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Market Wrap

Calling for Air Support

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After INTC's disappointing report last night, the overnight futures took a steep drop. Much of that drop had been recovered before the cash market opened this morning and then we got a little bounce right after the open. The first 15 minutes of trading was an effort to smoke the bears out of their holes. The bears just dug in and started mowing down the bulls and the cash market then dropped down while futures tested their overnight lows. That's when the leaders of the bulls started calling for some air support (that would be for Uncle Ben and his squadron of helicopters).

The bulls are getting frustrated at the constant pressure from the bears and they're getting desperate for the Fed to do what they believe is the right thing--shower them with more money and cheaper credit (which got us into so much trouble the first time) to get this market back up. The Jim Cramers of Wall Street have got to be the biggest group of whiny babies I've ever seen. They know the system needs a cleansing but they can't stand the idea that the market sometimes goes down before it goes back up. And they seem to really believe the Fed can save the day!

The Fed started cutting rates back in August (8/17) where the SPX had closed at 1411. Three rate cuts later and the S&P 500 is trading 40 points lower. Guess where the market will be after a fourth, and a fifth, and a sixth rate cut? There were 12 rate cuts between January 2001 and June 2003. During that time the S&P 500 dropped from about 1350 to below 800. Will we have the same kind of drop in our future? That's anyone's guess but the point is the Fed follows the market and the fact that they're cutting rates is not a good sign for the stock market.

Many will respond to my statement by saying "yes but the market is all-knowing and it knows a rate reduction campaign by the Fed will result in a stock market rally later and we're buying in anticipation of that." To which I of course say "hogwash". First of all, why buy the market now when it's got a big decline in front of it (wait for lower prices to buy) and second of all, wait for the Fed to start Raising rates again since that's your clue that the Fed sees growth returning and the stock market will rally during their rate-increase campaign. The market has it completely backwards and yet the screaming Cramers insist the Fed can save the day. Get real Jimbo. Booya.

And this is not a new phenomenon. I've shown this chart before which shows how central banks follow the market lower with their rate cuts:

Central Bank Rate Cuts in Down Markets, courtesy Elliott Wave Int'l

During major bear markets the central bankers start doing everything they can to stop the bleeding. They want to prime the economic pump with cash and lower interest rates in hopes of getting businesses to invest again and consumers to spend. What they don't understand is that bear markets are due to the change in psychology of the people and as they become more fearful they stop investing and spending. This is a natural cycle. One of the things that has held off the bear cycle in the last many years is an abundance of cash and credit, but in the process it created some very damaging bubbles. Who could possibly say the housing bubble was a good thing? If you were a seller at the peak then you'd say it was a good thing. But the massive losses that are starting to hit is just the beginning of the unwinding of the credit bubble.

The easy credit caused an inflation of just about all assets and it kept the punch bowl full and partiers happy. But eventually all parties must end and we've got a real hangover now. We've had way too much punch (credit) and people are outside on all fours and not feeling so good. Stand back as people (the markets) get rid of their binge drinking. No one likes the feeling after the party, and we usually swear we'll never do it again, but we are human and humans do in fact do it again. The markets repeat cycles because the markets are made of people and collectively we react the same way as we did back when the stock market consisted of two people trading on the street corner.

So we've got some tough times ahead of us and the only surprise for me is how incredibly long it's taking to manifest itself. I'm bearish the stock market and you know I've been bearish the stock market for a while. So I'm a bear and I have the claws to prove it (and the impalement injuries from the bulls' horns). Bears have cried wolf so many times in the last year that they're simply laughed off the stage anymore. And when the bear market arrives (as it has) people will just say "well, even a broken clock is right twice a day". The fundamental reasons for a bear market have been in place for some time (the need to cleanse the system of the excesses created from easy credit) and it's been a matter of time before enough fear in market participants starts to have a collective effect. We're starting to see that now.

But the market never moves in a straight line and as I mentioned in last night's Market Wrap, I think we're getting very close to a tradeable bounce. I suspected we'd get a bounce today (even though the after-hours futures last night made that look dubious at best) and then head for another low to finish the decline from the December high. I still think that pattern looks good and I will show that in tonight's updated charts.

