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Market Wrap

Toughest Market in a Generation

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There have been many people coming out recently and talking about what a difficult market we've had lately (probably talking about the rough time since the high in October). On Monday afternoon Ron Insana on CNBC said "This is the toughest market to trade I've seen in 25 years. Jeff Cooper, who writes excellent market analysis (big Gann user) said "I'll see your 25 and raise you five." Cooper then added "The worst January in 18 years followed by the best week in 5 years followed by the worst 2-day loss since January 2003 underscores just how frantic the playing field has become."

Have you felt lately that you're a little out of synch with the market and really struggling to makes heads or tails o it (usually after you've been dumped onto your head)? You are not alone, not by a long shot. The bear market leg down from the 2000 high was very volatile and yet we're hearing from many respectable traders that it's worse now than anything they've seen in a generation. If the October high marked the end of the cyclical bull market and we've entered the next bear market leg down in the secular bear market then there's a good chance the next leg down will make the first one (2000-2002) look somewhat mild.

There is a major battle going on right now because we have so many people believing in the ability of the Fed to save the day, that we'll be able to save the banks, the bond insurers and the housing industry if only we could print more money and lower interest rates. If only it were that easy. Bull and bear markets are more a factor of mass psychology and herd mentality. When the mood shifts, which is what major cycles are all about, it needs to play out. The battle, and the price volatility, is simply a reflection of the mood swings between fear and greed (with fear winning out more than greed right now).

The market is on pins and needles currently about the bond insurers. If they can't be saved from downgrades by the rating agencies (which is looking doubtful but there are constant streams of hopeful news) then the pain of downgrades across hundreds of billions of dollars in insured bonds will take a tumble. So the market is trying to factor a lot of what-ifs right now and the multiple 100-point price swings in the DOW is merely a reflection of panic-relief cycles that are washing over the market right now.

Just be careful playing in the sandbox with the big guys throwing multiple tens of millions of dollars of market orders at each other. Be the little mouse who nibbles at the cheese while the cats fight and then scurry back into your hole, happy with your little morsel but more importantly that you're still alive.

I like to keep an eye on the techs because they are one of the better "sentiment" indicators. Jim has often mentioned the small caps (RUT) as a great indicator since the fund managers will often try to be ahead of the market so they don't get caught scrambling to buy or sell these high-beta stocks. I like the techs for the same reason.

Another reason I like the techs is because retail loves them. And retail can be a great indicator of the mood of the market. This also includes many of the fund managers who often get caught up in the same mood swings as the general public. Many of the sentiment indicators, such as the COT report (Commitment of Traders) will show "Commercials" and "Speculators". Retail (you and I) and mutual funds managers fall in the Speculator crowd. We want to trade with the Commercials since they're typically on the right side of the trade (although you have to be careful with that report since they're often ahead of the turn and build their positions and can tolerate the market moving against them for a while).


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So I want to spend a little time this evening looking over various measures of the tech sector to see what the message of the market we get from that. It makes for a few more charts than usual so I shrank them down a little so as to use a few less trees for those who like to print out the reports.

First, a brief review of the two lonely economic reports today--productivity and unit labor costs and then crude inventories.

Productivity and Unit Labor Costs
Q4 productivity improved by +1.8% making for a +2.6% year-over-year improvement. Productivity slowed down towards the end of the year as the economy has slowed, with a drop from the +6.0% rate in Q3. But it was better than the expected +0.5% increase. The lower than expected increase in unit labor costs, which came in at +2.1% vs. the expected +3.8%, helped the productivity number. The lower unit labor cost also takes off some of the inflationary pressure on the Fed although they are more concerned about unemployment right now since an increase in unemployment will increase the number of available workers and suppress wage inflation.

The following chart shows these measures over the past 18 years:

Nonfarm Productivity and Unit Labor Costs, courtesy briefing.com

After rising fairly steadily since the low in 2002, the unit labor costs have dropped sharply since last year's peak. This is often a harbinger of a coming recession as businesses slow down and cut costs.

Crude Inventories
U.S. crude supplies rose by a rather large 7M barrels to 300M last week. As will be shown with the oil chart later, oil is currently sitting on a neckline and much lower could usher in some stronger selling in the black gold. Gasoline and distillate stocks also rose, up +3.6M barrels and +100K barrels, respectively.

I'll review the broader averages, the DOW and SPX, and then review in a little more depth the tech charts.

DOW chart, Daily

On Friday and Monday the DOW bumped its head against the top of its parallel down-channel from October, just above its November low of 12724. It has since pulled back sharply. Possible support by this chart is the uptrend line from October 2002, currently near 12125. However, not drawn in is the same uptrend line drawn from March 2003 and price closed right on that line today. Right below that is the mid line of the down-channel near 12K.

