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Market Wrap

Late-day Bear Attack, News at 11

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The morning started with a gap up after equity futures were ramped hard to the upside after 7:00 AM, helped a little more after the 8:30 reports and then leveled off just before the cash market opened. Once the cash market opened and gapped up, with SPX smacking its head against 1490 resistance, it then went sideways the entire day. This looked like a bullish consolidation and I think many traders were leaning that way as we approached the end of the day. That's when the bears came charging out of the woods and made slashing attacks on the hapless bulls that were blissfully munching on their favorite alfalfa plants while waiting for the next ramp up.

In 20 minutes the battle was over and when the bears were done the DOW had given up 130 points that it had worked hard to hold onto all day. After playing footsie with 1490, which is a very important level for SPX, it closed 20 points lower. The bears were probably feeling pretty smug as they looked back at the carnage they left in the field and the bulls were wondering who trampled them. Welcome to opex week, a time of volatility.

Opex week can exaggerate movements as traders quickly hedge or cover positions when they see the market moving against them. That can then exacerbate a move as traders hedge/close positions which simply adds fuel to the fire. And then the next day it turns around and goes in the opposite direction. That's the potential that I see on the charts as well. So bears shouldn't get complacent here--the bulls could come to life and gore you while you saunter back into the woods.

The table above shows the selling was clearly stronger than the buying. Volume, declining issues and new 52-week lows all supported the negative numbers in the indices today. While yesterday's strong rally was attributed to an oversold bounce (and then some), today's decline could be attributed to being short term overbought from that huge rally yesterday. In reality it's a battle between the bulls and the bears and there's a high state of "twitchiness" right now.

The bulls were certainly hoping for some follow through to yesterday's one-day wonder rally but the late-day selloff has probably dashed their hopes. And now that the bears are probably all excited about stopping that rally they're probably set up for disappointment tomorrow. That's just a guess at the moment but this market hasn't exactly been kind to buy-and-holders or sell-and-holders. Making slashing attacks in this market, and taking profits too early, has been the winning strategy. Even if we get into a tradeable downtrend, bear markets are difficult to trade and it's usually better to take profits too early rather than give them back. Taking chunks out of the middle usually leads to steady and consistent account growth.

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As for today's action, the early economic reports were credited with some of the early excitement but in reality a strong rally in the pre-market futures was well underway before the economic reports came out. People got excited about the retail reports but I think that was just the usual analyst-looking-for-a-reason reporting when asked why the market was rallying. I'd love someday to hear an analyst say "because people are in a buying mood" instead of making it up as they go. They really sound silly most of the time. I mean, did the market really rally yesterday because the price of oil dropped? Really? How come the strong rally in the price of oil didn't mean diddly to the market and then all of a sudden a $3 drop gets them all excited? Excuse me if I remain skeptical about the TV anal-ysts.

So this morning's economic reports were nothing to write home about and had very little impact on the markets:

Economic reports
The economic reports for today were retail sales, PPI (producer price index) and business inventories.

Retail Sales
October retail sales rose by +0.2%, better than expectations for sales to be flat from September. Retail sales ex-autos was also +0.2%. For the past year retail sales are up +5.2% (same for auto sales). For October the sales picture was helped by sales of gasoline which rose +0.8% which when stripped out left retail sales up +0.1%.

This shows that consumers are being pinched at the pump and have less for other purchases. The downturn in the housing industry is also being felt by furniture manufacturers and other durable goods that go into homes.

Here's a picture of how sales are looking this year as compared to previous years:

Retail Sales, 1995-2007, courtesy briefing.com

As you can see, retail sales growth has actually been on the decline since about 2006 which is about when the housing market started to experience trouble and home equity withdrawals began to slow down.

PPI and Core PPI
Wholesale prices rose +0.1% in October as the rise in food prices cancelled out the decline in energy prices. Excluding food and energy left the core PPI flat for the month. Producer prices are up +6.1% for the past year which is the largest jump since September 2005 which was at a 15-year high at the time. But core prices (excluding food and energy) are only up +2.5% for past year so I know that makes you feel better. But even that number is the largest increase since the +2.8% reading in September 2005 which was at a 10-year high at the time.

I had mentioned about two months ago that we would see jumps in the inflation rates as we approached the end of the year because of the year-over-year comparisons and the drop off of larger year-ago declines in rates. This puts the Fed in a bind (they knew it was coming) in being aggressive about further reductions in interest rates when inflation is ticking up.

The following chart shows how PPI has been increasing since the low in 2003:

Producer Price Index, 1991-2007, courtesy briefing.com

The finished goods PPI has been more volatile and has been spiking higher this year. The core PPI (red) has been more stable but approaching the high end again. This will put pressure on the Fed to contain inflation and is very likely the reason for their statement during the last FOMC meeting about returning back to making a balanced risk assessment.

