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Market Wrap

Did Anyone Get the License Plate on that Car?

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That's what the bears were asking by the end of the day. After getting run over by the car, and then the bus and then more cars, the shorts didn't exactly feel the love today. The strong rally brought out the bullish analysts slapping themselves on the back about what a wonderful buying opportunity it was and that here we go, welcome to the start of the year-end rally to new all-time highs. It seems to me we've heard that song before at each of the other sharp rallies in the past month and therefore we certainly need to consider those predictions as a possibility but the bulls need to keep this going in order to turn it into a probability.

Right now we've got ourselves another strong bear-market rally--these are typically very sharp rallies that flame out quickly. They spike out the short players, suck in the hopeful bulls and then the buying stops as suddenly as it started. To say we have something different this time is entirely too early. I've been expecting a strong bounce for the past few days as SPX came down to support (its long term uptrend line from March 2003) and was showing bullish divergences at its new lows over the past week. It was a very good setup to try the long side. For those who were short coming into today it would have been a good time to cover at support and wait for the break down. Today's rally has clearly put off until tomorrow, or next week or next month, a break of long term support (which I'll review on its charts).

Just as the market dropped to solid support on the SPX yesterday it rallied to what could be solid resistance for the DOW. After breaking its longer term uptrend line from July 2006 earlier this month, today's rally took the DOW right back up to it, practically to the penny at 13325. I had recommended a short play (in the Market Monitor) on the DOW based on that resistance and it's a good setup to consider tomorrow if it continues to hold as resistance. I'll also review that in tonight's charts.

So it was an exciting day and in actuality it's been an exciting month as far as big moves in the market go. From the emails I've received I would say it's probably been more frustrating than exciting for traders and that's because of the volatility and market turns coming out of left field. The market reversals have been hard and swift and unless you're very quick on the trading trigger it's been a market that has been whacking both sides unmercifully. Believe me when I say you're not alone if you've been struggling to trade this market. The trick has been, and will likely continue to be, to take chunks out of the middle of a move and be happy with that. Those who have been holding on for bigger moves find themselves typically giving it all back.

While it may be hard to exit a trade (hopefully with a profit) only to watch the move continue without you, it's very important in times like these to feel good about trading profitably and recognize you probably won't catch the entire move. If you have good entries with good risk management (try for at least 2:1 if not 3:1 reward:risk ratio) and then use a trailing stop (moving averages, previous high/low, trend lines, etc.) or profit targets then understand you're trading with good discipline and forget about what the market does once you exit the trade. Be thankful for trading well and taking money out of the market instead of resentful about what you didn't get. In fact there's a life lesson in there don't you think?

A reason given for today's monster rally was some Fed-speak about maybe the Fed will be forced to consider another rate cut, maybe, possibly, could happen, might not happen, but then again... In reality the market was ready to rally and the news didn't matter. It's just analysts looking for a reason. How about "the market was oversold and some buy programs (which started during the overnight session) spiked the shorts out of the market and then the rally fed on itself." Nah, then they wouldn't be able to make the big bucks declaring nonsensical reasons for why the market does what it does. And if it sells off tomorrow they'll say the market thinks the Fed is on hold again or maybe an economic slowdown really isn't good for the stock market. Efficient market? Hardly.

If the market truly rallied on hopes for another rate cut (vs. rallying more on short covering and bargain hunting) I would suggest that traders should be careful for what they wish for. Another rate cut by the Fed, especially in light of the rising inflation and sinking dollar (and all the associated unrest overseas from our trading partners), would indicate that the Fed sees significant risk of a slowing economy that outweighs the risk of rising inflation (we probably have both coming but that's a different discussion). One needs to ask if continuing to buy into a bull market would be the smartest thing to do in that case. In other words, why would the market rally if the economy is headed down the toilet to the extent the Fed would need to continue lowering interest rates?

There are many who still believe that the Fed lowering interest rates leads to a bull market. One look at 2000-2002 should quickly disabuse anyone of that idea (at least from a timing perspective) but of course a logical market is clearly an oxymoron. But beware--hoping for a Fed rate cut as a reason to rally the market would be one of the better bull traps. Just look at how well the three previous cuts in the discount rate have worked for the bulls (not very). To think it'll be different with a 4th rate cut is to ignore recent price action around the Fed's actions.