A look at the numbers in the table above shows a mixed to bearish day today. First of all I don't trust the volume numbers that I downloaded (from Yahoo's financial site). But the other numbers look good as far as I can tell. You can see the advancing and declining issues came in very even but the new 52-week lows continue to overwhelm the new highs, nearly 7:1 today. After yesterday's washout numbers it certainly seems like we should be close to putting in a bottom. Yes, crashes come out of oversold but I don't get that sense from the charts. Besides, Uncle Ben has his helicopters warming up and he should be ready to sprinkle his fairy dust on the market.

Economic reports
Today's reports were generally ignored. The initial reaction at 8:30 AM was a drop in the equity futures but then they were magically lifted before the cash market opened. We had CPI data, industrial production and capacity utilization numbers, crude inventories and then the Beige Book at 2:00 PM.

CPI and Core CPI
December's CPI came in at 0.3% while Core CPI was 0.2% ( 4.1% and 2.4% year-over-year, resp.). Energy prices were up "only" 0.9% which is small after the huge 6% gain in November. The core rate continues to tick higher and is the highest rate since March and up from 2.1% in September.

The following chart shows the CPI relative to where it's been over the past 15 years:

CPI, courtesy briefing.com

You can see the spike up in CPI (red) in recent months while the core rate (blue) has stayed relatively benign although starting to rise again this year.

Energy is not surprisingly the largest culprit in the rise in the core rate ( 17% yoy). Commodity prices were up only 0.1% from a year ago. Other areas that boosted the core rate were medical care services ( 5.9% yoy) and education ( 5.6% yoy). Rents have slowed down a bit, up 2.8% yoy which is down from 4.1% at the beginning of 2007.

Industrial Production and Capacity Utilization
Industrial production for December was unchanged from November. Capacity utilization, at 81.4%, was also essentially unchanged from November. Both of these were just slightly better than expected. With manufacturing utilization dropping to 79.7% these numbers do not put any inflationary pressures on products. But if businesses slow down in their capital investments then a reduction in capacity utilization will be more reflective of a recession than worry about inflation.

Between the inflation data and industrial production data most of the talk is about expectations for the Fed to cut the Fed funds rate by 0.5%.

Crude Inventories
Crude supplies rose 4.3M barrels to 287.2M which was a higher rise than expectations. Gasoline supplies also rose by 2.2M barrels and distillate stocks were up 1.1M barrels. Prices dropped across the board today (probably helped by a rally in the US dollar).

Beige Book
The Beige Book showed most regions of the country grew at a modest pace in late November and December. And while growth was modest the pace of that growth is slowing. While the unemployment rate has spiked higher the Fed reports a tight labor market. On balance the report showed little reason to aggressively lower interest rates while inflation ticks higher. There was little reaction to the report this afternoon except for an effort to rally the market after the report came out, but it fizzled into the close.

Not a lot changed from last night's charts but I'll go quickly through them and note the changes and what to watch for.

DOW chart, Daily

Today left a long-legged doji which simply means lots of indecision from today's trading. The numbers in the table at the top of this report reflect the same thing. Once again the DOW was unable to close above the August low near 12518 which would seem negative. But support should not be far away if we see a down day tomorrow. And it may not drop down out of the gate. Just as we had a very choppy day today, we could see the same thing on Thursday. I had mentioned last night (right Bob?--wink) that we could see a choppy day as the market works its way lower. That goes for tomorrow as well. The bottom of the parallel down-channel shown on the chart is near 12370.

DOW chart, 60-min

The ideal thing, from an EW (Elliott Wave) perspective would be another new low by the end of the day tomorrow. That would complete a 5-wave move inside a descending wedge pattern from the high on December 10th. The bottom of the wedge is near 12350 by the end of the day so I see potential support in the 12350-12375 area. The new low should be accompanied by more bullish divergences and I would consider this setup to be one of your better buying opportunities for a trade that should last at least a week or two and ride the DOW back up to perhaps the 13K area. A rally above today's high of 12613 would be a heads up that we might be starting the rally without a new low and above 12790 would be confirmation of that. In the meantime watch the chop.