Business Inventories
September inventories rose +0.4%, meeting expectations, and increased at a faster rate than the +0.1% in August. But sales rose +0.6% to the inventory/sales ratio remained unchanged at 1.27. A record low of 1.25 was reached in January 2006 so you can see how well businesses have controlled their inventory. This will enable them to withstand an economic slowdown in a little better shape.

Interest carrying charges on inventory aren't much of a factor at this point but having lower inventory levels also reduces the requirement for capital that pays for that inventory. What happens to interest rates from here is another question. Interestingly, even after the hard selloff in equities in November, yields dropped only slightly. That means there wasn't much of rotation into bonds from stocks (buying in the bonds would have driven yields lower). One reason may be the fear of what will happen to bond prices if inflation starts to rear its ugly head.

The chart of the 10-year yield shows we could be near the point of a rally in yields:

10-year Yield (TNX), Daily chart

The recent lows in yields are showing bullish divergence against the low in September and the recent lows since the end of October. This looks like it's getting ready to bounce and again that could be an indication that bond holders are becoming a little more fearful of potential inflation (higher inflation means bond holders want a higher return to compensate for inflation). Higher yields means lower bond prices which means we could be seeing some selling come into the bond market soon. I show some potential upside moves into December.

The next question, if that happens, is whether the money freed up from the bond market could rotate back into the stock market and help support a year-end rally. I think the stock market would not like to see an inflation scare holding the Fed back or worse having the Fed follow the bond market and raise rates again. The one and done scenario I think still spooks the market.

One potential contributor to the inflation problem is the sinking US dollar and a contributor to that is the excess liquidity (i.e., printed dollar bills) in the monetary system. Ever since Richard Nixon removed the US dollar peg to gold (to prevent other countries from converting their dollar holdings into gold) our country has enjoyed the ability to create money out of thin air. Well, out of electrons anyway. Now with the dollar hitting 40-year lows we're hearing some major rumblings from those countries holding US dollars in their reserves. The following chart shows just how much the Fed appears to be running their printing presses:

Calculated M3 Money Supply, Weekly, courtesy nowandfutures.com

After slowing down the printing presses into the summer it would appear the Fed has pulled out the stops and they're running their printing presses at breakneck speed now. The rate of increase (light blue line) has shot skyward since the credit crunch hit this past summer. It's clear from this chart that the Fed truly is trying to "liquidate" the problem. This is like giving a junkie some of his drugs to stop the shakes and sweats. But eventually the junkie needs to go cold turkey to get off the drugs. And when this country stops getting all the dollars the Fed can print, because of inflationary concerns and the eventual need to support the dollar (in deeds, not just words), there are going to be some painful shakes and sweats from the markets.

But those are concerns for tomorrow or the next day (as long as the Fed can hold back the Asian tigers). Let's see what the charts look like today.

DOW chart, Daily

Even with today's quick decline into the end of the day, which looked bearish, I'm thinking we could see the market turn right around and continue heading higher. Today's low held essentially at the 200-dma (13228) so the bulls want to see this turn right around and head back up tomorrow. If it pulls back further tomorrow, and depending on how far it pulls back, I would look to where the move up from Monday will have two equal legs up. As shown in dark red, I think we'll get a larger bounce that will then be followed by renewed selling that takes us back down to new lows that should easily and quickly break below the August lows.

I show in pink the possibility that the bounce is over and down we go from here but based on some other things I'm seeing I don't think that will happen. Even if it drops to a marginal new low keep your eye on the shorter term oscillators to see if we get some bullish divergences that would indicate another leg up. The bullish possibility (green) is that we're going to form a large rising wedge pattern into the new year and from here we'll rally back up to a new all-time high, pull back again, and then a final rally leg into early next year. While I think there are some fundamental reasons not to expect that (such as the credit crunch which I think is a long way from being resolved) we'll let price decide where it's going next. Any break of the downtrend line from October would be bullish.

DOW chart, 60-min

I'm showing a potential A-B-C bounce off Monday's low (dark red) where today's pullback may have completed wave-B and now we'll get wave-C up to the 13600 area (two equal legs up from Monday). If the pullback drops a little further then the upside projection gets pulled down with it. Also, if it pulls back further keep your eye on the uptrend line on MACD (or RSI) and see if it holds since that could be a good buy signal. But a break down in MACD/RSI would be bearish.