The other "positive" news was related to banks but in reality it's just another bottom call. The feeling is it can't get any worse (actually it can get a lot worse) and therefore it's a good time to buy the banks. They've been sold off hard the past month so to see them bounce hard today is very typical. I'll show a few charts on the banks to give an idea where we are in their price pattern. But the strong rally in the banks was very positive for both the SPX and the DOW. This gave the DOW its strongest rally of the year in percentage terms and only five points shy of its largest point advance of nearly 336 points on September 18th (the day the FOMC announced their rate cut).

As can be seen in the table at the top of this report, buying was extremely strong, at least as measured by up volume relative to down volume which ran better than 11:1. Advancing issues were better than 4:1 over declining issues. In fact it could be considered too strong--it looks more like what you see as a capitulation move rather than just a strong buying day. And in fact it was likely a lot of capitulation by the bears who covered short positions all day. This is exactly what causes bear market rallies and why it's dangerous to buy into them since they can turn on a dime with some hard selling. Whether or not we've got something different this time is entirely too early to tell.

One thing that I found odd, and highlighted in the table above, is the number of new 52-week lows being higher than the 52-week highs. Today started with a big gap up and rallied strong all day and yet new lows still outnumbered new highs by better than 2:1. This is not supportive a strong buying across the board, or even short covering in the beaten down stocks. Instead the weak stocks appear to have been sold even more. It's a warning flag at this point and something to keep an eye on as it's something we saw in the previous sharp one-day wonder rallies.


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Today's economic news was certainly not bull-friendly but nor did it stop the rally. Today's reports were essentially ignored (for now) although the afternoon release of the Fed Beige Book, showing a slowdown in the economy, created another buying spree on hopes for the Fed rate cut. I know, it doesn't make any sense to me either.

Starting the day, before the economic reports were released, was a statement by Fed Vice-Chairman Donald Kohn, "Federal Reserve monetary policy must be nimble, pragmatic and flexible given uncertainties over how the renewed turmoil in financial markets will effect lending to consumers and businesses." He further stated "If the turmoil stems from banks worrying that interest rates will rise, the Fed should be able to address it."

There are lots of ways for the Fed to address the banks' need for capital but what the market heard was a Fed ready to cut rates further. The stronger message from the Fed heads lately is that they see more risk from inflation and don't see the need to make further cuts but one "maybe, perhaps, could happen" from Mr. Kohn and it was off to the races. Did he just trap the Fed into making another rate cut, something they didn't want to happen? One can only speculate how the stock market will react if they don't get their rate cut now.

The rest of today' reports follows:

Economic reports
This morning's reports included durable goods orders, existing home sales and crude inventories. Then this afternoon the Fed's Beige Book was released.

Durable Goods Orders
High-technology goods suffered and that pulled the durable goods orders down for the third straight month, down -0.4% in October and worse than expectations for a slowdown of only -0.1%. But the details showed a picture that's worse than the headline number. Defense related goods rose +16.1% led by demand for military ships but when you exclude these military orders (which are not reflective of the economy), orders dropped -0.9%. So even with the export business doing better, thanks to the lowly greenback, the manufacturing sector is slowing down. Core capital equipment orders fell -2.3% which is the largest drop since last February. This tells us business leaders are not as optimistic about growth prospects for their businesses and want to instead hold onto their cash.

Existing Home Sales
More homes came onto the market and the supply, at the current sales rate, is the highest level in 22 years (since 1985). And the rate of sales continues to slow--down -1.2% to a seasonally adjusted 4.97M pace in October. This sales pace is the slowest it's been since 1999 and the inventory of unsold homes on the market stands at 4.45M, up +1.9%, for a 10.8-month supply, also the highest it's been since 1999. But the inventory of single-family homes is 10.5 months and the highest since July 1985.

Crude Inventories
The inventory data showed better inventory levels than had been expected and this helped pressure prices lower for crude which continued to drop from Monday's high, now about $8.50 lower, closing at $90.62 ($99.29 is the high so far for the January contract). EIA showed crude inventories fell by -400K barrels to 313.2, a little less than the 500K drop that was expected. Gasoline supplies rose by +1.4M barrels while distillate stocks fell by -100K barrels.

