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Market Wrap

Chinese Finger-lock

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I may be giving away my age (54) with this but do you remember those 5 and dime stores where you could buy little trinkets? One I remember was the Chinese finger-lock and it was a little tube made out of reeds and the diameter would expand when pushed and contract when pulled. So when you put a finger from each hand into one of these things you couldn't pull your fingers out. You were stuck. Could the Chinese have us in a market version of this thing?

We want China to allow their currency to float. But if they do that then their holdings of US dollars drops further in value. Since they hold well in excess of $1T in US assets they are naturally uncomfortable in allowing their holdings to drop in value. We've been pressuring them (as have most other countries who trade with China) to allow the yuan to float higher so that we can be more competitive in selling them product and help reduce the huge trade imbalance with them. It's even got our economically illiterate Congress looking to go protectionist on us (they need to study how well that worked for us in the Great Depression).

So last night the news out of China spooked holders of the US dollar (are there any left?) and it dropped hard. This in turn spiked commodities like oil and gold to new highs. Just as a side note, if you'll remember I had discussed not long ago the contrarian use of magazine cover stories (by the time a market move makes the cover a general publication magazine, such as Times, US News & World Report, or Barron's, the trend is likely near its end). Now comes news of a different cover story--I'll call it the Cover Girl signal. She's probably not a Cover Girl but she is a super model--Brazilian Gisele Bundchen--and she has decided that she would prefer to have her millions paid to her in anything but US dollars.

Now Gisele, who is a Brazilianaire, has done very well with her assets and is very likely a very intelligent woman but I'd have to question her ability to make predictions about the currency market. Therefore all the news about her not wanting the US dollar is very likely another indication of how oversold and unloved the US dollar is. It's time to be looking for a bottom in our beaten down greenback.

Back to the Chinese and their desire to diversify their holdings in something other than the US dollar. Last night Cheng Siwei, vice chairman of the Standing Committee of the National People's Congress, said Beijing authorities should consider other appreciating currencies, such as the euro, instead of the depreciating US dollar when the country purchases foreign bonds. That sent the US dollar tumbling lower and gold and oil higher. With $1.43T in foreign-exchange reserves it sends shivers throughout other countries when they think their own holdings in US dollars could get creamed even further if the Chinese start unloading US assets.

There was then some back-peddling and explanations from the Chinese that supported a dollar bounce from its overnight low and the metals (gold and silver) reversed much if not most of their overnight gains. Unfortunately for our equities the selling continued for most of the day. I have to wonder what the Chinese are doing when they keep sending this economist (who doesn't speak for the government) to float trial balloons to see what the reaction will be to talk of diversifying their holdings away from the US dollar. They keep firing those missiles across our bow to make sure we're paying attention to them. It's not nice being held over a barrel (and not oil this time) as we are.

And speaking of oil, it made another all-time high last night, edging closer to the $100 mark. It posted a high of 98.61, nearly $2 above Tuesday's closing price, it ended down on the day a few pennies at $96.45, and that was after reversing off a low $94.62. Oil traders are getting whipped more than equity traders these days and there's some big money in those daily swings.


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Even though China began to downplay the idea that they were thinking of diversifying (having made their point to all the countries trying to force them to let their yuan float higher more quickly) General Motors came in and stank up the place with a $39B bomb--they reported that their profitable string of quarters were not going to be so profitable after all. They're going back three years to restate earnings to adjust for unused tax credits. Their stock gapped down from yesterday's $36.18 close and finished at 33.96 today, down -6.1%.

One look at the numbers in the table above (I can't get reliable volume data on the NYSE today) shows how lopsided the day's selling was. Decliners were all over advancers 5:1 and new 52-week lows were almost 3:1 over new highs. Even on recent rally days the new 52-week lows were beating out new highs so it became obvious that there was an effort to raise the indices while unloading inventory. It pays to look at what's going on under the hood instead of just admiring how well the major indices are doing (same is true in reverse when the market has sold off).

Economic reports
Not much attention was paid to the economic reports today since there were other factors depressing the market. But we had the preliminary report on productivity, wholesale inventories, crude inventories and consumer credit.

Productivity in the nonfarm businesses increased at an annual rate of +4.9% in the third quarter, the fastest growth in four years. Unit labor costs dropped at an annual rate of -0.2% and this combination is good news for the Fed since these numbers help in the wage inflation area.

