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Market Wrap

It's Official

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There's been so much discussion recently about the fact that we're officially in a correction because the DOW is off its high by 10%. That's being said almost in a hopeful tone by many as they hope that it means we're close to putting in a bottom and it's time to look to do some buying. After all, past corrections of this magnitude have been perfect buying opportunities.

There's another, and more meaningful, "official" pronouncement for the market that very few will discuss. We're officially in a bear market as of today. The DOW dropped below the August low today, even if it was minor and only for a very short period of time, and in so doing it confirmed the breakdown in the transports (which broke the August low in December and again on Jan 2nd). This gives us a DOW Theory confirmation of the double top for the DOW in July and October. This does not preclude a monster rally in the next month or so but it will likely be a choppy one and eventually set up a monster short play.

As we headed into today, and with the market down so much this year (worst start to the new year since 1932 from what I've read), there were many traders asking if the bottom is near. The worrisome thing about that is that it's normally a signal that there's too much hope for a bottom and it will likely be much lower. But we're getting some real fear in the market now and everywhere you look there's just more bad news. Whether it's housing, banks, credit crunch, loan defaults, lousy retail sales, the weather, you name it, people are really getting down in the mouth.

Just something to add to your veritable treasure of trivia, know where the saying "down in the mouth" came from? It alludes to the downturned corners of the mouth as a sign of misery and it originated back in the mid-1600s. State of misery--I'd say that adequately portrays the state of stock traders at the present time. When you look at some of the measures of fear, such as the VIX and put/call ratios, you can see that traders are worried that the bottom may be a long ways away. And that's what we want to see if we're to hope for a tradeable bottom.

Take a look at the put/call ratio in the table above. This ratio is normally just under 0.60 (6 puts bought for every call). At nearly a 1:1 ratio it says a lot of people are buying puts right now, either for protection or for speculative bearish plays. Regardless, a put/call ratio that high tells us the bearish sentiment is thick enough to cut with a knife. Bears need to be careful. The ISEE (International Securities Exchange) also tracks data and provides a chart on their site for their call/put ratio. Here's today's chart:

ISEE Call/Put Index, courtesy ise.com

I plugged in date values to cover the past year to show where the call/put value dropped down near 50 and you can look at a price chart to see that those dates were very close to significant bottoms in the market. Today's low is 86 and is the lowest value since November 16th. This too is warning bears to be careful shorting the market right now. But it also shows that we're not as oversold, by this sentiment measure, as we were at previous market lows. That's a warning to bulls to be careful of buying bounces right now which could turn out to be nothing more than a quick bear market rally.

Before leaving the table at the top of the report, notice I also highlighted the volume--huge volume today. Then the number of new 52-week lows vs. highs--it looks capitulatory with the huge number of new lows vs. new highs. It of course makes sense when you consider the fact that the market was down before rallying back up at the end of the day. Many stocks have been sold off hard in recent weeks and were making new lows. By the end of the day the up volume and advancing issues were able to take over down volume and declining issues. So the big question tonight is whether or not we've seen an important bottom. The jury is still out, as I'll show in the chart.

Even though I believe we've had enough signals now to convince me that we've entered a bear market, it doesn't mean it will be straight down from here. I think we're near a good tradeable bottom, if we didn't hit it today. As traders we don't care which way the market goes. Just give us a signal to enter a trade that then trends for more than a day. In reality we should care less whether the market is in a bull or bear market.

But the damage from a bear market, which of course is a sign of a slowing economy, is not fun for anyone even if you are able to make money on the downside. It really is a lot more fun to make money in a bull market because you then get to brag to your family and friends what a trading genius you are. Try bragging about how much money you made in a down market, when they see their portfolios shrinking and people losing their homes and jobs, and I can guarantee you that you will not be viewed kindly by the others who don't understand how you can make money in a down market and be so happy about it.

We'll probably never see a change to the opinion that bulls are optimists and bears are pessimists. I prefer to think of technical analysis as market neutral and we trade what the market gives us. One of the tools of analysis is market sentiment and while it's not a good timing tool (depending on your trading time frame) it is valuable as a heads up for what could change (use market sentiment as a contrarian indicator). The market is driven by human emotions and when those emotions reach extreme levels then you know just about everyone with a vote has voted. That's what causes the market to find a bottom or a top. And that's why those put/call ratios are important to keep any eye on.

