It seems there's no good consensus about what the jobs number will be on Friday and that's translating into a lot of guesses as to how the market will react to the number. It's hard enough guessing what the number will be but then trying to guess how the market will react is where the real uncertainty lies. A bad number (a lot less than the estimated +100,000 new jobs) would of course be a negative sign about the economy and that should therefore be bad for the stock market. But it would also free up the Fed to keep cutting interest rates and most traders seem to feel a rate-reduction environment is bullish for the stock market. That hasn't been true for the past several rate cycles but don't try to confuse me with facts.
If we get a blowout positive number (well in excess of +100,000 new jobs) and a strong positive revision to the August number, which was -4000 jobs, then that would be a good sign for the economy (and earnings) so the market should rally. But of course it might not because then the Fed could use that as justification for going on hold and sit tight on rates. One and done? That's what the market fears. In past instances where the Fed lowered rates only once the stock market then sold off as it entered a bear market.
The employment report is a lagging indicator and shouldn't have this much of an effect on the market. And of course it's really not the number but it's how the Fed will react to the number. And that's what all the guessing is about. So the market has essentially gone nowhere the past two days and may continue to go nowhere on Thursday. Our task as traders is to try to figure out how to position ourselves for the eventual move out of the Friday morning report. As always I'll show some key levels on the charts for some clues as to what could be playing out and whether you want to be long or short.
In a nutshell though, I think the most the bulls should expect is another leg higher to finish the rally. Worst case (for the bulls) is that we topped out on Monday and Friday could see a flush. But we'll let price lead the way on this one. At the end of this report I show my usual weekly SPX chart and a very interesting setup in front of us that is a mirror of the 2002 bottom.
Before getting to some broader market issues and the charts, let's review today's economic reports of which there were only 2 (3 if you count the ADP jobs report).
The new orders component rose to 53.4% which is good but the price index also rose to 66.1% from 58.6% which is bad. The inflation pressure is not Fed friendly. The Fed knows they've stoked inflation fears (the bond market is telling us that) as the US dollar tanked and gold rallied. Most commodities are at record highs. Inflation Is a problem and the market knows Bernanke does not have a free hand in lowering interest rates. Greenspan told us inflation will be much more of a problem than he had to deal with when he needed to lower interest rates.
Consumption (demand) is down year-over-year with gasoline down -0.1%, jet fuel down -5.6% and distillates down -0.4%. The big question at the moment is whether demand is lower because the economy is slowing or we're getting more efficient. While I would like to believe the latter it's much more likely to be the former. The chart of the Transports is bearish looking and we know from several reports that shipments are down and Christmas is not looking so hot.
ADP Employment Report
I had mentioned above that the bond market has signaled its concern about inflation with the Fed having become more active recently in injecting money into the system and aggressively lowering the Fed funds rate and another reduction in the discount rate. We've been told the Fed is trying to help the subprime mortgage problem by making it easier for lenders to get the needed capital to make loans. But while the Fed has lowered their rates the 10-year rate (and the LIBOR, London's Interbank Offered Rate) has jumped up.
As most of know it's the 10-year rate (and LIBOR) that has the most impact on mortgage rates. If the Fed was truly trying to help the homeowners (yea right) then the move backfired on them. The Fed is more interested in helping their banking buddies but the homeowners, well, as the saying goes, sucks to be you.
Here's an update to the chart I've been posting regularly:
10-year Yield (TNX.X) chart, Daily
After bottoming in early September, a decline that was a clean 5-wave move down from June, the 10-year yield rallied back up to the broken uptrend line from the June 2003 low. I had been pointing out that we should see rates rise through the month of October for at least a correction of the June-September decline. The pullback from the September high looks very corrective and fits as wave-b of an a-b-c correction to the decline.
I am expecting to see TNX make it at least back up to just above 4.9%. More bullishly we could be at the beginning of a run higher in rates that takes it back above 5.4% (this would likely be in recognition of a worsening inflation problem). Regardless, the short term picture does not look good for homeowners who are facing mortgage resets (which will be accelerating as we head into the end of the year and the first six months of next year). Thanks Bernanke but no thanks--you can take back your inflation-feeding correction.
The stock market though has been absolutely giddy over the idea that the Fed has come to the rescue and lowered interest rates more than had been expected. They're anxiously waiting for more. As I've mentioned before, never mind that their interest rate reductions will follow a slowing economy, which will be reflected by a declining stock market, for now traders are happy.
