil traders to spike the price of oil for fear what it might do to oil production/shipping from Oman and Iran.

Gasoline supplies climbed by 3.5M barrels to 201.5M and up 8.4M over the past 5 weeks (but down 6% from a year ago). API had inventory up and even stronger 7.2M in the past week. Crude supplies were up 100K to 342.3M barrels according to the Energy Dept while API had inventories dropping by 5.7M. These two groups compile their data differently and rarely agree. Distillates, which includes heating oil and diesel fuel, were up 1.9M barrels to 122.3M according to Energy while API reported an increase of 3.5M.

Refineries slowed down a little with capacity dropping to 89.6% from 91.1%. This did not prevent the buildup of gasoline and distillates.

And with that let's turn to today's charts to see what the damage from the past two days' selling has done.

DOW chart, Daily

I added the 20-ema moving average to the daily chart to show that the DOW closed on it today, and also on the bottom of its parallel up-channel for price action since March. This is one of the reasons I said the market can't dilly dally tomorrow--it must start rallying now otherwise some important support levels start breaking. It might give us a quick jab lower in the morning but if the bulls are to save this then they have to step in right away and hoist it higher again.

The bullish upside potential I currently see is first to 13790 and then 14009. These are Fib projections based on the relationship between the 1st and 5th waves in the move up from March. If we do get another rally leg higher then it's possible it will be complete, over and done with, by the end of opex week next week. But let the break down from the up-channel be your guide--stay long until it breaks.

Moving in closer to that up-channel you can see that price hasn't quite reached it yet:

DOW chart, 120-min

By the type of correction that the DOW is in--a sideways consolidation since its high on May 21st--a downside Fib projection for the current leg down is at13392, hence the symbol for the key downside level there. It also matches up nicely with the bottom of the up-channel. Therefore I'd say the DOW is a good buy at 13400 and a goodbye below that. A drop below 13400 with a failed retest of that level would be a good sell signal.

SPX chart, Daily

I've drawn in a small parallel channel for price action since the mid-May high. The green EW labels calls for one more high in this pattern and a potential upside target at the previous all-time high near 1553. I had been thinking that the upside Fib projection at 1566 is where SPX would head but I'm starting to have my doubts about that, based on the 2-day decline we've just had. If we get another leg up I suspect it will be similar in size or smaller than the leg up from the end of May.

Note that SPX broke its uptrend line from March through the late-May low. This immediately makes the decline look more bearish. But two potentially bullish things here are the 20-ema where price closed and the bottom of that little up-channel for recent price action. But like the DOW, this can't tolerate much more selling without making it a lot more bearish looking.

The 60-min chart shows some downside levels to watch carefully for bearish signals.

SPX chart, 120-min

I show the parallel up-channel that's on the daily chart and I also have a trend line along the highs and lows that has created an expanding triangle pattern. Most of the time we see contracting triangles, including ascending wedges, as ending patterns but the less common expanding triangle is just as bearish. It's simply more volatile as the swings in the latter portion of this pattern can really whip traders around. This expanding triangle does support the higher Fib projection to 1566 by the end of next week. So the parallel channel says watch for the 1550 area to be the top and the expanding triangle says we'll see a rally up to 1566.

But the overlapping highs and lows gives the pattern a corrective look and these corrective patterns are topping patterns (distribution is what's causing the hard sell off days). So the only question in my mind tonight is whether we've already seen the high or we have one more high to go. The two key downside levels are today's low (although a brief break lower is OK) and then more importantly the 1505 level. If the prior low at 1505 is taken out then the bullish potential with this pattern gets blown out of the water.

OEX chart, Daily

For you OEX traders, have you got some bear call spreads? What's not to like about this chart from a bearish perspective? Whether or not we get one more minor new high out of this (like SPX), this puppy is toast. As I've reviewed in the past, the end of this 5-wave move up from October 2005 finishes the A-B-C correction to the 2000-2002 decline and will start the next bear market leg down. Does that make me a permabear by saying that? If following the wave count on this, which is clear as a bell, makes me a permabear then I'll wear that hat proudly.

But just to show I can see some strong bullish potential in this market, I'm showing what I see as a potentially strong rally ahead in the techs:

Nasdaq-100 (NDX) chart, Daily

NDX is clearly in an uptrend and it hasn't even made it down to test the bottom of its up-channel. I'm even getting the sense that money is rotating out of blue chips and into techs. That could be considered at least intermediate term (a few months at least) bullish. So this one bears close monitoring for additional signals. Any break above the key level at 1950 (other than a quick head fake break) would be bullish.

For now we've got trend line support near 1900. The trouble with making projections for NDX is similar to the others--the overlapping highs and lows makes for a number of potential wave counts, which is why I'm showing 3 different possibilities. Just stay long until 1900 breaks in which case get defensive. The bears aren't in control until they get this index back below 1867.

