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Market Wrap

Market Wrap

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Wednesday, February 27, 2008

Volatile But Flat


1.0 Overview

1.1 Markets at a Glance--Choppy Whipsaw Price Action
1.2 Market Hopes for Bond Market Save
1.3 Economic Reports

2.0 Equities

2.1 S&P 500 Index (SPX)
2.2 Dow Jones Industrial Average (DOW)
2.3 Nasdaq-100 Index (NDX)
2.4 Russell 2000 Index (RUT)

3.0 Featured Industry Groups

3.1 Banking Index (BIX)
3.2 U.S. Home Construction Index (DJUSHB)
3.3 Transportation Index chart (TRAN)

4.0 Currencies

4.1 U.S. Dollar (DXY)

5.0 Commodities

5.1 AMEX Commodity Index (CRX)
5.2 Oil Fund and Index (USO and OIX)
5.3 Gold Fund (GLD)

6.0 Summary, and a look at the VIX


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1.0 Overview

1.1 Markets at a Glance--Choppy Whipsaw Price Action

Since the bounce off the January 22nd lows, topping on February 1st, this market has been stuck in neutral. It keeps racing its engine, in an effort to scare the bears, but each attempt to get off the starting line results in an engine that coughs, sputters and stops. The bears then pounce only to get thwarted by the bulls shaking them off and restarting the engine. Rinse and repeat. One month and we've gone nowhere.

For those who continue to struggle to trade this market (and probably losing money or simply not making any headway after constantly getting stopped out), take heart--even the professionals are not having much luck. I read that the Citigroup trading teams (you know, the ones that made a gazillion dollars for their bank the past few years) have not been doing well either. These are the guys with all the sophisticated hardware money can buy, information (including inside) up the wazoo (not to be confused with money up the wazoo) and free money from the Fed to play with. And yet for each of 15 days this year they've lost $100M or more. That's $1.5B in trading losses. Probably just more "rogue" traders (wink).

The chop and whipsaw price action will end but the question remains when. It clearly looks like a consolidation pattern but whether it goes sideways, we get another leg up, or it drops from here is not yet clear. But one thing that is clear is that the longer it consolidates sideways the more bearish it becomes (the consolidation is a continuation pattern). From a trading perspective, this is probably the worst time to trade. It's boring but unless you're good at scalping day trades I'd stay away until this log jam breaks.

1.2 Market Hopes for Bond Market Save

Between Friday's "leak" of news on the saving of the bond insurers' credit rating, and a repeat of it on Monday, and then hopeful news that the Fed will keep easing rates followed by news that Fannie Mae and Freddie Mac will have their limits raised on March 1st for mortgage holdings, the market's hopes have been kept alive. This smells to me like a government bailout in the making. If you're bearish the market you probably think it's bearish that all this hopeful news has not resulted in a break to the upside.

One point about Moody's and S&P maintaining their credit rating on the bond insurers, there's really very little that has changed to support the AAA rating. But one theory being passed around is that the rating is being held high until the banks can close their books at the end of this month and keep the mark-to-model prices intact. Once we get into March those bond insurer ratings could get downgraded in a heartbeat. Be careful in this market.

But one could say it's bullish that so much negative news recently, such as slow growth, poor home sales, increases in core inflation and plunging consumer confidence (which has always pointed to a recession), has not been met with lots of selling in the market.

On the bulls' side is a flood of money coming into the system, resulting in new US dollar lows and increasing inflation. But the bears argue that the bulls haven't been able to do anything with it. I argue that the bulls' hopes for a save from Uncle Ben and Uncle Sam are just that--hopes. It's that ol' slippery slope of hope.

Speaking of money supply, I haven't shown the M3 money supply chart in a while. Very interesting:

Calculated M3 Money Supply, courtesy nowandfutures.com

Since 2004 the money supply is going parabolic and since last summer you can see by the rate of change (blue line) that it's skyrocketing. Just this year it has spiked much higher. It's not surprising the US dollar is taking a hit and inflation is taking off to the upside. I'll show a chart of commodities later but this is all causing quite a run up in the commodities, which has an impact on core inflation.