An OptionInvestor reader, John, sent me his response to a fellow trader who said, "Historically, markets move strongly higher in periods when the Fed is cutting rates." John writes, "I had to call him [on this] by reminding him that it was not a recent phenomenon. Between 1992-1995 the market was rallying strongly, and the Fed was raising interest rates the whole time. When the market crashed in October of 1998 the Fed had actually been lowering interest rates for over a year. And, finally during one of the sharpest rallies in recent history (1999-2000) the Fed raised interest rates six times in 17 months. I dont know what kind of "history" he is talking about but 15 years is enough for me."
I hear you John and completely agree. Same thing during 2001-2003 while the Fed was aggressively lowering rates the market sold off hard. And then it rallied hard during rate increases starting in 2003 and ending in 2006. I guess you'd be correct in saying the market rallied starting in 2003 because of those rate reductions but had you bought the market when the Fed first lowered rates you would have bought the SPX around 1300 and you would have seen your stock holdings nearly cut in half (more so in techs) and would not have recovered to breakeven until 2006 (but still down hard in techs) when the Fed stopped Raising rates.
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As for the reason the Fed decided to start lowering interest rates--the sudden credit contraction--what most are forgetting, and market pundits are happy to have you forget, is that the credit crunch really hasn't improved all that much. While the Fed's liquidity injections and rate reductions have helped, there's been relatively little improvement.
While there are signs that the credit crunch has benefitted some from the help by central bankers, there is plenty of evidence that there is much less of an appetite for junk bond deals and there appears to be a permanently smaller commercial paper market. This means many of the anticipated leveraged buyouts and other private equity deals will not get funded and worse, the banks will be forced to carry the loans on their books. This is a reason why banks continue to hoard cash and the liquidity injection is not making it into the monetary system as the Fed had hoped.
Several larger banks have recently reported huge losses from write-downs resulting from the liquidity contraction (bad loans, not able to fund loans, etc.) and the market has rejoiced. The banks rallied big this week. The feeling by many is that the worst is behind us and that it can only get better from here. Reminds me a little about the "slippery slope of hope". Be careful here and don't get sucked into a "hope" rally. We saw the same thing several times during the collapse of the home builders' stocks (including another bottom call by Citigroup this week) only to find the brief euphoria wear off quickly and prices plunged to new lows. Call a bottom, rally, plunge, rinse and repeat.
History shows that the market has typically rejoiced about Fed rate cuts, rallied for about a month and then crashed lower. The current bounce is on borrowed time. But let's see what the charts are telling us:
DOW chart, Daily
The rally in the DOW off the August low has formed an ascending wedge. The market could easily rally and bust out the top of the wedge but so far this is a bearish pattern and says the rally is ending sooner rather than later. I show a wave count (dark red) that calls the rally complete as of Monday's high. The internal wave count, with 3-wave rallies) is indicative of an ending diagonal and it fits very well as the 5th wave (wave-(5) from the wave-(4) low in August).
As I said, this could morph into a different pattern and in fact one of the things I don't like about this wave count (calling the end of the rally on Monday) is the lack of bearish divergences at new highs (except on the shorter term charts) which should be apparent at 5th wave highs. So caution is required here especially since I see the potential for a rally to at least the 14200 area if not 14400. The key level for the bears is 13697--a break below that level would confirm we've seen the market high.
DOW chart, 60-min
Moving in a little closer I'd say the bears will get an advance notice that it's their turn at bat if the DOW breaks below 13850. Until that happens we could easily see another leg higher in the rally and as I show with some Fib projections, there's some good correlation around 14217. If we continue to see a consolidation into Friday's employment report then a spike up to the 14200 area would be where I'd watch for potential topping.
SPX chart, Daily
SPX is sporting the same ascending wedge pattern as I showed for the DOW. Again, if this pattern is correct, it's an ending pattern. Whether it ended on Monday or has one minor new high to go, this is close to breaking down. I show a Fib projection to 1565 based on a potential a-b-c bounce off the August low and the interesting thing about that projection is that it's close to 1563 which I'll discuss with the weekly chart at the end of this report.
