Option Investor
Market Wrap

Stick Save

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I (Keene Little) am switching with Jim who will take tomorrow's Market Wrap.

In hockey a goalie will sometimes thrust his stick into the air in a last ditch attempt to block the puck and when it does it's called a stick save. Often times we'll see the same move in the market just before the close where "someone" does a stick save. It's usually a couple of big buy programs that starts the shorts running for cover and then it feeds on itself and the original party(ies) who started the buying will then quietly sell into the rally and make a little profit in the process. Whenever we see an end-of-day rally we're forced to wonder if it was a stick save or some real buying.

The NYSE volume was incorrect (again) today and therefore I don't have reliable volume data to refer to in the table above. And I'm wondering if the number of new 52-week lows is correct. At 1186 new lows vs. 134 new highs that sounds more like a capitulation bottom than anything else. It's certainly a warning to bears to be careful if you're short. The flip side is that crashes come out of oversold and as I'll point out on the charts I don't dismiss the crash scenario. Both sides need to be very cautious here since I've got a feeling that we could be on the verge of a large move.

The day, or I should say night, started with a very bullish rally in overnight equity futures for no apparent reason. With the low volume in overnight trading it's not difficult to get the futures moving one direction or the other but it's always suspect when you don't see any news or overseas markets driving it. Then before the cash market opened most of the gain in the futures had been lost and we found out that Freddie Mac (FRE) laid a stink bomb on the market with their announcement of a $2B loss and the possibility of a dividend cut. In addition to the loss they also are writing down the value of their net assets by $8.1B as they mark-to-market to fair value.

In addition to FRE's announcement of their losses they also need to raise capital. Considering their capital is only $600M over the statutory limit and the announcement of a $6B loss it's no wonder they'll need to raise some capital. They've got a mortgage portfolio of about $713B so their capital on hand is only a miniscule portion of their risk. This is all part of the problem I've been talking about in the banking sector with record low capital in reserve accounts for bad loans.

Interestingly, after FRE made the pre-market announcement the stock dropped sharply but then rallied at this morning's open, as did the broader market. The DOW and S&P 500 futures were driven back up to above the overnight highs. It makes one wonder if there was a little manipulation with "someone" trying to rescue the market after the bad news on FRE. But it didn't last as the DOW then lost 260 points from the morning high to the afternoon low. And then the stick save and the DOW rallied 170 points off its low to close almost 52 points in the green. Too bad the Transports didn't follow the DOW into the green but hey, there's only so much manipulation that can be done.

Needless to say it was another very volatile session. To say that traders on both sides of the fence are getting whacked in this market is a gross understatement. Unless you can catch these swings right, and it's hard when the moves sometimes come out of nowhere, you're probably feeling a bit shell shocked right now.

Supposedly the reason for the morning rally was because many felt the Fed would come to the rescue with Fannie Mae (FNM) and FRE suffering such huge losses. But then reality started to sink in when traders began to realize that it was supposed to be FRE and FNM that were to be doing the rescuing of broken mortgage companies. Congress had been pushing hard to raise the limits for these two government entities to be able to take on more mortgages so as to free up capital in the other banks. It's looking now like they'll need to find some capital first to take care of their own problem.

So if FRE and FNM are unable to buy more bad paper it's putting the other banks and mortgage lenders in the hurt locker. Predictably the banks and home builders sold off hard again today. As I'll show for the banks' charts, that's one sorry looking index. And believe it or not there are many pundits out there pounding the table about what a great buying opportunity they present. Excuse me if I remain skeptical--I think I remember not too long ago the same thing was said about the tech companies all the way down to below 10% of their original value. In fact the bottom was found when those same tech analysts finally issued sell signals. FRE and FNM closed at their lowest levels since October 1996 and November 1995, respectively. Ouch.

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Other than the news about the continuing rot in the mortgage business it was relatively quiet as far as news. Hewlett-Packard (HPQ) had announced earnings last night and they were good. They rallied after hours and then gave it all up, and then some, within the first hour of today's trading. They ended the day down only 7 cents after their own volatile day. Techs have held up relatively well, the only major index to stay above last week's low.

Economic reports
The only economic reports today were building permits and housing starts and then the FOMC minutes from their last meeting in October.

