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Market Wrap

The Bulls Blinked

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After what appeared to be a slow sideways/down correction since Friday's high, price suddenly let go to the downside today. The shallow pullback looked like a bull flag and has been the typical kind of correction we've seen time and again during the rallies. Usually when these shallow pullbacks fail they fail hard and that's what happened today. Now we're left guessing as to whether or not it's a one-day wonder for the bears or the start of something more significant to the downside.

I unfortunately lost my internet connection at the closing bell (great timing for me to get my charts updated for this report). By the time I troubleshot the problem, waited for them to fix it and used a very slow dial-up connection in the meantime, it was all I could do to get charts updated and analysis written in time for this report. I didn't get time to add some additional information about what's happening in the markets in general and I apologize for that. But in the end it's important what the charts are telling us anyway.

It was a quiet day for economic reports so there's not much to cover there. The only report was for crude inventories.

Crude Inventories
Crude supplies increased by 6.9M barrels last week for a total of 349.3M, according the Energy Dept. Gasoline supplies also increased, up +1.8M barrels to 203.3M. Distillate stocks (which includes diesel fuel and heating oil) rose 100K barrels to 122.7M.

The sharp sell off today certainly gives the short term charts a bearish feel and even the big red candle on the daily charts doesn't look too healthy for the bulls, especially on the heels of the negative divergences that have been building on the charts. There's still a way to view today's price action as part of what could be a choppy rise to new highs and I'll show those potential setups and the important price levels we'll need to watch.

Before getting to the regular charts I wanted to show the daily VIX chart:

VIX chart, Daily

While I'm still holding out for the idea that the market has more to rally before topping out, the VIX chart tells me I might want to rethink that a little. Notice it has held its uptrend line from December. While it could be considered bullish when VIX is rising with the market (bulls are climbing the wall or worry) I have to wonder if at least short term a bounce in the VIX here spells trouble for the stock market. Something to keep an eye on.

I wanted to show the monthly chart of the DOW again because of the potential significance of where the rally has stopped so far:

DOW chart, Monthly

Forgetting about the EW (Elliott Wave) count for the move up from October 2002 it's important to understand how the market often rallies and declines in measured moves. It's why I so often refer to two equal legs in whatever direction--I would say most of the time that is when the market will turn. It may not be a big turn or it could be a major turn so it takes the study of the larger pattern to help discern which kind of turn it might be.

In the case of the monthly chart, two equal legs up from October 2002 could mark a very significant turn. As large as the rally has been in the past 4-1/2 years (nearly 5) it might have been only a bear market rally. I know that sounds silly but when measured in anything other than a deflated U.S. dollar, the DOW has not yet made a new high above its January 2000 high.

Therefore I've been watching for the 13712.60 level to potentially mark the end of the rally and then start the next bear market leg down. The high on June 1st was 20 points shy of that number. So there's a very real possibility that we've seen THE high as I look at this chart. We've got another week and half on June's monthly candle but it will be interesting to see where it ends--right now it's a hanging man doji at Fib resistance.

DOW chart, Daily

Price has been flopping around either side of the top of the parallel channel for price action since July 2006 and today's move down is getting close to that trend line again, currently near 13450. I've drawn in an ascending triangle as a speculative idea for what we could see if the bulls aren't done yet. They may have let the bears out of the cave to frolic in the sun today but they might have sprung a bear trap.

It's too early to tell but the reason I'm thinking there's still a chance we'll see additional upside is because of the pattern in the bounce from the June low. It looks like a 3-wave move and if true then it could be part of a larger move down with more highs yet to come. Or it could be part of an ascending wedge which I've drawn in. This would be filled with choppy whipsaw price action and they're tough to trade. It's also the kind of pattern that's been very common at previous highs.

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The bearish thing is the negative divergence we've seen since early May. Since the bounce to last Friday's high failed to take out the June 1st high, it's possible that bounce was merely correcting the first leg down of the new bear market decline. The bearish divergences are always a good warning but not necessarily timely when it comes to trading. But it's been a warning that the rally is running out of steam and to be careful about the long side and now the price pattern could be telling us the high is indeed in. If true then the bearish wave count (dark red) is the one we're in. A break below 13287 would tell me THE high is in and to short all rallies. But until that level is broken, and especially if it rallies back above 13700, then look for a potential move up to the Fib target of 13823 which is based on equality between the 1st and 5th waves in the move up from March.

The 60-min chart looks a little closer at the move up from June 8th:

DOW chart, 60-min

The move down today came within a few points of overlapping the June 11th high at 13478. As long as that high doesn't get overlapped then it's still possible for the pullback from last Friday to be a 4th wave correction in the rally from June 8th. That calls for another leg up to finish the 5th wave. For the rally up from June 8th there would be equality between the 1st and 5th waves at 13708 (shown with the Fib projection from today's low). That's very close to the 13712 Fib target shown on the monthly chart.