SPX chart, 60-min
Same as the DOW--this week's pullback looks corrective and points to another run higher (depicted in pink). If price continues to chop sideways on Thursday then I think an upside resolution is the higher odds play. We've seen enough of these slow starts to a decline suddenly let go to the downside (making for a failed bull flag which usually break down hard as traders leaning long are suddenly forced to cover). So the dark red count calls Monday's high the end of the rally and now we're starting a new decline. Bears need to see 1489 break but a break below 1522 would be a heads up that it's their turn coming.
An index worth watch is the retail index since it's a very good indicator of consumer strength. If the consumer stops spending you can just about bet your bottom dollar we're heading for a recession.
Retail (RLX) chart, Daily
Right now the wave pattern for the retail index is bearish, and looks very similar to the banks and transports. After the sharp spike down into the August low this index has had a choppy bounce with overlapping highs and lows. This is the very definition of a correction and says we should expect more selling out of this consolidation. The only question in my mind is whether we'll see price head lower from here (as depicted on the chart) or first get another bounce up to its 200-dma before finishing. This index is Not bullish for the economy or the broader market.
Nasdaq-100 (NDX) chart, Daily
Different index, same ascending wedge pattern. If we're not seeing ascending wedges then we're seeing overlapping consolidations like the retail index shown above. Both are pointing to the same thing--the end is near for the bounce. As with the others, the only thing I'm not sure about here is whether we're going to get another high (probably after Friday's employment report) or if instead we've already seen the high. The key level for the bears is 2032, the high on September 4th.
Nasdaq-100 (NDX) chart, 60-min
Again, similar to the others, this week's price action looks like a bullish consolidation and the pink wave count is looking for a rally out of this. A heads up for the bears is a break below 2082 where it would take out the previous low and break its uptrend line from August 16th.
Russell-2000 (RUT) chart, Daily
The RUT has a stubbier looking ascending wedge than the others and it reflects the weaker rally in the small caps. The dark red wave count is the same as the others and shows what could end up being a truncated finish to the rally. Normally the 5th and final wave of the rally makes a new high and when it doesn't it's a truncated high. This would reflect the greater weakness in the small caps and fits well as part of the bearish signals the market is throwing off. Also like the others we could see another small rally before topping out. It takes a break below 798 to put the bears back in control.
The thing to remember about ascending wedges (and descending wedges) is they tend to get retraced quickly. That would mean a complete retrace of the August-October rally a lot faster than it took for the rally. You don't want to be caught long if these wedges break down.
Russell-2000 (RUT) chart, 60-min
Because of the overlapping bounce in the RUT since the August low it opens up several wave count possibilities and I'm showing two of what I consider the most probable. Another rally leg would finish off the pink count, perhaps with a rally up to the 840 area whereas the dark red count says the rally is already finished. A break of its uptrend line from August, currently near 810 would be a heads up that 798 could be next.
Before getting to the next chart, showing the NYSE and one of the breadth indicators, I came across some information from markettells.com that I thought was informative. They use a database of previous market moves and make projections based on past market behavior. It's uncanny how many times we repeat the exact same patterns (trading emotions don't change). Written on Monday I'll quote them--"From a longer-term time frame, we should keep in mind some negative indications lurking in the background. They may not make their presence felt immediately, but they suggest generally limited upside potential over the longer-term and the potential that new highs for the S&P will ultimately represent another false breakout.
"The SPX is only six points from its high close for the year at 1553, but cumulative breadth is not confirming (it's not even close to making a new high). Remember that we saw exactly the same type of negative divergence back in mid-July, which as we noted at the time was the first such divergence in years. The sharp reversal that followed was not surprising, and it's quite possible we could see a repeat of that action in the next 1-2 months. That's especially true with the 20-day moving average of the Nasdaq/NYSE Volume Ratio trading at such elevated levels, reflecting unusually heavy speculative activity.
"It's also noteworthy that combined Nasdaq commercials (standard & mini Nasdaq futures contracts) have unloaded the last of their longs and shifted to a small net short position as of last week. As I discussed back in March, the combined commercial activity in Nasdaq futures has performed well, much better than monitoring commercials in the big contract only. And performance has remained solid since then, with combined commercials remaining mostly net long except for mid-July when they briefly shifted to the short side."