Housing Starts and Building Permits
The good news was that October housing starts were up +3.0% at an adjusted annual rate of 1.23M units. This follows three months of declines. The bad news was that permits fell -6.6% to a seasonally adjusted annual rate of 1.18M. That's the lowest level for permits since July 1993. While very few analysts discuss it, a bottom in this industry will probably not be found until housing starts are below 1M.

As you can see in the following charts, the housing starts and permits have dropped steeply since the highs in 2006 and won't be at 1991 levels until they're below 1M. When a bubble is created it's common to retrace the entire rally leading up to the bubble.

Housing Starts and Permits, 1991-2007, courtesy briefing.com

As I've been showing with the home builders' chart, it has a little ways to go before finding a bottom but it could be within a month or so of doing so. That would suggest the drop in this chart (with a further drop to go) will have been priced into the home builders but not yet.

FOMC Minutes
The FOMC minutes showed the Fed feels the economy will slow more in 2008 than they had previously thought. Growth projections dropped from about +2.45% to a range of +1.8% to +2.5%. I suspect even the lower numbers are probably a bit optimistic considering some of the fundamental issues facing us. Some Fed officials had expressed more concern and projected growth as low as +1.6%. There's still no one projecting a recession but then that's not a surprise. They always miss a recession.

They feel inflation, as measured by the PCE (Personal Consumption Expenditures) index, will slow to +1.8% to +2.1%, down from about +2.95% this year. They are not including the costs for energy and food and eventually this is going to catch up with them. Really, who do they think they're kidding? Pretty soon there could be an eruption in the frustration levels of the people who are dependent on payments keyed to inflation rates (Social Security, military retirement pay and other benefits) and complaints to their Congressmen could start to have an impact. But with a cost of hundreds of billions of dollars if the government payments were to rise by the REAL inflation rates you can bet not much will be done to help the people dependent on these payments.

The bond market is showing less fear of inflation and more fear of recession. The daily chart of the 10-year yield still has me questioning the decline and how much more it will see:

10-year Yield (TNX), Daily chart

The move down from the October high has achieved two equal legs down at 40.72 and could be significant if the drop from October is to only be a part of a larger sideways consolidation (meaning another rally leg back up is due). The daily oscillators are oversold and MACD is holding a hint of bullish divergence at the new low. But there's a lower price projection down near 3.8% if yields are held down by the downtrend line from October. This chart continues to point to lower interest rates from the Fed unless it breaks its downtrend line and starts a larger bounce. In that case the bond market would be hinting that the Fed might stay on hold.

Now we'll take a look at the rest of the charts. After the recent volatility it's a challenge figuring out where this market is really headed. With the late-day rally we're left wondering if the Turkey Day rally may have started. It's typically a bullish week and with a light trading day on Wednesday and an even lighter day on Friday it wouldn't take much buying to keep the bears at bay. But the market is at a critical point and I think a violation of today's lows could be trouble.

DOW chart, Daily

The first thing to point out on the DOW's daily chart is the dark red wave count which is very bearish. It shows a series of 1st and 2nd waves to the downside since the October high. This count says we could see a minor new high for the current bounce but it's not necessary. This wave count is looking for a series of 3rd waves to the downside and is a setup for a very strong selloff. This kind of setup is normally not a high odds play and I hesitate to even point it out. But considering what we're facing with the credit crunch getting worse every day and not a lot of positive economic news, not to mention the continued cyclical vulnerability for the market through the rest of the year, the setup for a panic selloff needs to be considered more seriously than usual.

If the bulls can get something going this week and then follow on with a rally next week (with fuller participation) AND get back above 13300 (its 200-dma and broken uptrend line from July 2006), then there's a very good chance we'll see a rally back up to the 13500 area. That's where it could run into a downtrend line from October in early December. If the bulls can get above that downtrend line then there's no question we'll see a year-end rally and into January, even the possibility for a run to a new high. That doesn't sound at all logical to me that that would happen but I don't trade the market based on logic. Been there, done that and found you don't make money based on what the market should do logically.