SPX chart, Daily

SPX is very similar to the DOW and I'm showing the same potential moves from here. Assuming we've got some more upside work to do before it turns back down I think we can expect a rally up to the 1525 area. A break above its downtrend line from October would likely be bullish. A rally up to it would be a good short entry. Basically SPX was rejected at its 200-dma (near 1484) today so it's possible that that's all the bounce we're going to get and down we go (pink). The uptrend line from August 2004, near 1415, would be the critical level in that case. The bullish scenario (green) calls for a break of the downtrend line from October and then continue up to the trend line along the highs from July. This would be the top of a potential rising wedge pattern that will take prices higher into the new year (in a very choppy pattern).

SPX chart, 60-min

I like the Fibs correlating to a higher for this bounce near 1524, maybe a little higher to the downtrend line from October. It could certainly fail at a lower level (or just keep going as per the bullish (green) scenario) but a rally to get the bulls excited and bears frustrated would be a good setup for a bull trap. Assuming the bearish scenario, as shown in dark red, will play out, the next leg down will be the strongest decline we've seen so far this year. That usually comes from too many bulls sucked into the previous move and then get spit out on the following decline. Whether that happens or not is speculation on my part but it would fit the larger pattern that I see potentially setting up.

Nasdaq-100 (NDX) chart, Daily

The wave pattern in the techs looks clean so far in that the current bounce looks to be correcting the decline off the late October high. Another leg up should finish the correction to then be followed by a strong decline (wave-3). I suspect that leg down would take us right back to the August low before seeing another correction. The bullish (green) scenario calls for a choppy move higher to a marginal new high as it forms a rising wedge into the new year. It takes a break above 2224, which is practically at the previous high, to confirm the bullish wave count. A break above 2184 (a 78.6% retracement) would be a heads up that it's coming. In the meantime, if the bounce develops some legs and takes RSI up with it, watch the RSI downtrend line--if it holds then it should be a good short play setup.

Nasdaq-100 (NDX) chart, 60-min

I'm showing Fib time and price projections/retracements to give some guidance as to what to expect for the correction of the decline from October 31st. Typically a wave-2 correction will retrace 50%-62% of wave-1 and do it in about 62% of the amount of time. I show that with another leg up (dark red) which would be about 2140 by next Monday. If it only makes it to 50% at 2110 then the bounce could obviously finish sooner. This is just a guide. It could of course head right back down now that it's retraced 38% at 2080.

Russell-2000 (RUT) chart, Daily

The pattern for the RUT looks similar to the one for the DOW and SPX. Another leg up in its bounce could tag its downtrend line from October near 808-810. A break of the downtrend line could be potentially more bullish. For now we've got a down-channel in place so that's our trend.

Russell-2000 (RUT) chart, 60-min

A closer view of the down-channel shows the correlation of the top of the channel near a 50% retracement of the decline from October at 808. That's also close to where the bounce would have two equal legs up so that would make for a good place to try a short play. I show one possibility (in pink) for the bounce to have completed at this morning's high but unfortunately that wouldn't become a higher probability until it dropped to a new low.

BIX banking index, Daily chart

Based on the 5-wave decline from September I've been looking for a bottom in the banks for over a week now. I would expect the correction of that decline to make it up to at least the 340 area (previous 4th wave is usually a good retracement target) and then of course there's the broken uptrend line from October 2002 closer to 350. Whether there will be enough buying power to get it up there is the question but that's what I'm looking for. Assuming the banks get another leg up I'll be watching for a break of its uptrend line from the November low as a signal that the bounce could be over.

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

The home builders index continues to consolidate in what appears to be the final stages of a triangle pattern, which is very common for a 4th wave correction which is how I've been labeling the move down from February 2007. Once this 4th wave correction finishes (and it looks like it's relieving oversold in time rather than price) then we should get the 5th wave down (from either here or a little higher first). I continue to like the 215 area for a final low before this index gets a much bigger bounce. In fact I'd abandon any short play on the home builders at that level and look to dabble on the long side. Even if the broader market is selling off I suspect the home builders will be pretty much washed out at that point and won't experience more selling with the broader market. But wait to see if we get down there before considering any long plays in this sector.

For a bigger picture of this index, here's the weekly chart:

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

The bottom of a parallel down-channel for price action since the July 2005 high matches up very well with the Fib projection near 215 (for two equal legs down for its A-B-C pullback correction. That's a heck of a correction (1100 back down to 200, ouch). But it should be a good setup for longer term health in this industry and you might even hear me joining the chorus of bottom callers at that point. Actually at that point there will probably be very few looking to buy the home builders which is exactly what you hope to see from a contrarian perspective.

