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Market Wrap

Expired Feline Recoil

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I don't want to offend any cat lovers with the real phrase there. But thats the question tonight--was the bounce in the market just one of the dead cat variety or was it the start of another leg up? In other words, did this week's selloff begin something larger to the downside or are the dipmeisters going to bootstrap this market back up to new highs?

If you look at the numbers in the table above you might lean towards the dead cat bounce interpretation for today's rally. Total volume at 7.8B shares was very strong and the up vs. down volume ended at an exact tie. There's a real battle between the bulls and the bears here. But decliners beat out advancers by about a 4:3 margin. The real surprise is the number of new 52-week lows vs. highs. New lows beat out new highs by about a 4:1 margin. I looked at just the NYSE numbers and new lows beat new highs nearly 8:1 (411 to 51) while the Nasdaq had "only" 3:1 lows to highs (257 to 85).

So the market internals do not support the indices being in the green today and that's why I'm thinking today was a dead cat bounce. There was a lot of damage done to the charts yesterday and I'm thinking it's not going to be quite as easy for the bulls to lift this one back up. But they'll try (listening to the pundits on TV will tell you that a lot of people are looking at this "dip" once again as a great buying opportunity). I'll show some ideas on the charts for where I think the market is headed.

First, here's a history quiz--name the author of these words: "Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men...Finally, in our progress toward a resumption of work we require two safeguards against a return of the evils of the old order; there must be a strict supervision of all banking and credits and investments; there must be an end to speculation with other peoples money, and there must be provision for an adequate but sound currency."

I'll give you a hint--it was soon after the 1929 stock market crash. That would be from FDR's first inaugural address and I found it interesting to reread those words considering what we're dealing with today on Wall Street. I suspect we will have someone "reissue" those words a few years from now. Most of the changes that were made to the banking system to prevent a similar occurrence that led up to the 1929 crash have since been repealed. The rules were considered too archaic. And on July 5th of this year the uptick rule was abolished.

As I'm sure most of you know, the uptick rule was implemented to prevent panic selling in a collapsing market. Before someone could sell they had to catch the market on an uptick--the market needed a buyer before you could sell. Without the uptick rule the market is now vulnerable to a panic selling where there truly could be a no-bid situation. The stage is set for a repeat of 1929 and we'll be scratching our collective heads wondering how it could happen all over again. We truly never learn from our past mistakes.

The merger mania, excessive creation of credit (and the massive increase in liquidity as a result which floated ALL asset boats) and now the abolishment of the protective measures learned from the past have all set us up in a nearly identical scenario as was present in the late summer of 1929. Hang onto your hats if the same outcome should befall us.

In Monday's Market Wrap I think I beat up on the subprime issue enough so that I don't need to flog it anymore tonight. But I will add one more thought to why this subprime problem is critical to how you prepare yourself for the stock market's future direction. Basically the subprime bond market is considered junk. Actually its considered toxic waste which is a notch or two or three below junk. In fact it may be lower than whale excrement. But the thing to remember about the junk bonds is that tend to trade in synch with the stock market.

When you think about this it makes a lot of sense. Those willing to take on more risk in their investments tend to choose stocks over bonds. Of the bond players those who are willing to take on more risk tend to play in the junk bond arena. Therefore when the mood of the market changes we typically see the junk bond market and stock market trade in synch. Now take a look at this chart of the two and notice the disconnect:

Junk Bond index compared to S&P 500 index, courtesy elliottwave.com

You can see the two indices traded in synch from 2005 to March 2007. They both dropped in March and they both rallied. But then the junk bond market peaked in May and has since fallen off, taking out the March low. Have you checked the banks lately? I'll review the chart but they too have now dropped below their March low.

But the broader market averages, in lala land, proceeded merrily along making new highs into July. This kind of disconnect has been a warning that the party in the stock market is about to end. Did it end at last week's high? Only time will tell but this chart says look out below for stocks.