DOW chart, 60-min

Looking a little closer to the more immediate possibilities, I've got key levels at 13105 to the upside and 12840 to the downside (both are today's high and low). If the market rallies above the key level then we could see the start of the larger rally to at least the 13300 area over the next few days. If we get a small pullback and then another rally then watch for either the downtrend line from October 31st or the 13100 area to be resistance. Not shown but if the DOW drops below 13840 right away tomorrow then there's no way to put lipstick on this one--it'll be bearish.

SPX chart, Daily

SPX shows the same potentially very bearish wave count (dark red) as I showed for the DOW. It calls for some very strong selling to kick in if it drops below today's low and especially if it drops below the uptrend line from March 2003 which supported the decline in August). A violation of that uptrend line and especially of the August low could potentially set up the same scenario as the 1987 crash. That's probably not the highest odds scenario from here but it needs to be kept in the back of your mind as you watch the market over the next week or two. It would likely happen fast if it happens.

But until we see that kind of breakdown the other possibilities are just as likely. A 3-wave rally, or more, could take SPX back up to 1500 by early to mid December and meet its downtrend line from October. That kind of move could be a good long play from here but it could be a choppy volatile ride. But if it makes it up to there then the short side would be a good play to see whether it drops back down or consolidates for another run higher (green).

SPX chart, 60-min

Today's end-of-day rally took price back up to the downtrend line from last week's high so a break to a new daily high, confirmed with a break above 1453, would be at least short term bullish. It's a long way from 1490, a tough resistance level now, and would be a counter-trend play now so caution is advised on the long side. A drop back below today's low would likely have it stair-stepping lower to the August low and probably breaking it.

But here's another caution for the bears--the bullish percent index for SPX has dropped into bullish territory:

SPX Bullish Percent index, Weekly chart

The previous lows in the index correlate with market lows, including the one in August. The present low in the index is the most oversold it's been since 2005. So at first glance this chart is telling us to get ready for a stronger rally. But this index got as low as 16 in 2001 and about 13 in 2002. Oversold can clearly become oversold so it's not a timing tool but it is a heads up. RSI can be viewed bullishly since it's showing positive divergence or bearishly since it's not oversold yet.

Nasdaq-100 (NDX) chart, Daily

The pattern of the techs remains clearer than the others and right now it's bearish. But that doesn't preclude a bigger bounce to relieve the oversold conditions (dark red). A rally up to 2140 would be a 62% retracement of the November decline and would be a good short play setup. There's even higher bullish potential if it can rally above 2180. The more bearish possibility (pink) is that we'll see today's lows broken in which case we could see a quick move down to the 200-dma at 1942 or uptrend line from July 2006 near 1900.

Nasdaq-100 (NDX) chart, 60-min

The choppy price action since last week's low is what leaves me guessing as to what happens next. We could get another leg up as part of a larger correction pattern or it could drop immediately from here (which would set up a bearish 3rd of a 3rd wave down). If today's low breaks I'd be shorting any and all bounces, which could be small.

Nasdaq Bullish Percent index, Weekly chart

Like the SPX bullish percent index this one is warning us that we could be making a bottom here as the index makes lower lows than the past 3 years. As it did in August, we need to stay alert to the possibility that we're finding a bottom here and not the start of a more serious decline.

But also like the SPX, this index can go much lower. It dropped to about 24 in late 2000, about 21 in September 2001 and then about 25 in October 2002. It can always go lower and I wouldn't be buying the techs based on this chart but nor would I ignore any rally from here if in some short positions.

Russell-2000 (RUT) chart, Daily

The RUT would have to bounce up to about 775 to even challenge its downtrend line from October 31st, which would also set up a retest of its broken uptrend line from August 2004. The dark red wave count on this chart shows the same potentially very bearish setup--any further selling from here that breaks today's low could see some very strong and sustained selling. But if the RUT manages to get back above 775, or pulls correctively back from that level (pink) then a rally up to its downtrend line from October would be my expectation.

Russell-2000 (RUT) chart, 60-min

If the bulls can hang on here, even with just a small pullback, watch for a rally up to its downtrend line from October 31st. That would set up a shorting opportunity and we'd have to see if it drops sharply from there (bearish) or consolidates under resistance (bullish) before rallying higher. The steeper downtrend line from last week's high is near 753 so that's the first resistance level to watch on any bounce tomorrow.