Wholesale Inventories
There was good news in this department as well with sales outpacing inventories which dropped the inventory-to-sales ratio to a record low 1.10 from 1.11 in August and down from 1.15 a year ago. Either businesses are playing it very close to the vest in case we head into a recession (smart) or else just-in-time inventory control is working very well. The only caveat is that most of the sales increase came from a +7.7% increase in petroleum sales because of the higher prices.

Crude Inventories
Crude inventories dropped again the past week, down -800K barrels to 311.9M, making it three weeks in a row that inventory levels have dropped. However this was less of a drop than the -1.6M barrels that many had been expecting.

Crude hit a high of $98.61 in overnight trading, up nearly $2 from Tuesday's close (probably more a result of the US dollar getting blasted lower again) but then it gave up its gains, and then some, before bouncing into the close and finishing down only 16 cents. It was a pretty wild day in most commodities as many struggle to make sense with what's happening in the US dollar (e.g., did it find a bottom on the Chinese news?).

Gasoline supplies also dropped by 800K barrels and distillate stocks fell 100K barrels.

Consumer Credit
Consumers are still spending but they're finally slowing down. Maxing out those credit cards is starting to take its toll. Credit (credit card and non-revolving debt for things like autos) rose at an annual rate of +1.8% in September. Outstanding consumer debt now stands at $2.48T. Credit cards are still getting used a lot though--up +4.4% vs +9.3% in August while non-revolving credit rose by only +0.3% vs. +6.4%.

As I've mentioned before, with the home equity withdrawals screeching to a stop, consumers have resorted to their credit card as the consumer loan of last resort. That will be the next credit crunch. Capital One report losses of nearly $5B as they write off several hundred million dollars more in 2008 than they had previously reported. They see a worsening in loan delinquencies and the trouble in the housing market is expected to exacerbate their problem.

Capital One (COF) was down -$9.23 to $50.11 today for a -15.5% haircut. Their stock is now trading back down to mid-2003 levels. In fact it traded at this level in 1999. This is a common theme for many of the banks--prices are where they were 8-10 years ago so buy-and-holders haven't exactly done too well, especially when you consider inflation which has been a lot worse than reported when you consider the value of the dollar.

The major investment banks continue to be the albatross around the market's neck these days. Every time someone comes out and calls a bottom for the banks and that the worst news has been reported, another bank comes out and says well, maybe we have just a little more bad news to report. It reminds me of the multiple bottom calls for the housing market. In fact I came across a good cartoon about the housing market "hopes" for a bottom:

Dreamhouse cartoon, courtesy Slate.com

A bear market is called the slippery slope of hope as those who own stock keep on hoping the market will find a bottom. The housing market is in a bear market and it's being aggravated now by the inability for many buyers to get loans for the dream home. Leave it to a cartoonist to capture the mood in this cartoon.

Back to the banks though, they continue to disappoint with additional reports of investments gone bad. Most of you understand that this problem has a long ways to go before it's cleansed from the system and it will be a while before all of the "mark-to-model" holdings are "marked-to-market". Each time there's another downgrade or regulators force banks to report accurately what's on their books there will be another report of more write-downs. After today's close Morgan Stanley came out with another report stating that they will be writing down an additional $3.7B to account for reduced value in their subprime portfolio.

By the way, this is not just a subprime mortgage problem. Convenant-lite loans to businesses will be the next wave of write-offs, and then consumer credit card debt. It's why I've been saying for a long time now that the collapse of the credit bubble will be mind-numbingly swift, and painful. I came across one report showing the exposure to mortgage-backed securities and the potential trouble they're in:

Level3 assets within the major investment banks, courtesy portfolio.com

Level3 assets are considered the subprime slime and other risky loan portfolios (those tranches that were parceled out to investors that are now being downgraded). As you can see in the table, these Level3 assets are a significant portion of the banks' equity. Goldman Sachs (who has been suspiciously quiet) and Morgan Stanley appear to have the most exposure. Of course GS has mastered the technique of shorting whatever they sell you so they may have limited their exposure in that way. The banks are a long way from writing this stuff down and their only hope (including the Treasury's plan with their Super SIV fund idea) is to simply prolong how long it takes to write it down. The market may not be as accommodating as they would like in this regard.