SPX chart, Daily

The SPX daily chart shows a doji day with a minor poke below the August 2007 low. So the SPX has confirmed the break of that low by the DOW. As a reminder, this is the low that needed to break in order to confirm that the bullish wave count possibility that I had been carrying on the charts is no longer valid. It also confirms the bearish double top from July and October. This to me confirms that we are in fact in a bear market now. Today's decline tagged the March 2007 low and found support there (1364). The bottom of its parallel down-channel is near 1360 tomorrow.

SPX chart, 60-min

Like the DOW it would look good from an EW count perspective to see another low tomorrow and I like the 1358-1360 area for a downside target. It doesn't mean it has to get there but if it does then I'd start looking for support to hold and do some buying. The 5th wave in the move down from January 10th would equal the 1st wave at 1358 and the middle of the little down-channel crosses the bottom of the larger down-channel by the end of the day tomorrow at 1360.

I've mentioned before that the Fed hates shorts. Greenspan made it abundantly clear and Bernanke's actions make it clear that he as well loves a bear fry (he made a pre-market surprise rate cut on August 17th which was Friday of opex week). I commented in today's Market Monitor that it wouldn't surprise me if he pulled the same stunt this week. And now I'm showing a price pattern that looks like it could finish with a low by the end of the day tomorrow. Traders will go home thinking they might be safe in some short SPX positions and Bernanke will fry them Friday morning with a MUCH higher settlement price for SPX. And then Bernanke's banker buddies will buy him a round at the bar Friday night. Even Cramer will buy him a drink.

That is of course pure speculation on my part (about the drinks anyway) but Bernanke did let everyone know last week that he's prepared to aggressively cut rates to accommodate a slowing economy. Many have been surprised that he hasn't already cut rates after the kind of language he used. Was that his warning to shorts? I'd be real careful about short positions carried over Thursday night, or any night for that matter.

And if Bernanke surprises the market tomorrow then we could see the rally kick off sooner than I'm showing. Shorts need to be very careful now, regardless of what Uncle Ben will or will not do.

Nasdaq (COMP) chart, Daily

The COMP tapped support at its uptrend line from October 2002. This is a major uptrend line although it's been untested (until now). Like the others I see the possibility for another low tomorrow but I think this support level will hold on a closing basis, if not tomorrow then by Friday (so on a weekly closing basis).

Nasdaq (COMP) chart, 60-min

Trendline support near 1350 might get tagged if the market drops back down tomorrow. If you're short the market you should be bringing your stops down much closer now. Again, watch for bullish divergences to continue at new price lows as a signal that the selling is abating and look for a buying opportunity for a run higher into next week.

Semiconductor Holders (SMH), Daily

The EW count looks complete and price tagged the Fib projection at 27.67 (for equality between the 1st and 5th waves in the move down from July 2007). Confirmation of a bottom will be a rally above 29.25 but I like the setup here for a long play in the semis.

Russell-2000 (RUT) chart, Daily

The RUT has been playing around at the bottom of its parallel down-channel and the choppy price action over the past four days while price worked its way lower is typically a good sign of an ending pattern. The RUT has been holding up relatively well as compared the other major indices and this could be a bullish sign as smart money rotates some funds into the small caps in preparation for a rally. I'd suggest following smart money.

Russell-2000 (RUT) chart, 60-min

I show another low to be made by the RUT, to be in synch with the others, but today's low might have been it. It's a little harder to tell with this index. Maybe just a retest of today's low. Regardless, a break above today's low would be an indication that a bottom has been found and I would look to buy pullbacks from there.

BIX banking index, Daily chart

There are a couple of indexes that give me a little heartburn about expecting the market to rally after only a minor new low (if not from here). The banks are one of them. The pattern of the move down from the December high should be a 5-wave move if it's to be the last leg before setting up a larger rally/correction. So far the move down is only a 3-wave move and as depicted in dark red, we should see another decline which could potentially drop down to the 220 area. Any rally above the key level of 267.26 (which would violate the bottom of wave i) would suggest we've already seen the low for now. Until then I think we'll see lower prices before the banks are ready for a stronger bounce.

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

The home builders (and the Transports) have the same wave pattern as the banks and consequently they would look better with one more new low before they're ready for a stronger rally. One possibility, shown in pink, would be a larger sideways/down consolidation (similar to what it did in October/November) before heading lower. This kind of consolidation would be a result of weak conditions where oversold is worked off in time rather than price. So if the builders bounce from here then watch for resistance at the top of its down-channel otherwise look for another low directly from here.