BIX banking index, Daily chart

The wave count looks like it's "extending" to the downside for its 5th wave (the move down from the end of October) which is common when strong selling takes hold (or a strong rally) and we could see just a small bounce followed by renewed selling that takes the index to the 240 area. But a Fib projection at 262, which was nearly tagged today, is potential support for a much larger bounce (not shown). I'm bearish this index still since the wave count to the downside does not count complete yet.

The monthly chart is needed to show how much damage has been done to this index:

BIX banking index, Monthly chart

The rising wedge that was built over seven years could be completely retraced in less than one year. This is typical for rising wedges (or descending wedges followed by a strong rally) and graphically shows the pain the bank holders are feeling this year. This chart shows why I have 240 on the daily chart as potential support--the 2002 low.

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

The home builders index bounced off the lows found in 2002 (not THE low that year) but it should continue to work its way lower to a Fib projection at 215 if not lower to 153. At that point I would say the home builders will have found an important bottom, but not yet.

Oil chart, January contract (CL08F), Daily

The US dollar sank back down today and commodities rallied. The current leg up will do a good job at completing a 5-wave move up from August, as labeled on the chart. Whether it makes it up to the top of its up-channel, near 104, is the question. Keep an eye on its RSI since a retest of its broken uptrend line could correspond with an important high for oil. The next move after this should at least be a large correction of the Aug-Nov rally.

Oil Index chart, Daily

Oil stocks have bounce with oil but obviously held down by selling in the stock market. The bounce looks like it may have completed today (labeled wave-2 on the chart). This wave count suggests strong selling to follow in wave-3 down. The 200-dma at 733 should be next.

Transportation Index chart, TRAN, Daily

The pattern of the decline from October looks like a waterfall and is usually indicative of some strong selling to follow. That suggests we haven't seen the lows for the current leg down yet. But there's just enough or a corrective look to the whole thing that requires the consideration of another rally leg back up into December (pink). Fundamentally, with all the reports of a slow shopping season ahead and the warnings from the truck, train and air carriers, I have a hard time believing the Trannies could rally that much. But a rally back above 4750 would suggest it could happen.

U.S. Dollar chart, Daily

The US dollar dropped sharply after the FOMC minutes came out. It had been down marginally but much more after 2:00 PM. It now looks very likely that we'll see a drop down to at least the bottom of its parallel down-channel and the Fib projection at 74.42. That would likely be a very good setup for a long trade in the dollar.

Trading opposite to the dollar, and more in synch with commodities, is the euro:

Euro chart, Daily

The euro rallied up near the top of its parallel up-channel from August. You can see how RSI came back up for a retest of its downtrend line on RSI. If that holds then it will be another bearish divergence against new price highs for the euro. This fits the picture for coming reversals in the dollar, oil and as shown below, gold.

Gold chart, December contract (GC07Z), Daily

Gold (or silver) has not followed oil to new price highs, even though the US dollar is testing its lows. If the dollar holds its lows or makes slightly lower lows then gold could continue pushing higher, as shown in pink, including a retest of the broken uptrend line for RSI. It could bounce a little higher but I think the high for gold is in and the next large move should be to the downside, especially if the dollar finds its bottom soon.

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

Tomorrow's economic reports shouldn't be market moving. Unless we get some more bad news from an expected area tomorrow should be relatively quiet from a news perspective.

SPX chart, Weekly

I'll continue to show the bullish potential (green) until the August low is taken out (which would negate the possibility). It could mean some very volatile and choppy price action over the next many months. If true, get used to what we've been seeing lately.

But I think the greater likelihood is for a continuation lower to support around 1400, its uptrend line from October 2002. The bigger question tonight is what path it will take to get there (as discussed for the daily and 60-min charts.

The market could continue its volatile ways this week, especially as volume starts to dry up. I've found this week to be a good week to lay low and get some reading/research done. It's too easy for program traders to really knock this market around. That could only get worse by Friday. Enjoy your time with family and friends this weekend and know that the market will still be here next week. December could be a wild and wooly month as well.

Trade carefully if you must and good luck. I hope you all have a great Thanksgiving weekend and be thankful for all we have. With so much negative news around us it's easy to get caught up in and feel somewhat overwhelmed. Stay focused on the people who matter to you and we'll be back at this next week. See you Wednesday.
 

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