Bernanke started two days of testimony and he told Congress that the central bank remains committed to fighting a slowing economy (while ignoring inflation for now). It seems the Fed members are convinced that a slowing economy will automatically reduce inflation. After all, how can inflation climb when the economy slows down? How quickly they forget--go look at the 1970s. Arthur Burns dropped interest rates to fight a slowing economy (supposedly to help Nixon's reelection) and it took Paul Volcker several years later to break the back of inflation even while the economy still struggled. We've got a bunch of academics running the central bank and my concern is that they really don't know what they're doing. It's widely expected by the market that the Fed will further cut rates again in mid March, and I'm sure it will be equally successful in rallying the market (Not).

In the meantime the bond market is not in full agreement with the Fed. Inflation seems to be a greater concern as rates have been ticking higher:

10-year Yield (TNX), Daily

Bonds have been consolidating since the February low (high for yields) and as the yield chart shows, it's holding onto its uptrend line from January while fighting the downtrend line from October. I show two possibilities from here: the first is a slight push higher followed by a pullback and then another leg up to a Fib target near 4.3%; the second is a push higher to 4.3% from here. The jump in TNX (and the steeping in the yield curve) warns of inflation even if Bernanke and crew have decided not to pay attention to it right now. And remember, the mortgage rates are derived from the 10-year yield, and the LIBOR rate which also has remained stubbornly high.

1.3 Economic reports

Durable goods orders and new home sales were the two big reports this morning, neither of which is bullish. But it didn't stop the bulls from trying to rescue the market this morning (just couldn't hold onto the gains).

Durable Goods Orders
Orders dropped by -5.3% (-1.6% if you remove transportation orders). Core capital goods orders dropped -1.4% (-10% with aircraft and defense orders), indicating businesses are not confident enough in the near future to commit to capital improvements even with strong balance sheets and money in the bank. IBM would rather buy back its stock to manage earnings rather than invest in their business. Over the past six months the durable goods orders have dropped -15%.

You can see by the charts of orders that the trend has been down since the peak in 2005-2006 (courtesy briefing.com):

New Home Sales
January new home sales were down -2.8% or 588K on an annualized basis. But sales are down -19% over the past three months and -58% since the peak in July 2005. Sales are currently at a 13-year low. New home prices have dropped -15% from a year ago and -18% from the peak last March. Inventories of unsold homes are at a 9.9-month supply, the highest in the 17 years that this data has been tracked (so it's now off the chart). Lack of credit availability is being blamed for part of the reason buyers are not showing up.

The chart of new home sales and prices is downright depressing for anyone looking to sell a home right now (courtesy briefing.com):

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2.0 Equities

Back in October, as I was pointing out the setup for a market top, I showed a chart of SPX from 1999 to 2007. Jeff Cooper does a lot of good analysis on market symmetry and I liked what he was pointing out back then. He pointed out that the July 2002 low was slightly undercut in October 2002 to a minor new low. Then five years later (same period of time as the rally off the 1932 low following the 1929 crash) we had a high in July 2007 followed by a minor new high in October 2007. Nice symmetry there.

Following the October 2002 low the market rallied and thendropped back down in March for a higher low and it was off to the races from there. So the question is whether or not we can expect the symmetry to continue. If yes then a bounce into the 2nd or 3rd week of March could be in the cards. And if the rally fails at a lower high, which is what I expect to see if it indeed rallies, then it could be off to the races to the downside this time.

So we'll start with a look at the weekly charts for each of the four major indices I cover and work our way down to the 60-min charts in an effort to see what could play out in the next month:

2.1 S&P 500 Index (SPX)

SPX chart, Weekly

I show a downtrend line from the October high through the December high and then a down-channel off that (only as an initial guide). I then have a Fib projection for where the bounce off the January low would have two equal legs up (1442.72) for an A-B-C bounce (in pink). This happens to coincide with both the downtrend line and the broken uptrend line from October 2002 the week ending March 21.