Fed's Beige Book
According to the latest Beige Book the economic slowdown has begun. While the economy is still growing, it's doing so at a slower pace. The report acknowledged the glut of homes on the market and the downward pressure on the economy from the slowdown in home sales and the drop in construction activity. The report stated that no turnaround in the housing market is in sight and shouldn't be expected until well into 2008 at the earliest. (As a side note it should be noted that the economy has never avoided a recession when the country has experienced a significant slowing in the housing market).

It did note that manufacturing has benefitted some from the weaker US dollar, as has the tourism business. I listened to a news report last night about the increase in the number of tourists coming over from Europe and taking bus trips into NY City not to sightsee but to shop. The bargains they're finding, because of the weaker dollar, apparently more than covers the cost of their airfare.

The report cited soft retail sales and pessimism about the holiday season as retailers see inventory piling up on their shelves. The troubles in the financial market, and the negative impact on the credit market, have caused problems for businesses in getting loans. The report did cite stronger signs in the nonfinancial sectors. Demand for legal services increased (and I suspect will continue to increase as the subprime and other poor lending practices, not to mention shareholder anger, causes a sharp increase in the lawsuits that will start flying).

With today's big rally, following yesterday's, let's see what the charts look like. First I want to review the 10-year yield since it has made a strong bounce the past two days, with the stock market, and could provide some clues as to what's next:

10-year Yield (TNX), Daily

The wave count for the decline in the 10-year yield would look best with another low following the current bounce. The bounce in the yield should stay below 4.1% (to stay inside the down-channel) and then drop to a new low with 3.7% being a good downside Fib target. So the question tonight is whether or not the yield will drop a little lower and what that could then mean for the stock market. Right now the stock market and yields are trading somewhat in synch and therefore this chart, if it drops lower from here, is saying the stock market could do the same thing. So watch the bond market.

DOW chart, Daily

The DOW rallied right up to its broken uptrend line from July 2006, which it broke below earlier this month. If price drops back then it's going to look like a classic test of support-turned-resistance and could give us a kiss goodbye here. As bullish as today was, the bulls need to keep it going otherwise it will have been just another bear market rally. This kind of setup I always recommend a short play since you can keep your stop relatively tight. It might not work but it's always worth a try.

While the DOW rallied a little higher than its 200-dma it's not uncommon to see it over and under throw that moving average. I noticed the NYSE stopped dead at its 100-dma today at 9806.

DOW chart, 60-min

The move up from Monday afternoon would look better with a slight pullback on Thursday and then another minor new high (in order to complete a nicer looking 5-wave move). But I've seen enough moves "missing" the 5th wave on shorter timeframe charts to know that I can't plan on seeing it. Therefore any strong selling tomorrow would be potentially more immediately bearish. Not only did the DOW slam into its broken uptrend line from July 2006 but it also stopped at the mid line of its down-channel from the October high.

SPX chart, Daily

SPX stopped right at its 38% retracement of the Oct-Nov decline. It's still shy of its 200-dma and the top of a parallel down-channel drawn off the downtrend line along the lows, both near 1483, and there's the "wall" at 1490, so there's a little more upside potential on this one. As shown with the dark red wave count there is the possibility we'll get a larger upward correction over the next few weeks (expect some more whipsaws and choppy price action if true). Obviously a drop back below Monday's low at 1406 would be bearish.

SPX chart, 60-min

Like the DOW I show the possibility for a small pullback tomorrow followed by another push higher to complete a 5-wave move up from Monday. That kind of move could get it up to resistance at 1490 and would be a good level to try the short side if it happens. A 5-wave move will be followed by a correction and therefore would make for a good trade. At today's high it may have completed a sharp 3-wave a-b-c correction and that's another reason to consider the short side (coinciding with the DOW's resistance at its broken uptrend line).

Nasdaq-100 (NDX) chart, Daily

The very choppy price action following the low on November 12th makes it look like this week's rally is wave-C of an A-B-C upward correction off the low on the 12th. If this is the correct interpretation then it's a setup for a great short play for what will be wave-3 to new lows, shown in dark red. The c-wave of an a-b-c correction is known as the sucker wave because it convinces traders that the previous trend (down in this case) is finished when in fact it is the completion of a correction. It's what makes the 3rd wave so strong as traders (bulls in this case) get trapped in a swift decline. Watch RSI against its downtrend line for clues here.