So between what I've shown on the daily chart and 60-min chart we have a couple of different possibilities here. If we get a little choppy sideways/up kind of bounce, as shown with the dark red bearish wave count, which is then followed by another move lower then I would expect the bearish price depiction to play out. If the DOW drops below 13400 then I think that would be the heads up that something more bearish is happening, to be confirmed with a break below 13287.

But if we get another rally leg started on Thursday which looks strong then watch for the possibility of a new high. Then whether that new high turns into THE high or just one of another (as per the ascending wedge idea on the daily chart) we'll know only after the next pullback.

SPX chart, Daily

SPX also did not make a new high on June 15th and therefore leaves open the possibility that the bounce off the June 8th low was just a correction to the first leg down from June 1st, meaning THE high was on June 1. But I show, with the green bullish wave count, an idea for an ascending wedge to play out which will take SPX to new all-time highs. The 5th and 1st waves in the rally from March would be equal at 1561.12 so that makes for a good upside target if there's to be more rally.

But the 5th wave met its minimum objective when it hit 1533 where the 5th wave equaled 62% of the 1st wave. It found resistance at the top of its parallel up-channel for price action since July 2006. It also left bearish divergences since late April. There's every reason to believe we've already seen THE high. It's just those rascally bulls who won't take no for an answer that we have to worry about.

SPX chart, 60-min

Unlike the DOW, SPX did overlap its June 11th 1515.53 high. That removes the possibility that SPX has a 5th wave to go and that's what opens up some other possibilities. One is the ascending wedge idea that I show on the daily chart--this could conceivable head even higher than "just one more high" and it could take weeks to chop its way higher. These wedges are filled with 3-wave moves that overlap and make trading very difficult because there's no follow through and lots of whipsaws. Stay cautious about that possibility here.

The bearish possibility, shown in dark red, is that we've already seen the high (on June 1) and today's decline was the 3rd wave down in a new impulsive move down. If so we could chop around a little as we get ready for a steeper sell off after the July 4th holiday.

Nasdaq-100 (NDX) chart, Daily

I was hoping NDX would make it up to the top of its megaphone pattern, which is a bearish topping pattern, as it would have made a nice setup for the short side. It could still do that and if this turns around and rallies back up then watch for resistance around the 1972-1973 area--the top of the bullhorn and where the 1st and 5th waves in the rally from March would be equal.

Otherwise a drop below the bullhorn pattern, confirmed with a break below 1888, would be bearish and I suspect we'd see a harder sell off towards the uptrend line near 1850.

Nasdaq-100 (NDX) chart, 60-min

Today's pullback was just shy of the 38% retracement of the rally from June 8th, so no real harm done yet. By holding above its June 11th high at 1917.43, like the DOW, this still has the possibility to get one more leg up to finish its rally. Any continuation lower instead could take it down to the uptrend line from March and a 62% retracement at 1904.

Semiconductor Holder (SMH) chart, Daily

We've all heard it--as the semis go so goes the market. And with the semis having pushed back above the May high it has taken on a very bullish pattern. Of course if it rolls back over here then it will leave some nasty looking bearish divergences so it will need to continue its rally. It broke above its key bullish level at 38.35 so it's now in the bullish wave count. It takes a break below 35.54 to turn it back over to the bulls.

Russell-2000 (RUT) chart, Daily

The RUT has been in a very choppy climb since its March low and it has an ugly price pattern because of it (interpretation--hard to count). The choppy price action gives me the impression it's forming an ascending wedge for its 5th wave in the move up from July and that's what's drawn with the red trend lines. The high on June 1st was the end of its move according to the bearish (dark red) wave count. Otherwise another push higher to a high near 865 (two equal legs up from June 8th) is what I would expect to see for a top.

Russell-2000 (RUT) chart, 60-min

Today's drop came just shy of a 50% retracement of the rally from June 12th. If it drops a little lower before rallying then the Fibs between 832 and 835 should offer support. Any break below 831 will look more bearish but it takes a break below 820 to confirm the high is in.

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

Continuing to follow the NYSE and its new highs shows continuing bearish divergence in the lack of participation each time NYSE pushes higher. While there is the possibility, like the others above, for a minor new high (if it turns right around tomorrow and rallies), I suspect the bearish divergences will continue and a new high will be a gift to bears to short.

10-year Yield (TNX) index, Daily chart

The 10-year yield has pulled back sharply which is not a surprise. First, bonds were deeply oversold on a short term basis so the rally in bonds dropped the yield. Second, with yields spiking up to 5.3% it became enticing for some fund managers to lock in that return, especially if they believed bonds were oversold and could make some money on a bond rally. I think we'll see rates consolidate for a few weeks before pressing higher again.