Nasdaq-100 (NDX) chart, 120-min

The decline from last Friday's high was following a nice down-channel until it fell below it this afternoon but then climbed back inside. The price pattern of the pullback is very choppy and of all the indices today this one gives me the strongest impression that we're going to rally out of the current pullback. The flip side is very bearish and means a very strong and fast sell off is coming so get defensive with a break below 1896 and the uptrend line from March. Otherwise I see the probability for either a rally sooner rather than later (dark green) or a continuation of the choppy pullback into the end of the week/early next week and then a rally into the end of the month.

GOOG is another reason why I think we'll see more rally, and why I think the rally is close to finishing:

Google (GOOG) chart, Daily

GOOG broke resistance by climbing above 513 which was the level of the two previous highs in November and January and a Fib projection for two equal legs up from March. I think this one is headed for the trend line along the highs from January 2006 and I also think that will be the end of its rally. That top trend line is the top of a large ascending wedge on the weekly chart for its 5th wave and other than the possibility for a brief throw-over above that line, the current 3-wave move up from March should be the final move. So if GOOG is nearing a significant high, and is one of the heaviest weightings for NDX, I'm thinking the NDX is also near its final high. But not yet, and that's from a permabear (wink).

Russell-2000 (RUT) chart, Daily

The RUT looks similar to the NDX with a parallel up-channel that supports the idea that we could see a rally through the summer and head much higher. I think that's a much less likely scenario but I wanted to show it so that if we see a rally hold above 860 then you'll want to be on the long side on this one. Another rally leg could finish its upside pattern around 875 by next week. A break below 821 would be a confirmed break of its up-channel and I would start looking for shorting opportunities (such as a bounce back up to the broken uptrend line.

Russell-2000 (RUT) chart, 120-min

A little closer look at the uptrend line from March and a shorter term one from May 16th, currently near 834.50, shows where to watch for support. Any rally back above 850 should be bullish

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

Another update of the NYSE vs. the 52-week highs of NYSE stocks shows continuing bearish divergence. At least the new highs at the last high matched the number at the previous high, but with a higher price we should also see more 52-week highs. The 20-dma of new highs shows the clear bearish divergence. This is not a timing tool but is one of the best heads up that the rally is on its last legs and to stay cautious.

The most dangerous thing with this market is that too many have become complacent in their expectations that the market will simply continue to rally higher. The lack of a sell off to the Chinese stock market sell off this week is proof that there is very little fear in the current market. There should be more fear if only people would look under the hood.

Semiconductor Holder (SMH), Daily chart

The semis look weak. The bounce off support at the top of its consolidation pattern got rejected at the downtrend line from January 2004. The key level is 36.70 which would be a sufficient break of support to suggest it's going to head much lower and faster.

As go the semis so goes the tech market, or at least that's been the way for quite some time. Whether that's changing is anyone's guess but until proven otherwise, follow the semis. So I thought it would be a good idea to compare the relative strength of the semis to the techs:

Relative Strength of SMH to Nasdaq (COMP), Weekly chart

This is a relative strength chart, not RSI. It simply compares one thing vs. another. So when the line is headed up then it's outperforming the index/sector/stock to which it's being compared. Both can be headed lower in price but if the first is heading lower at a slower pace then the line will be heading up. The fact that the semis have been underperforming the Nasdaq since the 2003 high, except for the brief period in 2005, is not a bullish sign. After "consolidating" in 2007 the line is headed south again. A weaker semiconductor group will not support a bullish tech market so this is another warning flag.

BIX banking index, Daily chart

The semis lead the techs and the banks lead the broader market. And the banks don't look so good here. After breaking down from its ascending wedge it appears the decline in the banks will pick up some speed, as it should from a break of an ascending wedge. It doesn't mean the broader market will roll over with the banks but it does mean the broader market will soon follow.

And again, a look at the RS of the banks to the SPX shows how they're underperforming:

Relative Strength of BIX to SPX, Weekly chart

Since the bounce into June 2006 the banks have not been keeping up with the rally in the broader market, and in fact quite the opposite. You can see this doesn't work well as a timing tool but what it does tell you is that we're setting up for a long term sell signal for the broader market and not just another correction to the rally. When the current rally tops out, wherever that will be, the next decline will be significant.

The brokers are stronger than the banks at the moment (thanks to merger mania and leveraged buyouts) and they appear to need another rally leg to finish their rally pattern.

Broker (XBD) index, Daily chart

The move up from mid May would look best with one more high to give us a 5th of a 5th wave to end the leg up from March. The Fib projection just shy of 270 makes for a good upside target. Otherwise a break below 260 would negate the bullish setup.