Nasdaq-100 (NDX) chart, 60-min

The 60-min chart shows the A-B-C bounce up close and I show where wave-C = wave-A at 2098.20, which is where price stopped today. As with the DOW and SPX I show the possibility for a slight pullback and then another new high to complete a 5-wave move up from Monday (c-waves are 5-wave moves) but too many times a small 4th and 5th wave are "hidden" and it's unreliable to count on it happening. That makes this a risky place for bulls and a good place to consider a short play. If it pulls back then use today's high as your stop. But then watch for a new high with negative divergences to set up the next shorting opportunity since it should at least pull back if not start a major decline. If it keeps heading higher, as shown in green, then look to buy the dips for a while.

Semiconductor Holders (SMH), Daily

The semis got a nice bounce today as well and almost made it up to its broken uptrend line from October 2002, currently near 33.25. That would be the first place I would look for failure (if it gets there) or else it could head to its broken neckline just above 34. The last low was met with a very bullish divergence on MACD after coming out of oversold so based on that signal I would expect a larger bounce, even if it pulled back first. So stay cautious about this one if shorting the semis, and keep an eye on it for bullish signals for the techs in general.

Russell-2000 (RUT) chart, Daily

The top of a parallel down-channel, based off the downtrend line along the lows of its decline, crosses its broken uptrend line from August 2004 near 776 so a slight pullback followed by another push higher could find resistance around that level. It was a strong bounce today but the RUT is clearly in a downtrend so any plays on the long side are still to be considered countertrend.

Russell-2000 (RUT) chart, 60-min

Once again, a slight pullback and then push higher (to the 776 area) would look best here but is not required. Based on this chart though, with no bearish divergences, I would think it's a risky play to consider a short play. I'd wait on this one to see if it follows the others if they start dropping back.

BIX banking index, Daily

The way I've got the decline from November 14th labeled the BIX can't rally above 289.85 without violating an EW rule that says wave-4 can't overlap wave-1 so based on this I'd say the banks are a short here against that level--makes for a very tight stop. This is also where the top of its parallel down-channel is currently located. If the banks can break above 290 then I'd look to buy the dips for now.

A look at the weekly chart keeps this year's steep drop in perspective in the larger pattern:

BIX banking index, Weekly

As I've pointed out before, the rising wedge pattern since the 2000 low is a bearish pattern and these typically get completely retraced. That would take the index back down to the 240 area if not the 2000 low near 211. The wave count for this year's drop is "squished" on this chart but shows the need for a stair-stepping lower into the new year.

Looking at the weekly chart of the brokers shows today's bounce brought price right up to its broken uptrend line from March 2003 through the May 2005 low (seems to be a common theme about today's rally). If it drops back down from today's high then it will look like a classic kiss goodbye and in fact is a short here until it proves it can rally further (needs a close above today's price).

Citigroup has been in the news a lot this week as it secured (expensive) funding from Abu Dhabi in an effort to continue to hide the true value of its mortgage-backed assets and other derivative mess. Instead of coming clean as HSBC did yesterday with their SIV holding, and get them onto their balance sheets, C continues to try to push their garbage under the carpet and hope no one notices the big lumps. Our banks have been shameful in their dealings with the public. As a shareholder I'd be outraged. But I'm not a shareholder so all I can do is mouth off about their despicable behavior. And with that I'll step down from my soapbox and discuss their chart since today's rally was supposedly about being relieved that the banks have seen the worst and it will get better from here (cough). Its chart says otherwise:

Citigroup (C), Daily

Like the banking index the wave count for this year's decline is not finished. It needs to stair-step lower in order to complete the count and my best guess is that we'll see C work its way down to below $20 (perhaps $15) into next year before it finds meaningful support. It could happen much faster than what I depict (for example it could finish well within the first quarter of 2008).

Citigroup has a different pattern than the BIX but the end result is the same--this monthly chart suggests further downside:

Citigroup (C), Monthly

The choppy price decline from its high in 2000 was followed by a corrective rally into the end of 2006. Notice the bearish divergence on MACD at the retest of the 2000 high. Two equal legs down for the A-B-C correction from 2000 would have it dropping to 22.35 but I'm thinking C will drop down to 15 before all is said and done, which will be back to its 1995 low.