I thought their comment on the Nasdaq trading volume and what the commercials are doing was a very interesting observation and I plan on watching these more closely. So here's a chart showing one of the market breadth measures to see how healthy the rally has been (and reflects the same observation that markettells pointed out above):
NYSE (NYA) vs. New 52-week Highs chart, Daily
The NYSE is retesting the July high but notice the clearly divergent market breadth as shown with the number of new 52-week highs. Both the raw number of new highs (the spiky black line) and the 20-day moving average show a lack of participation in this rally as compared to the rally into July (which was also weaker than the rally into the February high). This whole year has been an effort to rally the market on fewer and fewer backs of stocks. When this rally finally does end I'm thinking it's not going to be a slow correction.
BIX banking index, Daily chart
The pattern in the banks looks very similar to the one I showed above for the retailers and it has the same message--the overlapping choppy mess since the August low has been a consolidation of the decline which worked off all the oversold conditions. This could bounce back up for another retest of its broken uptrend line from October 2002, and maybe the 200-dma this time, but this is a bearish chart pattern. Even the moving averages have all moved into bear mode.
I often mention Mother Merrill (MER) as an important stock to watch because it's a good barometer for how many of the fund managers are feeling. So taking a look at the brokerage index can be informative in this regard:
Brokerage (XBD) index, Daily chart
It's a combination of an ascending wegde and the same choppy consolidation seen in many of the other indices. It has tagged the top of the wedge and its 200-dma at the same time. The shorter term charts are showing negative divergences at recent highs and the pattern can be counted as complete here. Just another warning sign...
Banks have been rallying on the "bad" news of a collapse in earnings because traders feel the worst news is now behind us. This is a bit like repeated calls for bottoms in the housing market. Speaking of which, Citigroup upgraded the home builders from a hold to a buy so we got another bottom call this week. The index reached the bottom of its parallel down-channel from the May high and has bounced back up to the top of the channel today. I've got a few parallel down-channels on its daily chart now and it's a bit confusing looking. So I bolded the three trend lines that I think are the more important ones right now:
U.S. Home Construction Index chart, DJUSHB, Daily
I've been pointing out the building bullish divergences at the new lows since August and have been suggesting we're near a point that the home builders are going to get a bigger oversold bounce. The bolded descending wedge has been accompanied with the confirming bullish divergences and that's why I'm thinking it's ready for a bounce. Today's rally stopped at the top of the wedge which is also the top of its parallel down-channel and where each rally has been stopped since the August rally (which was another bottom call). At the same level is the bottom of the larger parallel down-channel for earlier price action from the February high, and right above it is the 50-dma. To say it has resistance here is an understatement.
But if ever there was a time to break out of its down-channel, now is it. The decline hit a Fib projection at 343 where the 3rd wave (dark red wave-3 at the recent low) equaled 162% of the 1st wave down, a very typical projection. The wave pattern suggests we could see a larger sideways/up correction over the next month for wave-4 (back up to the top of the down-channel for the decline from May) before it heads lower again.
Oil chart, December contract (CL07Z), Daily
Last week I said oil was ready to decline since it had tagged the top of its parallel up-channel but noted that it hadn't quite made it up to the level where it would have two equal legs up from January 2007. Well, not wanting to miss that important level the oil traders sent it up there last Friday to ring the bell. It's now free to drop.
Oil Index chart, Daily
Oil stocks rallied with oil last week but to a lower high and thus gave us a bearish non-confirmation for oil's rally. I have 787 as a key level for the bears but that's a little arbitrary. The pattern looks good from here for a full-fledged decline to kick into gear now.
Transportation Index chart, TRAN, Daily
Another index, another wedgie. While some will look at the ascending triangle (flat top, rising bottom) as bullish, when it's following a move down such as the July-August decline it can also be a continuation pattern which is what I'm considering it to be here. A break of the uptrend line, confirmed with a break below its last low at 4734, would confirm the bears are in control.
Many pooh-pooh the DOW Theory as being archaic but usually the more people say it's different this time the more you should become skeptical of the naysayers. The idea of course is that if goods are not being transported then that means orders are lower and that means the economy is slowing. If the Transports are not confirming a stock market rally then you have to question the sustainability of the rally. The same thing in reverse--if the Trannies start rallying while the broader market continues to make new lows then it's a time to start accumulating stocks. Here's what the Trannies are telling us right now:
Transportation Index vs. the DOW Daily
Any questions? This is a glaring bearish non-confirmation of the DOW's rally. This is one of the better sell signals and while it's not a good timing tool it does say you should take a break of support seriously. Just as you would be accumulating stock at a low you should be liquidating on this rally.