The other possibility, shown in dark red, is for price to chop sideways into March as it completes a sideways triangle before dropping to new lows into April. It could of course drop straight from here and a break below 1317 would confirm a potentially very bearish wave count, shown on the daily chart:

SPX chart, Daily

For the sideways triangle pattern I show a continuation of it into mid March and then a rally out of it (instead of breaking down as shown on the weekly chart). This would set up the rally leg into the 3rd week of March and a test of its downtrend line from October (and broken uptrend line from October 2002). From a Fib projection and retracement perspective I can see the possibility for a rally to 1460. As shown on the chart (target symbols), the key levels are 1317 below and 1396 above (as has been true for a few weeks now). A break of either should indicate the direction of the next move. A heads up for the downside would be a break below 1350 and then 1327 (Feb 22nd low), hence these are the keys levels to watch:

Key Levels for SPX:
- Short term bullish above 1396
- Longer term bullish above 1460
- Short term bearish below 1327 and then 1317
- Longer term bearish below 1270

SPX chart, 60-min

Once again, the borders of the sideways triangle (thicker red lines) are shown on the chart as well as a parallel up-channel from the January low. A rally above 1396 would suggest a move up to the top of the channel and that crosses the downtrend line from October near 1450 next week. So if we get a rally in the next week watch that level and timing for a potential top to the bounce off the January low. But a break below 1350 from here would suggest we'll either stay stuck in the sideways triangle or we're starting to break down. A break below 1317 would negate the triangle pattern and suggest a strong decline is in progress.

2.2 Dow Jones Industrial Average (DOW)

As usual the DOW charts look very similar to the SPX charts:

DOW chart, Weekly

On the weekly chart I'm not showing the sideways triangle as a continuation pattern like I did for SPX. It has to do with the overlap at the February 1st high (12766) and the November 26th low (12724) and that negates the possibility that the triangle is a 4th wave correction. All it means is that we're either getting ready for a monster drop or else we'll get a continuation of the bounce off the January low and for that scenario I like an upside target just above 13200.

That would be an a-b-c rally off the January low with equality between the two legs up at 13202. It also coincides nicely with the downtrend line from October. As shown on the chart, any rally above 13220 would be bullish.

DOW chart, Daily

On the daily chart I'm showing a small parallel up-channel for price action since the January low. This is for guidance only but what's interesting is that the top of it crosses the October downtrend line at 13218, the 62% retracement of the Oct-Jan decline, on Friday. That would be a 500-point rally in the next two days and frankly I have my doubts about that one. But the two Fibs coinciding just above 13200 suggest it could be strong resistance if and when it gets there.

Key Levels for DOW:
- Short term bullish above 12767
- Longer term bullish above 13220
- Short term bearish below 12155 and then 12070
- Longer term bearish below 11634

DOW chart, 60-min

Price stalled just under the 12767 level from February 1st but it looks like it's consolidating for a run higher and if it does then a run up to 13200 is the target (it will probably take longer than by Friday that I've depicted on the chart).

2.3 Nasdaq-100 Index (NDX)

Nasdaq-100 (NDX) chart, Weekly

Like the DOW, NDX found support at the bottom of its parallel up-channel from October 2002. That's a bullish setup for at least a bounce. The best that NDX has been able to do is consolidate. That's bearish. The pattern of the consolidation since the January low suggests it could let go at any time and if selling kicks back in then a downside Fib projection is the 1550 area. The January 2004 high near 1560 would likely be good support.