In the meantime the US Treasuries have seen a bid because of the relative safety in those as compared to corporate bonds. But the rally in Treasuries (drop in yield) could be coming to an end soon:

10-year Yield, daily chart

Two equal legs down from its June high is at 48.72 and it's looking like that level might get tagged. From there we should see another rally leg in yields (selling in the bonds) and that could coincide with a general selling in all bonds soon (and stocks). People are so highly margined right now that the risk is for any selloff to spark some more selling as people try to sell whatever they have in order to meet their margin calls.

Other than the battle between the bulls and the bears today, it was a relatively quiet day. Even with the indices in the green it looked more like consolidation. The economic reports were rather benign and earnings reports were mostly as expected with an occasional upside or downside surprise. But the real surprise is often how the market reacts to good vs. bad news. That's why I prefer to stick with the charts and try not to get caught in the crossfire.


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Economic reports
Existing Home Sales, Crude Inventories and the Fed Beige Book were the only scheduled reports today and none of them moved the market appreciably.

Existing Home Sales
Sales of existing homes fell -3.8% in June to a seasonally adjusted rate of 5.75M. This is the lowest reading since November 2002 and down -11.4% vs. a year ago. Inventories of unsold homes fell -4.2% to 4.2M which is a 8.8-month supply at the June sales rate. It remains the same as in May which is the highest month's supply since 1992. The good news for the month is that the median selling price was $230,100, up 0.3% since a year ago June. This is the first time in 11 months that the median price has not dropped vs. a year ago.

Crude Inventories
Crude supplies fell 1.1M barrels to 351M while gasoline and distillate stocks were up, 800K barrels to 204.1M and 1.5M barrels to 123.7M, resp. Refinery utilization climbed to 91.7% from 91.0% the previous week.

Fed Beige Book
The report was essentially neutral--moderate growth in most districts with some softening in a few. Kansas City and Dallas reported a slowdown in growth, Boston and Atlanta reported "mixed", and Philadelphia reported "improved". The other seven districts reported "modest" or "moderate" growth. The overall impression from the report is that the economy is not strong but hanging in there. There are some concerns about the 2nd half of the year.

And now onto the charts.

DOW chart, Daily

The DOW dropped to or near its uptrend line from March (depending on which low in June you pick for it) this morning and bounced. The big question of course is whether or not that trend line will hold. If the trend line is drawn through the very low in late June then that support line is a little lower near 13625. That would actually be a big drop from today's closing price of 13785. Today's low did not overlap the high on July 9th (green wave-i on the chart) and therefore keeps open the possibility that we're going to see a 5th wave rally to a new high. I'm having my doubts about that at the moment but never say die to these bulls until we see a confirmed breakdown (which I would say is a break below 13600 just to confirm a break of its uptrend).

Getting in a little closer, the 30-min chart shows the decline from last week's high:

DOW chart, 30-min

Before discussing the bearish possibilities here, notice first that the decline is only a 3-wave move and even has a descending wedge appearance to it. That interpretation is bullish and says the pullback is finished and up we go again to a new (and would be final) all-time high.

But the bearish interpretation could be very bearish. First of all, by the strict definition of EW (Elliott Wave) rules, the 4th wave correction, which I'm calling today's bounce, can't overlap the 1st wave low, which is the low on Friday the 20th. Therefore this is either bullish, as per the paragraph above, or it's very bearish and today's bounce is a smaller degree 2nd wave correction. What that would mean is that we're due a very strong 3rd or a 3rd wave down. I show the DOW finding support at its uptrend line around 13625. If we have a 3rd of a 3rd coming, forget about that support--the DOW will slice right through it at a high rate of speed.

So that's the very bearish possibility from here. The less bearish possibility, and the way I have the move labeled, is that today's bounce is a 4th wave and we have a 5th wave down to finish a larger degree 1st wave (wave-(1) on the chart). I've learned on smaller time frame charts that you sometimes have to "wave" the rules. I usually look to the other indices for confirmation and I don't see the same dilemma on the others, yet.