The mid line of these channels can be very important. If price finds support at or above it and then heads back up to the top of the channel there's a good chance price will break out of the channel. So watch for that possibility over the next week.

The bearish thing I see is what MACD is doing (highlighted). When MACD returns to zero line after coming from overbought or oversold and then reverses back (down in this case, back towards where it came from), that's usually a very good trade signal. I'm using a faster than normal setting so my indicator is a little early but a cross back down here would be a sell signal. Support needs to hold here and price needs to rally back up in order to get MACD turned back up and above the zero line.

It takes a rally back above Monday's high near 12766 to get this back on at least a short term bullish path, in which case watch for a rally up to about 13300 and its downtrend line from October.

For the DOW, bullish above 12766, bearish below 11634 with a bearish heads up with a break below 12K.

DOW chart, 60-min

The DOW broke marginally below the bottom of a parallel up-channel from the January low. This channel is just a guide but if the market rallies tomorrow then it will look like the 50% retracement at 12206 essentially held and then it will time to see if it can challenge Monday's high.

** If instead of a rally above 12800 we see a bounce that retraces some Fib portion of this week's decline that is then followed by a new low, it confirms the bearish price pattern (dark red). Take a bounce and new low seriously as it could be followed by a significant flush to the downside.

SPX chart, Daily

No surprise, the SPX looks very similar to the DOW so the same comments hold for this one as well. The key upside level is Monday's high near 1396--get above that and we could see a rally as high as 1460 and its downtrend line from October. A break below the key level at 1310 (the mid line of the parallel down-channel) would be a heads up that something more bearish is about to play out (confirmed with a break below the January low near 1274).

Long above 1396, short below 1310, watch the chop in between.

SPX chart, 60-min

Like the DOW, price broke below the bottom of a parallel up-channel from the January low. It's currently close to a 62% retracement of the rally from January 22nd (the DOW is just under a 50% retracement). Depending on how the wave pattern is interpreted, this week's decline could be finishing a corrective pullback or is instead the start of the next big leg down. The pink wave count shows how it would typically look if we've got another rally leg coming (two equal legs up from January 22nd is near 1445 and then the October downtrend line is near 1460). The dark red wave count assumes the market is ready for at least a bounce but then will turn back down to new lows.

** Again, if we get a bounce followed by a new low below wherever the current decline finishes, that will be potentially very bearish. You'll want to be short the market if that happens. In the meantime, respect the upside from here.

Before looking over the Nasdaq charts I wanted to review a couple of things about the techs. As mentioned above, the techs provide a good measure of sentiment about the market and therefore watching them relative to the broader market can be a great way to get a sense of what's happening. Oftentimes a disconnect between the techs and broader market is a warning. When they're in synch you'll find the techs often leading.

I showed the following chart several months ago since it shows the relative performance of the Nasdaq (COMP) to the S&P 500 (SPX):

Relative Strength of Nasdaq vs. the SPX, Weekly

When I showed this chart last summer I pointed out the sideway triangle consolidation pattern. The pattern is a continuation pattern which means the techs will lead to the downside again when the market turns. This is a relative strength chart and the thing to remember with these is that the chart could turn down even if both are rallying. It would simply mean the SPX was outperforming the COMP in that case.

At this point we have a "throw-over" above the triangle pattern and now a drop back inside. That's a sell signal. If "price" drops below the bottom of the triangle (the uptrend line from 2002) it will be a confirmation of the sell signal and it's what I'm expecting to see. It would confirm in my mind that the techs will lead the way down relative to the SPX.

When I look at the NDX monthly chart I see that the index has dropped to the bottom of its longer term parallel up-channel from 2002. I showed a chart similar to this back at the end of October when I was pointing out the significance of time and price in marking a potential high:

Nasdaq-100 (NDX) chart, Monthly

I cut off the top of the rally into 2000 because it squishes price action since 2002 if I don't (remember, it topped out above 5000). Towards the end of October I pointed out that highs and lows during the 2002-2007 rally were found at the same time spans as the first rally from October 2002 to January 2004. After the July 2006 low the next time window was the last week of October. In addition to that there was a Fib price target at 2211 where the rally off the October 2002 low had two equal legs up. The high for the NDX was 2239 on October 31st. Gotta love them Fibs.

NDX is currently finding support at the bottom of its parallel up-channel. Bulls will look at this as an outstanding buying opportunity and normally I would agree. But the wave pattern, Fibs and time tell me we made a major high and have started the next bear market leg down (dark red). The only question here is whether we get a bounce now or from a lower level.