Economic reports
It was very quiet for economic reports today with only the crude inventories report and mortgage applications this morning.

Crude Inventories
Crude supplies dropped in the past week by 6.8M barrels to 282.8M, which was a much larger drop than the -2.1M that had been expected. Gasoline supplies were up by 5.3M barrels to 213.1M and this was quite a bit higher than expectations for a +1.6M gain. Distillate stocks were also up more than expected, rising +1.5M barrels to 128.7M as compared to expectations for a drawdown of -300K. Refinery capacity rose more than expected to 91.3% from the previous week's 89.4% (a +0.1% gain had been expected). This would help explain some of the unexpected build in refined crude inventories.

Mortgage Applications
The good news was that a drop in mortgage rates, and perhaps slightly friendlier banks, created a more favorable environment for mortgage applicants. Applications jumped a seasonally adjusted +32.2% last week as compared to the week before (which of course was a holiday week so one would expect a jump in the new year). The bulk of the applications were for refinancings. Total applications were up an unadjusted +8.7% as compared to the same week last year.

Looking at some market statistics I was intrigued by the fact that some numbers support the whipsaw price pattern we've seen, especially since last July. If you look at the price pattern of the stock market you can see very choppy price action that is full of whipsaws. Most everyone I talk to tells me they've had a very difficult time trading the market in the past year and most especially since the summer. There has been a lot of confusion and the battle between the bulls and the bears has been extraordinary.

An example of the pushing and pulling going on can be seen in the number of 90% days. A 90% downside day is one where downside volume divided by the total volume is 90% or more, and it's the opposite for a 90% upside day. Historical data over the past 50 years shows that normally the market experiences about four 90% days per year. Heading into the last week of December there were 23 90% days in 2007, nine to the upside and 14 to the downside. That's some amazing volatility which really wasn't reflected in the volatility index. That's what you call a whipsaw market.

That kind of volatility is also a very common sign at market tops. Market bottoms tend to be put in quickly but tops take a long time. A rolling top is a common pattern because of all these battles back and forth. A bearish diamond top is an example of a rolling top. It's much more common to see a v-bottom than it is to see a v-top. The battle during 2007 has in fact created a bit of a rolling top. One look at the weekly SPX chart that I regularly post at the end of my Market Wraps will show you what I mean.

So the danger for traders continues--the whipsaw price action is likely to continue and if we have in fact rolled over into a bear market take a look at price action in 2000-2002 to remind yourself how violent bear market rallies (and selloffs) can be. Let's take a look at the charts to see what may lie ahead.

DOW chart, Daily

The first thing to notice on the DOW daily chart is that I've removed the bullish wave count. I said a few weeks ago that we should get some clarity soon as to what is playing out and today we got at least a partial answer. By dropping below the August low, even if it was a minor violation and only for a minute, the EW (Elliott Wave) rule is clear on this--the sideways triangle pattern that I had been considering (that called for a 5th wave rally to a new all-time high over the next few months) has been negated. In my opinion we now have two choices by the EW pattern--a bearish wave count and an even more bearish wave count.

Both wave counts call for a low very soon, either today's or within the next day or two, and then a larger bounce. The dark red wave count calls for a big correction that lasts well into February if not March and will likely retrace at least 50% of the decline from October. Bulls will soon be yelling the 10% correction was another fantabulous opportunity to buy the market as it heads for new all-time highs. It's not going to happen. After that big bounce is done, which we'll obviously have plenty of time to evaluate along the way, will set up the biggest decline we will have witnessed in a very long time.

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The more bearish wave count (pink) says we'll get a smaller bounce from here but it will likely be a choppy sideways/up correction of just the leg down from December 26th (pink wave-(iv) up against the uptrend line from August). That would then lead to another decline into the end of January/beginning of February before we get another larger bounce that then sets up the same kind of downside whoosh as the dark red count following its larger bounce.