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

The home builder index continues to work its way lower towards its 215 Fib projection (and early 2001 low). It could drop lower but it's getting close now to where it could find a significant bottom. Shorts in these stocks should understand the risk is going to be shifting over to their side soon.

Oil chart, January contract (CL08F), Daily

Oil has broken its uptrend line from early October and could bounce back up for a retest of that trend line (shown in pink) which would have it rallying back up near 95 but it's just as likely to see it drop further to its next uptrend line and 50-dma near 87.

Oil Index chart, Daily

The oil stocks rallied with the broader market today but not as strongly and they're likely being influenced by the drop in the price of oil. If the rally can make it a little higher keep an eye on the downtrend line that's currently near 810 as the next leg down could be accompanied by some strong selling.

Transportation Index chart, TRAN, Daily

There's additional upside potential for the Transports to its downtrend line from July which coincides with its 50-dma near 4772. Not shown but if it can press a little higher than that then the broken uptrend line from March 2003, and its 200-dma, would be good upside targets. Otherwise a reversal in the broader market back down would likely have the Trannies following.

U.S. Dollar chart, Daily

The US dollar got a good bounce yesterday and was promptly slapped back down today. It broke above its downtrend line from October 22nd yesterday and then dropped back down below it today. The more important downtrend line is the one from August and is currently near 75.75. Until that trend line is broken the dollar could get another leg down in which case the Fib projections near 74.40 make for a good downside target to finally find a bottom.

Gold chart, December contract (GC07Z), Daily

With the US dollar probing for a bottom (I believe) it looks like gold already topped. After tagging a Fib projection at 845.37 in early November, where I suggested a short play on gold, the recent bounce should be a 2nd wave correction and the next move should be a strong decline that breaks the lower uptrend line near 786. A drop below 771 would confirm that we've seen the high for gold.

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

Tomorrow's reports include the preliminary GDP report and new home sales, either of which could move the market if there's a nasty surprise. Otherwise Friday will be the more important day with some key reports that could influence the Fed for their December 11th meeting (or at least the market's reaction based on what it thinks the Fed will do with that data).

SPX chart, Weekly

The weekly chart has RSI hinting of a turn back up from oversold (but not MACD yet as it's more of a lagging indicator). I'll continue to show the possibility for a choppy rise higher into next year until the August low is taken out (which would negate the bullish wave count). The RUT may have provided us with a heads up in this regard--this week it broke the August low and therefore negated a bullish potential for a new high in that index. While we could always get a new high in the DOW and SPX without the RUT (which would be a bearish non-confirmation) I think it's unlikely that new highs are coming. But I'll keep it there as long as it's a possibility.

Today's rally was bullish and it has a lot of people looking for the rally to continue now for at least a few days if not a few weeks. The rally into the end of the year is something many expect. While the bearish sentiment has increased dramatically (bullish from a contrarian perspective) there are still a lot of people hoping for a year-end rally. Today's rally, especially off some strong support at this week's lows, will have many believing that rally has begun.

But we've seen too many of these bear market rallies suddenly fizzle and reverse sharply (part of the whippy stock market traders have been dealing with lately). So today's rally should be considered in that context. We need to see follow through, especially since we've got some significant resistance levels that were hit today. A pullback from today's high would be typical and if it consolidates in a sideways/down move (with overlapping highs and lows) then that would be a good signal that the rally will continue and bust up through resistance. However, if the pullback starts to become sharp with only small corrective bounces then I'd be looking to stay on the short side.

That leaves us looking to see what happens tomorrow, and maybe Friday, to help us figure out what's the next move for the market. Shorting it here should be a good move but keep your stop fairly tight. As I showed on the 60-min charts we could get a relatively quick pullback and then a new minor high which would be the next opportunity to short it to see what kind of pullback/decline develops. It's risky when you consider the fact that you're stepping in front of a strong rally but catching turns in the market is always faced with that risk.

The more conservative thing to do here is let the market tell us what's next. If we get a sharp decline then short the bounce. If we see a continuation of a strong rally, through resistance, then buy the pullbacks. Be satisfied with taking small chunks out of the middle and stay disciplined. The volatility is a killer if you don't manage your risk properly. Good luck.

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