Oil chart, December contract (CL07Z), Daily

Those steepening uptrend lines (from the parabolic rise) finally started breaking this past week. Three of the lines have now been broken and today's bounce took oil right back up for a potential kiss goodbye against its most recent broken uptrend line. While I show (in pink) the possibility for oil to walk back up underneath this trend line (perhaps back up for a stab at $100) I think oil has peaked. A quick drop back down to $80, a little bounce and then a continuation lower is the kind of pattern I would expect to see from here. A return to $75--its uptrend line from January 2007 and a quick retracement of the parabolic portion of its rally--would be pretty typical here.

Oil Index chart, Daily

Like the broader market I see the possibility for another leg up in its bounce but then a continuation lower. Back down to its 200-dma near 730 before a larger bounce would be a typical move here.

Transportation Index chart, TRAN, Daily

The choppy price action in the Trannies has left me a bit baffled for a while now. I kept thinking it could bounce back up in a larger bounce pattern from its August low, and still show that (in pink), but if the broader market struggles to rally much more than just another leg up before rolling back over then I think the Trannies will do the same. The dark red price scenario shows the possibility for a bounce up to its downtrend line from October and its broken uptrend line from March 2003, near 4850, and then roll back over and head for new lows.

U.S. Dollar chart, Daily

Ideally I think the decline in the US dollar would now look best with a minor new low that perhaps tags the Fib projection at 74.43 and bottom of it steep down-channel as well as the down-channel from 2006. The long term bullish divergences continue, the bearish sentiment is unbelievably strong (bullish from a contrarian perspective) and we're looking at potential support very close. Whether the dollar makes another stab lower (or continues much lower) can't be known but I think it would be a good setup for a long-the-dollar play. A break above 76.50 and its downtrend line from August would be a good signal that the dollar has finally found its bottom, its hands are firmly in place to protect it, and we'll start a multi-month rally into the 90's.

Gold chart, December contract (GC07Z), Daily

Gold has now broken back below its two steepest uptrend lines and if the current bounce can make it a little higher it could give its most recent broken uptrend line a kiss goodbye (825-830). That would make a good setup to try the short side on a gold play (futures, gold stocks or gold bugs index--HUI.X). Notice the sharp break of the uptrend line on RSI--that was the signal that we've probably seen the top for gold, right after it hit its Fib projection near 845. It's always possible that price could run back up for a test of the high, or even a minor new high, but watch the RSI for a kiss goodbye against its broken uptrend line if that happens. That would be another good short entry signal (this works for any symbol you're watching).

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

Tomorrow's economic reports could affect the market (as long as futures haven't been run hard in one direction before the report), especially CPI if there are any surprises in there. If the NY Empire State index were to show significant slowing while CPI takes a big jump up then I suspect the market would not be happy with that combination. Or if the index shows strong growth and CPI takes a big jump then the market also might not like that (increases the chance the Fed might have to reverse course and raise rates again, especially if the US dollar is still tanking). Otherwise I think the market will treat the reports as bullish (or at least they'll paint them as bullish) so that it can rally again.

SPX chart, Weekly

As discussed last week, I'm showing the possibility for a rising wedge into next year with a final high for SPX just above 1600. I don't favor this scenario and it will only become more likely if the downtrend lines from October are broken. Any move below the August low would negate this potential. I think the more likely scenario is a drop to its uptrend line from October 2002 near 1400 and then a bounce into year-end. Or it will drop below that trend line (major sell signal if that happens) and then bounce back up to it for the kiss goodbye.

It's a bit dicey for tomorrow. Today's late-day selloff certainly looked bearish but you've got to be careful with these moves during opex week. We have no idea how traders may have added to the selling only to hedge their November options positions.

For example, if traders sold a lot of November puts thinking the market will stay above them, the latest selloff had threatened many of those positions. Yesterday's rally may have been helped by many traders removing the hedges (either by selling the protective puts they had or buying back the stock they had shorted to protect their short puts). Today they may have been putting many of those hedges back on in a hurry once the market started breaking down again. If we see a rally get started again tomorrow we could again see those hedges come off quickly which could create another powerful rally. Whiplash? Oh yea. How'd you like to be the one chasing this up and down like that and keeping track of your hedged positions. Been there done that and it's not fun.

So be careful you don't get caught in that whipsaw (otherwise known as a buzz saw). Thursdays are usually pretty tame days in opex week and this afternoon's price action might have been the remaining bulk of traders exiting their November positions. So it could be very exciting or unbelievably boring. In either case it could be a tough trading day. Just keep reminding yourself that flat is a position and unless you like the excitement of opex lottery plays I'd even suggest simply waiting until next week when the dust should have settled a bit here and we'll see which direction is the right one to play.

I'll be filling in for Linda tomorrow so hopefully we'll have a little clearer picture as to whether or not we can expect another leg up in the bounce from Monday and if so what to look for as far as a shorting opportunity or where a breakout should be bought. Good luck and I'll be back tomorrow.
 

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