The question as of tonight is whether or not we've seen the final low for the leg down from December 26th. As of tonight I'm thinking we have not seen the final low yet. I think we'll see another consolidation on Thursday followed by one more drop to either a new low or a test of today's low. The 60-min chart shows what to watch for:

DOW chart, 60-min

The bounce off today's low took price from the bottom of a parallel down-channel back up to the top of it. It won't take much of a rally tomorrow morning to break the downtrend line and that's what we'll need to see for an indication that today's low might have been it. I'm using the dark red wave count to show one more drop before setting up the big bounce into February/March but understand it can take off from today's close and just keep heading north. The pink wave count shows a break of the downtrend line, a pullback, a little higher bounce and then another low heading into next week (opex week). That slightly larger bounce could happen from the new low as depicted with the dark red count.

That all sounds confusing so for now just keep your eye on that downtrend line and use it as your guide. Just stay aware that it could get choppy over the next couple of days as a bottom is put in. There is a potentially important turn date tomorrow, shown on the SPX daily chart next, and between the wave pattern, Fib price projections and time projection it's why I'm thinking we've got one more new low to go. If we get it then I think it will be an very good opportunity to get long the market and we'll see what kind of bounce develops.

SPX chart, Daily

The vertical lines on the chart are time projections based on the time between the July and October highs (the 100% label at the bottom is on the October high). At each of the 50% time lines the market had a significant turn, including the November low. The next turn date is tomorrow. Did we turn a day early with a low today? That's very possible and these turn dates are +/- a day so we're in the turn window.

I also show a drop down to 1353.58 which is where the move down from October would have two equal legs down (each labeled in dark red as an A-B-C move down and you can see the two legs are essentially a fractal of one another. Ideally we'll see both time and price get met before finding a bottom. But that would mean a very scary drop tomorrow and I have no idea what could or would cause that kind of move. Therefore we have to respect the possibility that the bottom is already in.

Because SPX did not violate the August low I can't take off the bullish wave count (even if I think it's chances of happening are about equal to Britney Spears getting her kids back). The bullish potential will have to be evaluated over time assuming we start to get a larger bounce back up, which the bearish (dark red) wave count calls for as well.

The 60-min chart shows the same thing as the DOW as for what to watch for tomorrow:

SPX chart, 60-min

SPX just about kissed its downtrend line at today's close. An early morning rally will be able to break it and then watch for it to be support on any pullback (may not get a pullback to test it) for an opportunity to get long. If price consolidates tomorrow, especially under the downtrend line then there's a good chance we'll get the new low. While I show the Fib projection down to 1353 on the daily chart, the shorter term Fib projection for the final 5th wave would have it dropping down to the bottom of a larger parallel down-channel from the October high which is currently near 1367 (which would be a break below the August low).

Nasdaq (COMP) chart, Daily

In one respect the COMP (and RUT) look more bearish than the DOW and SPX. It had a cleaner decline from the October 31st high, a corrective bounce into the December high and then a clean impulsive decline since then. It's looking like a very bearish set up as shown by the dark red labels. That count also calls for a bigger bounce over the next month but it would set up a very strong decline in a 3rd of a 3rd wave down as the next big move into the summer.

But the alternative is a bullish wave count as labeled in green. The move down from October is only a 3-wave move so far, labeled A-B-C in green, which came within two points of achieving equality between the two legs down at 2405. From a bullish perspective this could set up another rally to a high above the October high. I'm from Missouri on this one. If the DOW and SPX supported that kind of rally then I'd be very bullish the techs right here. Certainly a bigger bounce, like that shown for the DOW and SPX, is very likely but I'll wait for a break of its downtrend line from October before getting any more bullish than that.

Nasdaq (COMP) chart, 60-min

The leg down from December 26th looks just like the DOW and SPX in that ideally it will get another leg down to finish the wave count. The trouble is the little jiggle in price back at the end of December, which I've labeled as waves (i) and (ii) may really be part of the 1st wave down to the low on January 2nd. What that would mean is today's low was the final one. As with the others, a break of its downtrend line would be bullish and I'd look to buy pullbacks from there.