The daily chart shows the consolidation pattern has formed a sideways triangle, typically a continuation pattern (meaning it should continue down from it):

Nasdaq-100 (NDX) chart, Daily

A lot of people are watching the sideways triangle and expecting to play the break. It always makes me nervous when too many people are watching the same thing. So I've been thinking that we could get a head fake break to the upside (throw-over finish) followed by a collapse back inside the pattern (a sell signal). A break below 1715 would be the confirming sell signal, especially with a break below 1693. But if the bulls can drive this above 1865 then it would negate the triangle pattern and suggest a rally at least to 1900 if not 2000.

Key Levels for NDX:
- Short term bullish above 1865
- Longer term bullish above 2000
- bearish below 1715, confirmed with a break below 1693

Nasdaq-100 (NDX) chart, 60-min

The bounce off the February 24th low looks choppy and corrective and therefore supports the sideways triangle pattern. But one could easily argue the bullish case here with what appears to be a consolidation at the highs the past two days in preparation for a break to the north. As shown on the chart, the first upside Fig target is just below 1848 (two equal legs up from February 7th and then 1910-1920 where trend line and Fibs may be strong resistance.

2.4 Russell 2000 Index (RUT)

Russell-2000 (RUT) chart, Weekly

The RUT's weekly chart shows the same setup as NDX--it looks like price is consolidating before another leg down. If price does drop as depicted then a downside Fib projection is at 606 (where the 5th wave would equal the 1st wave in the move down from the October high). This coincides with the April 2004 high and would be a very good setup to trade a bounce back up to current levels.

Russell-2000 (RUT) chart, Daily

As mentioned a few times now, it's not clear whether we'll see another leg up as part of a larger A-B-C bounce off the January low (pink) or if instead price will drop from here. The daily chart shows the key levels to play off--735 to the upside and 683 to the downside. Potential chop in between (as we've seen).

Key Levels for RUT:
- Short term bullish above 735
- Longer term bullish above 770
- Short term bearish below 683
- Longer term bearish below 650

Russell-2000 (RUT) chart, 60-min

I've tightened the key levels a little on the 60-min chart since a break above today's high near 724 would be a good indication that the rally is continuing. A break below 694 would likely mean at least a test of the 683 area (might be slightly lower to test the bottom of a possible bull flag pattern). You can see that a solid break below 680 would be bearish.

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3.0 Featured Industry Groups

3.1 Banking Index (BIX), Daily chart

For all the "good" news for the banking industry lately the bulls certainly haven't been able to capitalize on it. There are a lot of small-bodied candles this month. While it could still push a little higher and tag the top of the parallel down-channel, as it did February 1st, currently near 280, the pattern looks like a continuation lower should be expected. It takes a rally above 297 to negate that bearish expectation.

3.2 U.S. Home Construction Index (DJUSHB), Daily chart

The home builders got a little boost the past few days and came close to testing the February 1st high. I would want to see the index above its 200-dma near 420 before getting more bullish this index. Like the banks we could see another leg down before putting in a tradeable bottom.

3.3 Transportation Index chart (TRAN), Daily chart

The Transports have been all over the place but the current rally leg brought price right up to the top of a parallel down-channel based off the trend line along the lows since the July high, and just shy of its 200-dma. The new price high has negative divergence against the oscillators. This looks ready for the next leg down and it takes a rally above about 4900 to make this more bullish.

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4.0 Currencies

4.1 U.S. Dollar (DXY), Daily chart

I had thought the US dollar would stay inside a sideways triangle for a bit longer and it still could if it recovers right away, leaving a 1-day throw-under below the November low. Otherwise a continuation lower to the bottom of its parallel down-channel from 2005-2006, currently near 73, looks like the next move. The drop in the dollar has created additional inflation concerns and commodity prices have reflected that.

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5.0 Commodities

5.1 AMEX Commodity Index (CRX), Weekly chart

The rally in commodities just since the January low has been strong and the price of the index is already challenging the January 3rd high. With the US dollar looking like it's headed for the bottom of its down-channel I'd say there's a good chance we'll see the commodity index head for the top of its up-channel, currently near 917 which is about 3% higher. But the negative divergences against the new highs since July 2007 make it look like the new high will not hold.