SPX chart, Daily

SPX looks more bearish than the DOW. First it clearly overlapped the July 9th high (unlike the DOW which needs to get below 13670 to do the same) which negates the bullish wave count that I had on the chart. The only other way to have a bullish wave count now is to assume we've got a larger choppy rally ahead of us that takes us through August. I'm just not ready to buy that one. The bearish interpretation says we've seen THE high and it's all downhill from here.

SPX chart, 30-min

Notice there is no overlap between today's high and last Friday's low. This pattern suggests we've got another leg down to finish the next larger degree 1st wave which will set up a bounce into next week. A 50% retracement from the 1498 area would give us about 1526 to look for the next shorting opportunity (the next, and even better, MOAP--Mother of All Puts).

Nasdaq-100 (NDX) chart, Daily

The NDX also maintains the bullish possibility to give us a new high. By the green bullish wave count it would look perfect for another push back up to finish the rally from March. Bullishly, price found support at the midline of its parallel up-channel. I don't like the oscillators rolling over but it could rally to a new high with bearish divergences, as it should be for a 5th wave. This daily chart should keep bears alert here. But if today's bounce is followed by more selling tomorrow, especially if we see a gap n crap off AAPL's positive earnings response, then the pattern turns more bearish.

Nasdaq-100 (NDX) chart, 120-min

Also potentially bullish is the fact that price found support at the top of an older parallel up-channel (it broke above it in early July). This is why the bears need to see today's bounce lead to another breakdown whereas the bulls want to see the bounce continue. If NDX gets much above 2025 I'd begin to feel more bullish about this index.

Russell-2000 (RUT) chart, Daily

They can't seem to sell small caps fast enough. Yesterday's selling took the index below its uptrend line from August 2006 and it was unable to recapture that support today. If it can't get back above it tomorrow then it will look like a confirmed break of support, especially if it drops below today's low which was at the 200-day moving average.

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

I wanted to show that the NYSE broke its support by its uptrend line from March and was not able to close back above it today. Not shown on this chart is its 50-dma which coincides with the uptrend line. Like the RUT, if it can't recapture this support tomorrow, and especially if it breaks today's low, then the fat lady has sung her tune and you need to listen to her--short the rallies.

The lower number of new 52-week highs during its rally has been our warning and that's why the break of its uptrend will be serious. And today's new highs vs. new lows (8:1 negative) could be one of our best indicators for what's going to happen tomorrow.

BIX banking index, Daily chart

The banks have been in what appeared to be a very bearish setup with multiple 1st and 2nd waves. The strong decline from the July high helps confirm the wave count because it looks like a 3rd of a 3rd wave down, which are typically so strong they break below (or above in a rally) the bottom of the channel. The bottom of the parallel channel should now act as resistance and price will likely continue to drop away from it. In other words, the selling has just begun on the banks. And as I said in Monday's Wrap, follow the money.

With the banks tightening their lending standards, and a slew of other problems, the home builders have obviously been struggling to sell their homes. Ryland Group (RYL) reported their earnings today and it didn't help the sour mood in the home builders. For its 2nd quarter it swung to a net loss of $52.4M, or -$1.25 a share, from a positive $94.8M, or $2.03 per share a year ago. They took a big hit on inventory valuation adjustments (home sale price reductions, giveaways, etc.). They continue to write off options on land purchases. Closings on homes totaled 2,461 units, down -35.3% from a year ago. New orders declined -16.6% from last year. You can see why the CEO of one of the home builders said last quarter that 2007 was going to "suck".

And the home building index hasn't fared too well:

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

The first potential Fib support at 487.56 has been tagged and it appears the index is trying to find support near it. A bounce from here could take it back up to or slightly above the July 2006 low before tipping back over. Either that or it'll just keep truckin' south from here.

Oil chart, September contract (CL07U), Daily

Oil did a quick reversal of the 2-day pullback and matched the previous high. It should be able to rally a little more, pull back and then head up to its Fib target and the top of its channel just shy of $81. From there I think oil will turn around and head south for the winter.