So today was bear-ugly (or I suppose bear-beautiful if you were short the market). Let's see what the charts are telling us from here. Starting with the VIX, since it was giving us a good heads up about the vulnerability in the market, it's definitely on a "buy" signal (which is bearish for stocks):

Volatility index (VIX), Daily chart

When the VIX came back down for another test of its 200-dma with the very clear bullish divergence on MACD, it was a buy signal. Now watch to see if it drops back down and breaks the uptrend line on MACD (and/or RSI) as a heads up that the market could get a bigger bounce.

DOW chart, Daily

Potential support for the DOW is very close now. The 200-dma and uptrend line from July 2006 are on top of each other at 13208. Nice round number support at 13200 could help. As I show on its 60-min chart there are a couple of Fibs pointing to the possibility the DOW will drop to the 13150-13175 area before bouncing (if it does). I show a couple of possibilities to watch for. The most obvious is a bigger bounce off some pretty solid support. Whether that bounce turns into just another correction and heads lower (dark red) or starts another rally leg can't be known from here.

The new rally leg idea (green) is based on a large rising wedge pattern that could be playing out from the August low. This pattern would be full of chop and big whipsaws as the market works its way higher into the beginning of next year. Another rally may not be logical in light of what we're facing but since when has that stopped a rally. So I do not discount that possibility. It takes a break above 13962 to suggest the bullish possibility is playing out. If 13150 does not act as support (assuming it drops to that level) then the next downside target is near 12800.

DOW chart, 60-min

The bottom of a parallel down-channel for price action since the October high matches up with two equal legs down from that high, at 13175. In the move down from October 31st two equal legs down is at 13151. So this looks like it has potential to be support, and keep an eye on the rising trend line on the RSI chart since support there could see another bullish divergence. But a drop below those levels, and out the bottom of the parallel channel, would be bearish and I'd be looking for at least another 300 points lower before finding support.

SPX chart, Daily

SPX is closer to potential support at the bottom of its down-channel and Fib projection for two equal legs down from the October high, at 1467. Similar to what I said for the DOW, it's possible we're going to see this market turn right around and start heading higher again, building a rising wedge into the beginning of the year (which would have SPX likely topping out just above 1600). A bounce off the 1467 (or slightly lower as shown in the 60-min chart below) could lead to a correction that takes it back up to the top of its channel before spilling to the downside again. If SPX gets below 1460 then the next Fib support level I see is near 1414 would could coincide with the uptrend line from August 2004.

SPX chart, 60-min

In the move down from October 31st two equal legs is near 1461 so the 1461-1467 area holds potential for support to this decline. Also like the DOW, watch to see if the rising trend line on RSI holds. If price looks like it will hold this area, with bullish divergence, I'd buy this dip and see where it takes us. We should get a rally that lasts for at least a few days (could be very choppy with lots of whipsaws). But if that support doesnt hold, look for another 35-45 points lower (depending on whether the DOW finds support sooner or not).

Nasdaq-100 (NDX) chart, Daily

The techs have been leading the charge to the upside and for that reason it's critical what they do here. The bearish thing today is the break of its uptrend line from August. It's the last index to have done this and it did it with gusto today. The bearish divergences I've been showing since early October were a dead giveaway that this was coming (the hard part is knowing when but it was telling longs to take their profits and run). I show one minor bullish possibility (pink) with a push back up to one last high as part of a larger rising wedge pattern. One of the EW (Elliott Wave) patterns points to that possibility and I could see it happening if the DOW and SPX catch a bounce as I showed on their charts.

But I think the greater likelihood at this point is for a continuation lower. Maybe a bounce back up to retest its broken uptrend line but I'm not so sure about even that possibility.

Nasdaq-100 (NDX) chart, 60-min

The bullish (green) wave count is the one calling for one last high (which could coincide with a retest of its broken uptrend line) but it would have to start without much more downside here. A break below 2141 would negate the bullish wave count.

Russell-2000 (RUT) chart, Daily

In a similar move down from the October high, two equal legs down is at 767 and coincides with its uptrend line from August 2004, where it found support for its August low. If that level can't hold then the next downside target would be the August lows around 740 or possibly the Fib projection near 728.

Russell-2000 (RUT) chart, 60-min

In the move down from October 31st two equal legs down is at 756, lower than the bottom of its parallel down-channel and the 767 target shown on the daily chart. The RUT has a habit of overshooting targets so it's quite possible it could drop to the 756 area before bouncing, or not.