Now moving in a little closer on that chart, here's the weekly view:

Nasdaq-100 (NDX) chart, weekly

This simply shows a closer view of what's happening at the bottom of the channel and where NDX might find support if it drops a little lower--price level support near 1630 which acted as support and resistance in 2004 and 2005. I have the key downside level at the January low near 1693 because it would make the price pattern of the decline from October impulsive and say we have a confirmed trend change (in addition to a break of this long term channel.

So what other clues do we have as to what might happen to this index? Looking at some of the individual stocks could provide some clues. It would take a lot of work to post all 100 charts but looking at the ones with the biggest influence would certainly be helpful (one of which reported this evening, CSCO, and depressed futures after hours). Here are the top ten NDX-100 stocks (making up the QQQQ which represents this index):

NDX or QQQQ composition

AAPL and GOOG were the high flyers the last couple of years. I even used AAPL in my end-of-year special report on the use of the EW (Elliott Wave) roadmaps that you see me creating on my chart. AAPL and GOOG saw some heavy profit taking in January and that has had a large influence on the Qs. For the NDX I showed above how it has come down to the bottom of its longer term up-channel. This is not true for AAPL and GOOG:

AAPL and GOOG, weekly

First thing to mention on these charts is that I'm using the log scale. The rallies went parabolic last year and the price change from 2005 was drastic so trend line analysis is best done with log scales instead of arithmetic scales. As noted on the AAPL chart, it has broken below the uptrend line from April 2003.

GOOG's uptrend line is drawn from its August 2005 low because an uptrend line from its inception in August 2004 (my, how time flies) makes no sense because the stock went vertical until late 2005. Since then it rallied in the steady up-channel that's shown.

The point with both charts is that the high flyers, which have a heavy influence on the index itself (and now with CSCO disappointing with tonight's earnings announcement it's down from its close), are pointing to probably further weakness in the index (and the Qs obviously). The only stock holding up is QCOM but it hasn't really gone anywhere for more than three years now.

And that brings us back to the index itself. I'm using the COMP for the daily chart here since I've been following it the past few weeks after QCharts lost my NDX chart. I'll then use the NDX for the 60-min chart for a little closer look.

Nasdaq (COMP) chart, Daily

It's the same parallel down-channel that the DOW and SPX are in but obviously it started down a couple of weeks after the others peaked in October. After stopping at the top of the channel (parallel line was attached to the end of wave 2 which is the EW way of drawing these channels). Possible support will be at the mid line of the channel near 2250 if this week's decline is only a pullback that will lead to a break of the down-channel (pink). Otherwise a continuation lower will likely mean a break of the January low and a continuation down to the bottom of the channel.

For the COMP, bullish above 2420 (last Friday's high), bearish below 2250, possible choppy price action in between.

Nasdaq-100 (NDX) chart, 60-min

The bounce in the techs was weaker than that seen in the DOW and SPX. I show potential support near 1716 by a Fib projection for a sideways A-B-C correction (green) before rallying again to a new high for the bounce off the January low. If it manages to rally from here then two equal legs up from January gives us an upside target of 1904.

** Bearish below 1716 or if after a larger bounce it turns around and sells off to a new low. Bullish above 1862 (but maybe not much more above that).

Russell-2000 (RUT) chart, Daily

Another index, the same down-channel. The RUT didn't quite make it to the top of its down-channel before turning back down. It so far has a very corrective bounce off the January low, like the others, and therefore a break below the mid line of the channel near 675 would be bearish. A bounce back above Monday's high near 731 should be bullish for a run up to its downtrend line from October.

Bearish below 675, bullish above 731, potential chop in between.

BIX banking index, Daily chart

What a surprise--another parallel down-channel. The banks rallied up to the top of the channel on Friday and have since sold off. If it can find support at or above the mid line near 250 and then rally above Friday's high near 297 it should be bullish. While it would be bearish below 250 I think it's time to exercise caution about the short side on banks. There is a very good possibility that one more new low, with a downside target near 212, could finish the selling for the banks, at least for a while. They've been sold hard and unless financial Armageddon is upon us (could be) I don't see them selling off lower than 200.

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

The buyers of home builders got carried away last week and rallied the index above the top of its down-channel (from the February 2007 high). It achieved a Fib projection just above 409 for an a-b-c bounce off the November low (to complete a 4th wave correction, labeled in dark red). That wave count calls for one more leg down, like the banks, before the decline from January will look complete. I like the Fib projections aligned near 213-216 for a downside target if selling takes over. Otherwise a turn back up and rally above 445 will be bullish for at least a larger correction of the 2007 decline.