Semiconductor Holders (SMH), Daily

I had pointed to 30 and 28 as potential downside targets for SMH and today's decline brought it down closer to 28. The Fib projection at 27.67 makes for a good downside target (it's where the 5th wave down will equal the 1st wave down) if there will be one more new low in this index before getting a bigger bounce (my preferred wave count on this). If you look at the move down from the December high it's only a 3-wave move and it would look much better if it gave us a small 4th wave bounce and then a new low for the final 5th wave of wave-5, which is what I've depicted. SMH would be a buy if it follows that path.

Russell-2000 (RUT) chart, Daily

The RUT is very similar to the COMP so I don't need to repeat what I said for it. The bullish wave count calls for a rally above the October high from here (cough) while the bearish wave count calls for a larger bounce to correct the decline from October which should take at least a month if not two. The more immediate question, like the others, is whether today's low was the final low for now. There are certainly enough indications to support that idea so being short the market right now is risky.

Russell-2000 (RUT) chart, 60-min

Also like the others, watch the downtrend line for a break to indicate a bottom is in. If it breaks then start looking to buy pullbacks for now. But if the downtrend line holds tomorrow then look for one more new low and as shown on the daily chart, two equal legs down from October is at 678.77. I've noticed that the RUT is not nearly as accurate when it comes to using Fib projections and retracements so use those numbers as only a guide. FYI, I find the NYSE hits its Fibs almost on the nose.

BIX banking index, Daily chart

Help, I've fallen and I can't get up. Instead the orderly comes over and kicks sand in the face of this poor index lying on the floor. But I see hope here. Today's low tagged the first Fib projection just under 235 for this leg down and it hit the October 2006 low (which is the same low as pullbacks in 2000 after its low in March 2000). So it looks ready for a bounce. Unfortunately it looks like it could be just a small bounce.

Similar to what I explained for SMH, the move down from the December high looks like just a 3-wave move so far and it needs to be a 5-wave move to complete it. It's possible there's a tiny little 4th wave correction in there but that would be a forced count as of this evening. Therefore I'm looking for a small bounce and then another new low to then set up a much larger bounce in the banks. The final downside target could be the March 2000 low near 212.

For a little perspective on the drop in the banks, take a peak at its monthly chart:

BIX banking index, Monthly chart

The rising wedge from its 2000 low sure got retraced in a hurry. The wedges typically get completely retraced (which it just accomplished at today's low) in a much shorter time than it took to build but even this one surprises me. A 7-year rally retraced in one year. Wow. The decline is due a correction but I don't think the pain is over for the banking sector.

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

The choppy decline in the home builders suggest a bottom is not far away but it's been threatening that for the past six months. The move down from the December high needs a little bounce and then a final low (starting to see a common pattern here?) and the Fib projection at 216, which matches the early 2001 lows, is a good downside target. One other possibility, shown in pink, is that we'll see a larger sideways triangle pattern form from the November low. That would project a final low down around the Fib projection just under 154. So we'll see how it plays out over the next week for some additional clues here. Regardless, it's too early to be thinking long the builders.

Again, for a little perspective, the monthly chart of the builders is sobering:

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

Right back down to where it started, well almost. By the time this index bottoms it probably will be back down to its 2001 low. Certainly many of the housing numbers we're hearing do not support a bottom for the builders yet, even if they do look six months out. Two equal legs down from the high is at 215.59 which is the 216 projection on the daily chart (slightly different between the weekly and daily charts for some reason) so that makes for a good downside target for now (unless we see a larger consolidation first).

Oil chart, Oil Fund (USO), Daily

After a bounce following the crude inventories report oil then gave up its gains and closed lower. It's at the bottom of its parallel up-channel so there's still the possibility we'll see another push back up to give us a complete 5-wave move up from the December low. That would have oil hitting about 105. Otherwise a drop from here would suggest a sharp drop to about 65 (oil will drop to 80) before potentially setting up another larger bounce.

With the economy slowing down, which will be a global slowdown, it's very likely that we'll see a sharp pullback in the price of oil as demand slows.

Oil Index chart, Daily

I'm showing the possibility for a rising wedge pattern for the oil stocks and this is based on the corrective wave structure of the rally from August. It suggests another 3-wave move higher into February to finish off the longer term rally (which suggests that oil will do the same thing). It takes a drop below the uptrend line from August, confirmed with a break below the 770 November low, to declare a top is in.