BIX banking index, Daily chart

Last week I identified on the chart two key levels--the bullish one at 405 and the bearish one at 395. So far neither price level has been hit so theoretically it could still go either way. But today's candle will send shivers down the bulls' spines. At this point I expect 395 to break than that keeps the banks on a bearish price path. Any additional rally in the broader market without the banks will be highly suspect and just add to my bearish conviction about the market in general.

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

I thought housing might get a bounce but so far nothing. It looks like it will continue heading lower from here. After the generally negative news about housing and from home builder sentiment, not to mention the higher mortgage rates and all the added worries about mortgage resets, this index is finding few willing buyers. There have been fewer bottom calls recently. Of course if the sentiment gets too bearish then it will be ripe for a relief rally (only a relief rally). This is still a bearish chart--timber!!

Speaking of timber, the chart of lumber shows a nice short covering squeeze:

Lumber chart, July contract (LB), Daily

After the warning from bullish divergences at the new lows of April and May the traders who were short lumber got hammered as short covering spiked them out. Now we have bearish divergence at the June high and I expect the price of lumber to come tumbling back down. The slowdown in home building is still a fundamental lack of demand for lumber.

Oil chart, July contract (CL), Daily

Oil moves to the August contract this week so I'll show that chart next week. With the break of its downtrend it would appear oil is in its next leg up. I've drawn a parallel up-channel and put in the Fib projection for two equal legs up at 78.62 which crosses the top of the channel in the 1st week of August. That stays in play unless oil drops back below its May 31st low of 62.43.

Oil Index chart, Daily

While oil is trying to rally it would appear the oil stock traders are willing to take some profits. That's the biggest red candle this index has seen for a while. It's still in a bullish up-channel but today's selling was a change in character. Be careful if you're long these stocks. One of these highs, if not the last one, is going to lead to at least a much more significant pullback if not the start of a major decline.

Transportation Index chart, TRAN, Daily

After bouncing up and testing the broken up-channel for price action in May the Trannies have since been selling off. If the broader market has new highs to go then I suspect the Transports do as well. But any drop back below 5000 will say we've seen the top.

U.S. Dollar chart, Daily

There have been no bearish divergences in the US dollar's rally so I suspect the current pullback will lead to another rally leg and if so it should convincingly break its downtrend from March 2006. But so far the bounce off its low is only a corrective 3-wave move so any drop back below its June 5th low of 81.70 would leave it as a 3-wave bounce and strongly suggest the dollar is headed for another new low.

Gold chart, August contract (GC), Daily

Gold was held back at the 665 level I identified last week. I thought it might make it up to its downtrend line closer to 670 but it's now back below its 200-dma and looking bearish. The wave count that I have on it, with multiple 1st and 2nd waves (each in the next smaller degree pattern) is very bearish and I don't like to bet on these setups as they're often a corrective pullback instead. If it's a corrective pullback then we should see the dollar sink back down and gold break its downtrend line. That would be bullish and I'd be a buyer of gold in that event. But if the bearish wave count, with multiple 1-2 waves to the downside, is correct then we're about to get a hard sell off.

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

Tomorrow's reports should be relatively tame for the market. Sometimes the Philly Fed index will move the market, and even the LEI could spook some players if they think the Fed might react to them. At this point I think most are worried that the Fed will start talking about the need to raise rates. If they even hint so much that that's the way they're leaning then the stock and bond markets will see some serious selling.

SPX chart, Weekly

The weekly chart of SPX shows the oscillators in a clear sell signal although it could be argued that the MACD, which is even a faster setting than typically used, hasn't crossed yet. While MACD is more a lagging indicator than stochastics, it could still do just a kiss here and head back up if price does. And if it does rally a little higher then two equal legs up from October 2002 (similar to the discussion under the monthly DOW chart) is at 1562.80. Note that this is very close to the Fib projection I showed on the daily chart at 1561.12. That would be a sweet setup for a short play if it were to rally up to that level--pop the shorts out who have their stops at new all-time highs and then hit it short. But things are looking a little dicey for the bulls here so be careful if long.

The bullish patterns require an immediate rally on Thursday. If the market even consolidates for a little bit then it will look bearish. Any further drop in the DOW and NDX will have them joining SPX in overlapping the June 11th highs. Then the two possibilities from there would be a very choppy climb higher over the next several weeks or else we've already seen the highs and we're going to start selling off in earnest after the July 4th holiday.

We're on the edge here but in either case (bullish or bearish) I see the likelihood for some choppy price action at least for the next few days. Therefore if you're trying to trade this market intraday be aware of that possibility. If you're waiting for some swing trades then I see the better chance for you with a move down. We don't quite have the sell signal for that yet but we could be close. This time next week and we should have the answer to that question.

Good luck and I'll be back here next Wednesday. Hopefully this pattern will clear up sooner than next Wednesday in which case I'll identify it as soon as I can on the Market Monitor. See you there.
 

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