Oil chart, Oil Fund (USO), Daily

Oil is perched on a neckline along the December and January lows, near 68.30 for USO and just above $85 for the March contract. As long as price holds above this neckline we could see another rally attempt (or at least a bigger bounce). Otherwise the decline could pick up some speed.

Oil Index chart, Daily

If oil stocks can turn around and rally back above last week's high near 802 then a run up to at least 830 should be next. Otherwise a break below the January low will put this into a bearish price pattern. Possible support along the way will be its uptrend line from March 2003 near 690 and the August low near 675.

Transportation Index chart, TRAN, Daily

The Transports are in a very volatile price pattern and making it very difficult to figure out where to next. It poked above the top of its parallel down-channel but has since dropped back inside. MACD is threatening to curl back over out of overbought. As above, so below means it could dip below the bottom of its down-channel if it takes another trip back down. Talk about confused traders in this index!

U.S. Dollar chart, Daily

The US dollar is giving me the sideway triangle feeling--a continuation pattern that works off some of the oversold conditions before making one more move down. But a break above 77.85 will be bullish while a break below 74.48 will be immediately bearish (but perhaps not for much of a drop. Not shown is the possibility the dollar will chop its way lower to the bottom of its channel (dark red). A choppy move down like it has done since the December high would be an ending pattern and suggest a longer term bottom is about to be made. Need to see how this plays out over the next couple of weeks to get sense of its direction.

Gold chart, Gold Fund (GLD), Daily

Gold sold off after tagging the top of its longer term parallel up-channel from July 2005 and almost reaching the top of its shorter term up-channel from August. But the price pattern is not clear yet and it has me wondering if gold is going to push to one more new high as shown in green. I have some Fibs pointing to 966 for the shiny metal if it does push back up. A drop below the January 22nd low of 85.77 (855 for the April gold contract) would negate the upside potential and point to a move down to the apex of its previous sideways triangle pattern near 79 (810 for gold).

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

Tomorrow's reports shouldn't be market movers (ignore the Crude Inventories report--that came out today).

CSCO depressed futures this evening so that could have more of an influence over tomorrow morning's trading than the economic reports. But, as we've seen time and again, the reaction in the futures to these earnings announcements has often been reversed the following morning and it seems to catch a lot of traders leaning the wrong way so be careful around tomorrow's open.

There are a lot of arguments about whether or not we're in a bear market. Many arbitrarily assign the value of a 20% decline in the stock market as a sign of a bear market. While I suppose it's a decent guide, it is arbitrary. How about the 18--month moving average:

SPX chart, Monthly, 1991-2000

Other than the brief dip below the 18-month moving average in 1998 (Long Term Capital Management banking crisis), this average did a great job supporting the rally through the 1990s. And after 2000?

SPX chart, Monthly, 2000-present

Any questions? We're in a bear market. The last time this average was broken was in late 2000 and it held prices down until it was broken to the upside in 2003. It has now been broken to the downside in January. If we get a bounce back up to it, currently near 1419, use it as your opportunity to lighten up on long positions and enter some longer term short positions. KISS.

Watch for early volatility Thursday morning if CSCO spooks traders. The negative futures tonight may or may not carry over. The pattern of the decline this week has me thinking we should be looking for a bounce. It's dangerous stepping front of a strong decline so be careful if you're trying it. If you're looking for something other than a day trade (hard to do in this market), here is a summary of important price levels to keep your eye on:

DOW--bullish above 12766, bearish below 11634 with a bearish heads up with a break below 12K.

** If instead of a rally above 12800 we see a bounce that retraces some Fib portion of this week's decline that is then followed by a new low, it confirms the bearish price pattern (dark red). Take a bounce and new low seriously as it could be followed by a significant flush to the downside.

SPX--Long above 1396, short below 1310, watch the chop in between.

** Again, if we get a bounce followed by a new low below wherever the current decline finishes, that will be potentially very bearish. You'll want to be short the market if that happens. In the meantime, respect the upside from here.

COMP--bullish above 2420 (last Friday's high), bearish below 2250, possible choppy price action in between.

NDX--bearish below 1716 or if after a larger bounce it turns around and sells off to a new low. Bullish above 1862 (but maybe not much more above that).

RUT--bearish below 675, bullish above 731, potential chop in between.

Good luck in this market. Remember, you're not the only one struggling with this whippy thing. Professional traders with beaucoup experience are having a very difficult time. I know everyone feels they're wasting their time if they're not trading but the long timers will tell you (read Jesse Livermore) that their success was as much dependent on knowing when to be out of the market as when to be in it. Flat is a position. See you next Wednesday on each day on the Market Monitor where we'll try to ride this pony with some profitable trade setups.

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