BIX banking index, Daily chart

The banks have been in a decline long before the broader market topped out, which is typical and why I say follow the money--they usually find a bottom first also. The wave pattern shows a clean 5-wave move down from September and as such looks ready for a bounce. The wave count could easily "extend" and we could actually be in the 3rd of a 3rd instead of the 5th wave as I've shown. But I wouldn't expect to see some bullish divergences creeping onto the charts as they are if that were the case. So I expect to see a bounce and today's low tagged a Fib projection for the 5th wave that may in fact have been it. If so, they bounce tomorrow.

Just because the banks could bounce doesn't mean the broader market will. The banks are much more oversold than the general market. But it would be a heads up to bears to not get complacent. But first let's see if the banks bounce in which case they could make it back up for a retest of the broken uptrend line from October 2002.

To keep this index in perspective, here's its weekly chart:

BIX banking index, Weekly chart

It's obviously been a sharp decline from the February high and most especially from the September high. I've drawn a horizontal line across from October 1997 to show how well "buy-and-holders" have done in this market. By many measures our stock market has been in a bear market since 1998. If a normal secular market cycle lasts approximately 18 years that makes it 2016 before this one will be over. Do you really want to hold on for the long term?

Unfortunately most small investors have been convinced of the buy-and-hold mentality and it won't be until the end of this bear market that most will be convinced they want nothing to do with the stock market (and for baby boomers it will be too late). Does it make me a pessimist to say this? Call me what you will. I prefer to think of myself as a realist and one who tries to listen to what the market is telling me.

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

I'm starting to get mixed messages from the daily chart on the home builders. The rising trend line of MACD and RSI looks bullish. But if price continues to work off its oversold conditions by chopping sideways then it will be bearish. I show the possibility for one more bounce up in a triangle consolidation pattern. From there it should drop lower and the early 2001 low coincides with a Fib target near 215.

Oil chart, December contract (CL07Z), Daily

We have liftoff! I drew in the rising uptrend lines to show the rise has gone parabolic. But notice the alternating red and white candles--the choppy rise at the high here is typically an ending pattern. RSI is showing bearish divergence at recent highs. Look for a break of each uptrend line, and maybe a retest, as confirmation the top is in. Is oil the next bubble waiting to be popped? Stay tuned since this rally could see a rapid retracement back to the $80 level.

Oil Index chart, Daily

Just as oil has been chopping its way higher so too has the index. This gives it a rising wedge appearance (which might get one more push higher to finish it) and the bearish divergence on the oscillators backs up the likelihood that we're close to a top in this index (if today's wasn't it).

Transportation Index chart, TRAN, Daily

The price pattern for the Trannies has been ugly--very choppy up and down and it has left me guessing which way it was going to go. Today's kiss goodbye against both its short term uptrend and long term uptrend lines gives it a bearish look here. Because of the choppy price pattern I don't discount the possibility for another bounce back up but it's now looking like the decline will continue from here.

U.S. Dollar chart, Daily

What's that song? Nobody loves me, everybody hates me, guess I'll go eat worms... First Greenspan disses the dollar and now indignation of all indignations, super model Gisele Bundchen has done the dollar dirty by refusing to be paid in it. That's the last time I watch her walk down the runway in skimpy lingerie. Well, maybe one more time.

The dollar found support at the bottom of a parallel down-channel for price action since the August high. The bullish divergences continue on all time frames and the Chinese news item might have caused the final low for the dollar to get put in (often a news item finishes off a move). But the bottom of a larger parallel down-channel from 2006, currently near 74.50 where the bottom of the steeper channel intersects it, could be the ultimate downside target. It takes a break of the downtrend line near 77 to declare a bottom is in. The coming rally in the dollar should be large and multi-month.

I'm surprised Gisele didn't say she wants to be paid in gold bullion. I guess it might stress the straps of her Gucci bag. Starting with the weekly view I'm showing gold hit a potentially important Fib level in overnight trading:

Gold chart, December contract (GC07Z), Weekly

The move up from October 2006 is an A-B-C move (the triangle b-wave adds confidence in this count since that pattern does not appear in 2nd wave positions, plus the 3-wave move up from October was only a 3-wave move and therefore is wave-A and not wave-1). I had thought 771.40 was going to be the limit of the rally since that's where the move up had equality between waves A and C. Price was even stalling at that level at the time. But that call to short gold didn't last very long when it blasted higher again.

Now wave-C = 162% of wave-A at 845.37 which was tagged in overnight trading (843.70 in regular trading hours as its first trade) and is the next level where a top would be expected. Stepping in front of this rally has been an invitation to get cut and sliced by all those rising knives so I'm a bit reluctant to call out a short on gold here. But this is the level to try it again (or take profits on trades, which are different than long term investments). More conservatively, wait for a break of its steepest uptrend line and hopefully a retest to try the short side. This is shown a little closer on the daily chart.