U.S. Dollar chart, Daily
Did the US dollar finally find a bottom? My hands, arms and body are all bloodied from catching falling knives on this one. I've shown the bullish divergences that have accompanied each low on the weekly chart so I continue to think it's just a matter of time. And the EW pattern calls for a strong rally out of this. Maybe it's starting...
And if the dollar is finally getting ready to rally then that should hurt the prices of most commodities (except corn probably because of the myopic government policies in regards to ethanol production and subsidies).
Gold chart, December contract (GC07Z), Weekly
Gold hit the top of its parallel up-channel for price action since the October 2006 low and I had mentioned recently how it would be a great short play setup. After tagging the top of the channel on Monday it has now pulled back sharply. While upside risk remains to 771.40 for two equal legs up I like the setup here for shorting bounces in gold now. The leg up from the August low counts complete as wave-C (a 5-wave move) of the A-B-C correction to the decline from the May 2006 high.
Gold is a longer term short from here as it should now head for $500 if not lower. And since equities and the metals have been in synch I'm expecting the same for equities. If we haven't put in the high then it should be soon.
My bearish opinion on gold is probably disagreed with by about 91% of you. That's the daily sentiment on gold right now--91% bullish and an extreme not seen since the May 2006 high. It's just as bearish the US dollar.
Two equal legs down from May 2006 is at 552.60 and a 162% projection is to 427.52. Either one is a significant drop from here. From a fundamental perspective we need to keep in mind that the credit contraction has only just begun. The stock market has decided it doesn't like to look at bad news and is ignoring the fact that the housing problem is a long way from finding a bottom (mortgage resets don't really kick into gear until next year) and the credit problem is equally weak in the commercial area.
A credit contraction is deflationary and gold bulls will soon come to realize this. And with a 91% bullish sentiment there's not much room for more bulls. Once the stock market gets a whiff of the real problem, that hasn't gone away, it too will resume its decline. A credit contraction always leads to a recession and the stock market always sells off when heading into a recession. Don't get caught like a deer in the headlights on this issue.
The COT (Commitment of Traders) report as of September 18th shows commercials were net short gold by about 7:1 while non-commercials were net long by 2:1. The commercials are usually on the right side of the trade.
Speaking of the COT report as related to the US dollar and euro, it showed commercials better than 5:1 short the euro while non-commercials added significantly to longs and were 4:1 long.
Results of today's economic reports and tomorrow's reports include the following:
Thursday will be a light day for economic reports but the factory orders number could move the market if it's a surprise.
SPX chart, Weekly
I've squeezed the weekly report on the SPX in order to show price action since
the high in 2000. I mentioned yesterday on the Market Monitor an observation
about this chart that was prompted by reading a
I'm showing an A-B-C count for the 2000-2002 decline and wave-C is the move down
from January 2002 to the October 2002 bottom. It's a 5-wave move and it's hard
to see but wave-5 bottomed only 7 points below the July 2002 low which was
wave-3 (768 low vs. the prior low of 775).
So we come to where we are in the rally pattern. This too I have labeled as an A-B-C rally with wave-C as the move up from October 2005. Wave-3 ended at the July 2007 high and now we're into October 2007 looking for an end to wave-5.
Do you see the symmetry here? The July 2002 low was undercut by seven points in October 2002. We've had a July 2007 high and a 7-point move higher in October 2007 would take it to 1563. As I've been showing on this chart, two equal legs up (wave-C = wave-A) is at 1563. You can't make this stuff up.
If we get one more rally leg as I've shown on several of tonight's charts we just might get this setup and if we do I'd look it over very carefully for what could be an outstanding shorting opportunity. Just be careful about trying to stop those rising knives.
And if we get another rally leg it could drop the VIX to support:
Volatility index (VIX) chart, Daily
If the VIX drops to its uptrend line and/or its 200-dma, currently at 15.80, I'd say we'd have a good setup for a reversal. If that coincides with the SPX tagging 1563, well, that beep-beep sound you'll hear will be me backing up two trucks.
Good luck over the next week and especially after the Friday employment report.
It could literally go either way and will probably move quickly. I'll be back
next Wednesday and on the Market Monitor each day.