Transportation Index chart, TRAN, Daily

The Transports would look best with a small bounce and then another drop lower to the bottom of its parallel down-channel from July, potentially bottoming around 3900 later this month. A rally back above 4513 is needed to say we've seen the low for now.

U.S. Dollar chart, Daily

It's not very clear yet what the US dollar is up to. The rally off the November low left a corrective taste in my mouth and suggested we haven't seen the final low for the dollar yet (shown in dark red). A rally back above its last high at 77.85 would say the next leg up in its rally is underway.

Gold chart, February contract (GC08G), Daily

What the dollar does will obviously have an impact on gold's price (and other commodities) although if you compare the two you can readily see that it's hardly a direct inverse relationship. Gold has rallied much stronger than the pullback in the dollar in December would have warranted. Many flock to gold as a safe haven and the December jewelry sales boosted demand for the shiny metal. The relative lack of upside performance by silver suggests gold's rally may not be sustainable.

The wave count calls the leg up from December as the last one, as triangle patterns typically point to. Today's candlestick is rather bearish looking and if tomorrow's candle is a big red one then it will have created an evening star reversal pattern. In that case we should see gold start back down and a drop below 789 would confirmation of a top being put in (likely for a long time).

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

Tomorrow's economic reports will not move the market so it will be on its own with whatever rumors it can concoct. Earnings news could move the market although I suspect a lot of bad news is already priced in for now. A surprisingly strong earnings report could give the market a nice shot in the arm.

SPX chart, Weekly

The weekly chart shows price pierced the uptrend line from March 2003 this week but closed back above it today. The weekly candle so far looks like a very bullish hammer at support. With oscillators in oversold I'd say we're looking at a buy signal on this chart. How far the bounce will progress is anyone's guess but I wouldn't want to be short here.

Rumors are flying like mad that the PPT (Plunge Protection Team), which is the President's Working Group (a not-so-secret group that messes, er I mean, fixes our market with liquidity when needed. Supposedly President Bush had the group meeting last Friday to figure out what stops need to be pulled out to fix the market. The best they can hope for, imho, is to slow the carnage that's about to happen to the financial market but never underestimate the short term bullish effect this group can have on the market.

This is another reason the US dollar may tank again since the creation of more money that gets thrown at the market (in hopes of bypassing the piggish banks which won't let go of the hundreds of billions lent to them by the Fed) will fan inflation and depress the dollar. This group acts to support the stock market in times of stress and apparently the higher ups are feeling the stress big time. They do this by buying futures contracts on the major stock indexes. Many times you'll see their footprints pre-market in an attempt to fry the shorts.

According to some articles coming out of Britain (the UK Telegraph), the PPT is getting ready for action so shorts beware. I would not want to take a short position home with me, starting now. And if we get the final new low, as I showed in many charts, watch for a very strong v-bottom as the PPT pulls the triggers. The Bush administration of course has another agenda here--save the Republican party. With higher unemployment, people losing their homes, banks collapsing before our very eyes (but hush-hushed everywhere) and the stock market starting the year with the worst decline since the Great Depression (1932) it doesnt take a rocket scientist to know the PPT will be put to work.

Moral hazards be damned and free market be damned, this is war. At least that's how the PPT will feel about this. And they'll feel uniquely qualified to slay this dragon. They'll get fried in the process but not before doing serious harm to our economy and banking system in the long run, not to mention those who dare try to short this market. I agree with Ron Paul when he says the Federal Reserve system needs to be canned. It can't happen soon enough (and probably will when this is all over).

So be wary. The market could be in for some jolts out of the blue. The PPT will be trying to buy and big players will use the opportunities to sell. Think we've seen whipsaw in the past several months? Stand by. Trade very carefully right now and don't overstay your welcome if you've got some profitable trades. Sorry to say, longer term investors are probably safer on the sidelines. Protection of capital is far more important than return on capital right now. Be safe and I'll be back next Wednesday. I will of course offer updates to all this every day on the live Market Monitor. See you there.
 

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