5.2 Oil Fund and Index (USO and OIX)

Oil Fund (USO), Daily chart

Oil is struggling to hold onto $100 and as the USO chart shows, it's very near potential resistance at the trend line along the highs since November. As noted on the chart, the pattern could be topping in an expanding triangle finish. It takes a break back below 68.50 (85 for oil) to say a top is in.

Oil Index chart, Daily chart

Oil stocks have rallied about as far as they can before turning the pattern more bullish (i.e., new highs on the way). Right now the index has jumped back up for a potential test of its broken uptrend line from August 2007. A drop back down from here would leave a bearish kiss goodbye.

5.3 Gold Fund (GLD), Daily chart

Gold could push a little higher to hit the top of its parallel up-channel from August 2007, currently near 96 (about 975 for the metal). Like the commodity index, the new highs for gold are being met with negative divergences which says the high is probably not going to hold.

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6.0 Summary, and a look at the VIX

The market is in hope mode and the rally off the January low has the earmarks of a bear market rally--traders hoping they've caught the bottom for the next run to new highs. They of course could be correct but so far the evidence in the price pattern strongly suggests the bounce will be just that--a bounce to correct the Oct-Jan decline. For me it's a matter of figuring out whether there will be another leg up before the next decline kicks into gear or if it will drop from here.

Cyclical patterns and market symmetry point to mid to late March could be the timing window for the market to finish another leg up to complete the bounce off the January low. As I showed on a couple of charts, I could see a rally leg finish as early as the end of this week (paint the tape for month end). But the choppy price action leaves too many guesses to make a solid call tonight. Expect more of the same chop and whipsaw until we break one of the key levels to the upside or downside and then take the trade in that direction.

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One thing that should concern bulls is what's happening with the VIX (volatility index). It has dropped to new lows for the year and is close to testing its 200-dma, currently at 21.30. It has not been able to break below this moving average, except for a day or two, since climbing above it in February 2007. The last two times it was tested, in October and December, it identified a market peak. Slightly below its 200-dma is its uptrend line from June 2007, currently at 20.30. So there's room for a little lower which could happen if we get the next rally leg. I believe it would set up an outstanding shorting opportunity in the equity market if that happens.

Another worrisome aspect of the VIX is that it's showing complacency when it should instead be a little more worried. The negative divergence between a lower price high and a lower VIX low was last seen in December and it resulted in a swift decline into the January low one month later:

Volatility Index (VIX), Daily chart

We've got a similar setup at the moment. I have no idea if something similar will play out to the downside, as we saw from the lower high in December, but the wave pattern suggests it will. Again, I don't know if the decline will happen from here or after another rally leg but I'm confident another leg down is coming.

If you want to play the short side the conservative entry is to wait for they key levels to the downside to break. Otherwise small entries as the market appears to be topping could have you catching a top. It's difficult to do and you have to be uber disciplined to control your risk. But I find it a good way to take small risks as far as where I can place my stops. Often it takes multiple attempts to get it and small stops are important. If the upside key levels are taken out then go with the bulls and wait for upside targets to get hit. Good luck in this very difficult-to-trade market right now.

Key Levels for SPX:
- Short term bullish above 1396
- Longer term bullish above 1460
- Short term bearish below 1327 and then 1317
- Longer term bearish below 1270

Key Levels for DOW:
- Short term bullish above 12767
- Longer term bullish above 13220
- Short term bearish below 12155 and then 12070
- Longer term bearish below 11634

Key Levels for NDX:
- Short term bullish above 1865
- Longer term bullish above 2000
- bearish below 1715, confirmed with a break below 1693

Key Levels for RUT:
- Short term bullish above 735
- Longer term bullish above 770
- Short term bearish below 683
- Longer term bearish below 650
 


 

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