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

The home builders sold off pretty hard today but the index stopped right at its uptrend line from April and on its 50-dma. Any break lower from here will be bearish, period. But I see the possibility (shown in light red) for another push back up that extends the corrective bounce off the April low. But it has to bounce now.

Oil chart, July contract, Daily

I'm showing the oil contract this week (as opposed to the USO ETF fund) because the pattern is a little cleaner at the moment, or at least it's trading the trend lines a little better. As you can see, traders are using the downtrend line from August 2006 to sell oil but the pattern in the move down from the March high looks very corrective, like a bull flag. This looks like it will break to the upside but it's not clear whether we'll see another move down to the bottom of the channel first. The flip side to this pattern is that a break below the down-channel would very likely see strong selling and drive oil to new lows.

Oil Index chart, Daily

The oil stock index just keep chugging higher and now would look best with another new high before potentially topping out. Price is currently in the top half of the up-channel so until it drops below the mid line you should stay bullish. But after another minor new high, especially if met with bearish divergences, it would count well as a completed rally pattern and I'd be more cautious about the upside after that (take some profits off the table or hedge your long positions).

Transportation Index chart, TRAN, Daily

I expected to see another leg up in the Transports but the hard sell off today put a damper on those expectations. This has to turn around immediately tomorrow and rally in order to preserve the bullish potential. Otherwise a drop back below 5100 would be bearish.

U.S. Dollar chart, Daily

The choppy rise in the US dollar finally caught up with it and broke down from its up-channel. It's a funky pattern which leaves open several possibilities, one of which is for the dollar to head back down for another test of the low by tagging $81. Otherwise a rally back above $82.59 would probably have it heading up to challenge its downtrend line from March 2006, currently just above $83.

Gold chart, August contract, Daily

Similar to the oil contract, the gold contract is trading a little better technically than the GLD fund so I'm using its chart here. Gold bounced off its 200-dma and then found resistance at its broken uptrend line from October 2006. So far it looks like a classic kiss goodbye and is a short against that trend line.

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

The rest of the week remains quiet as far as economic reports go. The market will on its own, subject to what happens in the overseas markets.

SPX chart, Weekly

Similar to the OEX chart I posted earlier, this chart is a screaming sell signal (albeit an early one). We've still got two days before completing the weekly candle so anything can happen here but right now it's a tweezer top candlestick at resistance by the top of its up-channel. If it drops lower by Friday's close then we'll have a bearish engulfing candle for a key reversal week. These signals are taken seriously by institutions. The weekly stochastics has issued a sell signal.

Speaking of institutions, you may have seen the report today about Morgan Stanley advising its British client of its "Full House" sell signal (why is it that they don't offer the same advice to their U.S. clients?). This particular signal is derived from a triple warning based on rising interest rates, an overvalued "composite valuation indicator" (it divides the P/E ratio on stocks by bond yields) and a drop in the new orders component of the ISM (Institute for Supply Management). Only 5 signals have been generated since 1980, the last of which was in 2002.

Each time this signal has been generated the market was down 6 months later by an average of -15%, even more in 2002 and 1987. It's not so much a timing signal (as in get out tomorrow) but instead is a warning to their clients to significantly reduce their exposure to the stock market. Their September 1987 signal was followed by a -25.2% decline the following month. Pay attention here since this signal follows some very bearish setups in our own market.

A possible turn date is next week, June 13-14 to be specific:

Bradley Sideograph (turn dates)

I profess not to understand the effect of the alignment of the moons, planets and stars on our psychological beings but it seems to work more often than not. So the first major turn date according to the Bradley Sideograph is June 14th, next Thursday, the day before opex Friday. As noted on the chart, the direction of the turns is not relevant, only the turn dates.

Bradley chart vs. Dow, November 2006 through July 2007

Lining up the DOW with the Bradley turn dates since the end of last year shows some dates work while others don't. So I wouldn't trade strictly off this signal (but many do) but I think it's more than coincidental that I see many other signals lining up for a top next week. That's if we rally tomorrow into next week otherwise we may have hit a turn already.

To summarize, the market needs to rally right away tomorrow. It can tolerate a brief spike lower in the morning but it must be reversed quickly (and therefore could make for a good opportunity to test the long side on a brief sell off. If there's no rally tomorrow then I'll turn more immediately bearish. If we get the rally then hold into next week as we should get another opex run higher. Just understand that the system is ready for some shock treatment--something to act as a catalyst to start the selling. And when it starts you'll want to be out of the way or short.

Good luck in this whippy environment and stay cautious about both sides. I'll continue to update the pattern on the Market Monitor and attempt to zero in on what's playing out here. I'll be back here next Thursday (swapping Wednesday with Linda). Have a good trading week.
 

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