Gold chart, December contract (GC07Z), Daily

Just like oil, the steepening uptrend lines shows the move up has gone parabolic. A typical retracement would be a quick decline back to the 730 area before bouncing and then continuing lower. Because the larger pattern from October 2006 is an A-B-C bounce the entire thing will get retraced (so back below 600) before the gold correction finishes sometime next year.

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

It will be very quiet tomorrow--only the jobless claims data. The market will be much more focused on some earnings news and news from overseas (ECB interest rates, the US dollar, what the Chinese say, etc.). It's getting to the point where we can expect a large gap to start the day but we just don't know which direction. By the way, a lot of volatility, as we've been seeing the past several month, near the highs is very often a topping pattern. It's been another warning sign for the bulls. Whether that continues for another couple of months is the question but it remains a topping pattern.

SPX chart, Weekly

Because I discussed the possibility for a choppy rise into the beginning of next year I thought I'd show that on the weekly SPX chart (in a rising wedge ending pattern). This possibility will only become more obvious if the bounce exceeds the key levels I showed on the daily charts. Until that happens I believe the market has already topped out and we're in the very early part of the next bear market decline. The excesses of the past few years simply need to be wrung out of the system in order to get us back to a healthy state. It's all part of the normal cycles (which the Fed tries to stop but only aggravates).

Cisco reported after the bell and I think many were hanging their bullish hopes on their earnings report. They did very well, reporting a +37% increase in profits. Sounds like a reason to sell and sell they did. CSCO had dropped from its 34.24 high on Tuesday to close at 32.75. It then dropped after hours to 29.82. CEO John Chambers reported that he sees some "softening" in orders from big customers. As he said, "We continue to expect US enterprise growth to be very lumpy." Um, will that be one lump or two?

Chambers blamed some of the softening in sales to the fact that big banks, who are some of the biggest purchasers of IT equipment, are cutting back on capital expenditures as they buckle down and deal with their losses. The subprime problem contained? I hardly think so.

Equity futures took a nose dive after hours and have recovered some and there's a lot of darkness before tomorrow morning but so far we certainly have a negative tone in the market right now. What we need to stay aware of is the vulnerability of the market. I've mentioned a confirmed Hindenburg Omen signal, we're in year 7 of the decennial pattern (known for steep market corrections which we haven't had yet), excessive bullishness in the market (measured by things such as cash levels in mutual funds, record high margin levels, and a plethora of sentiment indicators) and now we can add the "Dark Days" to the bearish mix.

This "Dark Days" phenomenon relates to the lunar calendar and was written up by Christopher Carolan who won the MTA (Market Technician Association) Charles Dow Award in 1998. It can be found at this link if you'd like to read it. Basically it calls for a steep decline today and tomorrow followed by a sharp rebound on Friday. We got a sharp selloff today and it leaves tomorrow to see if it completes the pattern. For those who brush away astrological "stuff" like this, JP Morgan was quoted saying, "Millionaires don't use astrology; Billionaire do."

I don't profess to follow a lot of astrological signs but do watch some of it to see if it fits the picture I'm developing about the market. Today's decline, and a continuation tomorrow, fits the wave pattern and a slew of other technical indicators so I definitely don't scoff about this. Be careful tomorrow.

On the flip side, trying to short this market can be a bear (pun intended) as the buy programs, with the help of short covering, can spike out most of the shorts who then watch as the market rolls back over and heads for new lows, without them. It can be a very frustrating market to trade. For this reason I like to trade tops--pick a bounce and try to short it. If it takes a couple of tries, as long as you keep your stops tight, the winner can easily recover a couple of losses.

Stay disciplined and if you miss a move just keep reminding yourself that another bus will come along and give you a ride. This market will always be here and always offer up trading opportunities. You don't need to be in the market all the time (and shouldn't be) and you need to pick and choose carefully--set up your trade and let the market come to you. The minute you start chasing the market is the minute you're about to get whipsawed out of your trade.

Good luck tomorrow and err on the cautious side. If we do get a steep selloff then extra caution is required as 100-point swings in the DOW could happen in a matter of minutes. And beware the v-bottom if the Dark Days scenario plays out. See you next week and on the Market Monitor each day.

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