Oil chart, Oil Fund (USO), Daily

The two possibilities that I see for oil are for USO to find support at or above 69.80 (today's low was 70.49) and head higher again (green) or else continue its decline to support near 64 which is a Fib projection for the current leg down and a price high at the end of September 2007. This would be equivalent to about $80 oil. From there it should correct the decline before heading lower into the summer. It takes a rally back above the 79.09 high to negate the bearish wave count.

Oil Index chart, Daily

Oil stocks have stumbled badly the past two days and today they broke the uptrend line from August 2007 as well as its 100-dma. Watch for a little bounce back up to retest its broken uptrend line or a further drop before bouncing up for that test.

Transportation Index chart, TRAN, Daily

Like the banks and home builders, the wave pattern for the Transports would look best with another low to complete a 5-wave move down from December. If it drops as depicted it should find support at the bottom of its parallel down-channel near 3900. It takes a rally above 4513 (wave i low), which would be a strong rally just to get to that level, to suggest we'll see it rally up to the top of its down-channel.

U.S. Dollar chart, Daily

The US dollar got a strong bounce today and as you can see by the large white candle it engulfed the previous 4 days of trading. That's a bullish candlestick. Follow through (what's that?) would mean a rally to a new bounce high and two equal legs up would be at 78.57 and the top of the down-channel is near 79.50. A drop back below 75.20 would likely mean the dollar is headed to new lows.

Gold chart, Gold Fund (GLD), Daily

Dollar bulls mean gold bears and the solid up day in the US dollar today was not good for gold bulls. The last two days of selling is a sharp reversal of its rally up to the top of a parallel up-channel for price action since the July 2005 low. If it reverses higher (likely with a drop to new lows for the US dollar) then the top of its shorter term up-channel near 92.50 would make for a good upside target. But until it makes a new high above yesterday's 90.35 high, I'm looking for the current pullback to grow some legs. Gold is a short against yesterday's highs and if it plays out like I think it will (dark red), it's going to be pretty shocking to a lot of gold bulls. But it's obviously very early to make that kind of call.

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

Since it looks to me like the chart on the home builders is calling for another low before finishing the leg down from December, perhaps that means more disappointing news on housing starts and permits. The only other report that might move the market is the Philly Fed index tomorrow at noon.

SPX chart, Weekly

The bearish double top in July and October has been confirmed with a break below the valley in between which of course is the August low. This negates the potential for a bullish wave count on SPX and I'll be removing it from the chart. We're officially in a bear market according to this chart. Therefore the next bounce in the market should set up a very strong decline into the early part of the summer. Then we should get another strong bounce back up which will be followed by another strong decline. Get yourselves a ready supply of Dramamine for motion sickness as we could be sailing some rough seas this year.

As I mentioned on most of the charts, we should be very close to a good tradeable bottom, if today's low wasn't it. When I say tradeable bottom I mean just that--it's a long play for a trade and nothing more. I see the potential to rally into the first or second week of February (potentially lasting longer although then it would be a choppier kind of move with a deeper pullback in the middle of the bounce) so I think it's a trade worth making. Once the bounce is complete it should set up one of the best shorting opportunities we'll see this year (as far as downside potential).

But we'll let the market tell us whether or not that short play will set up next month or not. In the meantime let's see what we get for our efforts to buy a bounce. If we do get a new low tomorrow then be looking to nibble on a long. For quite a while now I've felt it would be dangerous to be long overnight or the weekend. With the Fed hot to trot to lower interest rates, and fry bears in the process, I would not want to be short overnight or over the weekend. Have a couple of cheap OTM calls stuffed into your pockets if it looks like there's even a hint of a coming rally. Usually all it takes is a catalyst to make the market move in the direction the chart is telling you it could go.

As I mentioned last night, we are potentially still in the little descending wedges shown on the 60-min charts of the broader averages and these patterns are notorious for lots of choppy price action with lots of whipsaws (like today). I see the possibility for that to continue through tomorrow. If the lower levels that I identified get tagged tomorrow and it looks like support could hold, it'll be time to nibble on some longs. By all means tighten up your stops if you're still short.

Good luck tomorrow and the rest of this opex week. See you back here next Wednesday and on the MM each day.
 

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