Oil Index chart, Daily

Oil stocks should break the uptrend line from March and I think it will head down to the top of its old parallel up-channel, bounce and then break that support. This should be just the start of a large decline in these stocks.

Transportation Index chart, TRAN, Daily

The Transports almost made it down to the uptrend line from March today but bounced just before getting there. It may get a decent bounce off that support line but then break it and head for its uptrend line from September. It needs to break below 5000 to confirm the bull market is finished. If it continues to rally from here, especially with a move back above 5400 then it will very likely head to a new high near 5600.

U.S. Dollar chart, Daily

The US dollar finally did a little punching back today. It looks like a bullish engulfing candle today and all it needs to do is get back up inside the descending wedge pattern to give it a buy signal. It may take a few days but that's what I anticipate happening.

With the dollar's big bounce it didn't help the metals at all:

Gold chart, August contract (GC07Q), Daily

The big red candle today looks like a sharp reversal off the high which I'm counting as the end of a 2nd wave correction. This is the second 2nd wave correction (you can see the wave-(2) high in April) which means we're due a 3rd of a 3rd wave down and for that reason, if you're bearish gold, now's a good time to be short. We should see gold quickly take out its previous low near 640. The more bullish interpretation says we'll see this pullback followed by a rally. Any push back above 690 would be bullish and I'd be a buyer of gold in that case. Just keep an eye on the US dollar.

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

Durable goods orders and maybe new home sales could influence the market if the number comes out as a surprise. Same with GDP and Michigan Sentiment on Friday. Otherwise it should be relatively quiet as far as economic reports go. The market could be more greatly influenced by earnings reports.

SPX chart, Weekly

The weekly oscillators have crossed back down and have left clear bearish divergences in their wakes. With a high of 1555.90 I'd say it was close enough to the 1562.80 Fib projection that was based on the entire 2002-2007 rally. After a 787-point rally, to have missed it by 7 points, or less than 0.1%, well let's just say I'm not going to quibble. By this chart the rally certainly looks done.

After the bell Apple Computer (AAPL) announced 3Q earnings and didn't disappoint. They reported a profit of $818M, or 92 cents a share vs. $472M, or 54 cents, a year ago. Revenue was up 24% to $5.41B vs. last year's $4.37B. It expects to sell 1M iPhones by the end its fiscal 4th quarter. After closing regular hours at 137.16 it was trading up around 150 in the evening (after a post-earnings dip below 130--needed to make sure they nabbed a few stops before rallying).

The equity futures are up a little this evening but I've long ago given up figuring out how that will translate into the morning, especially for the cash market. Be careful though of a quick flash of buying followed by more selling (that would be the gap n crap).

We've seen the bulls pull the market out of these nosedives countless times, especially in the last year, so we need to remain vigilant about that possibility. Certainly there are many trying to buy this dip in hopes of catching another 500-point rally in the DOW. Today's heavy buying, and selling, point to that. Whether they will be able to overwhelm the sellers this time is the question.

Based on the evidence I'm seeing in the market I'm saying the selling will continue. It's a matter of how strong and for me that depends on which wave pattern is correct. The very bearish wave counts, looking for a 3rd of a 3rd wave down, such as in the banks, says we've just begun some very serious selling. The pattern for the SPX points towards more selling but not serious and that says we should expect it to find support around the 1500 level. If it plays out that way and bounces into next week then I'll be looking for another MOAP to ride the next wave of selling which should be stronger than what we saw this week.

So from a bearish perspective it either sells hard right from here or it sells hard from a higher bounce next week. But don't rule the bulls out yet. There's disagreement between the indices on this but I can see a way to call for new highs. Maybe not all the indices will make new highs and give us intermarket divergence in the process. But that's all speculation and right now I'm in the bearish camp until the bulls prove me wrong. It wouldn't be the first time and that's what stops are for. Good luck in your trading and I'll be back next Wednesday. I'll be with you Market Monitors tomorrow as usual.

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