Option Investor
Market Wrap

I Want My Maypo!

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I'm aging myself here as only those who are old enough to have witnessed John Kennedy's inaugural speech will remember the commercial for Maypo cereal. The first commercial actually came out in 1956--I was probably still sucking my thumb then (come to think of it, not much has changed--this market still makes me want to curl up in a corner and suck my thumb). I remember as a kid thinking the commercial was of a whiny brat screaming for the cereal he wanted. Well, fast forward a few decades and the whiny babies on Wall Street must have really liked Maypo and that commercial. They've been whining for a Fed rate cut and want an indication from the Fed that they're not done cutting. They got their Maypo today but I suppose it didn't have enough brown sugar on it (the only way liked eating it).

The Fed cut the expected 25 basis points to a 2% Fed funds rate and their wording was such that they continue to be concerned about the slowing in the economy, leaving room for expectations of further rate cuts. But they changed the wording just enough to cause some concern that the Fed is going to pause for some extended period of time while they assess how the market is doing. They seemed a little less worried about the slowing economy and a little more worried about inflation. But the reality is there will be two months before the next Fed meeting and the expectations at this point is that the Fed will hold at the current level for now. Hence the whiny Wall Street response "What! No more cuts for eight weeks!?"

But a one-day drop following the FOMC announcement does not a trend make. We've seen countless times where the post-FOMC move is completely reversed, and reversed hard, the following day. The market seems to like setting bear and bull traps and then spring them the following morning. We of course have seen an equal number of times where we get follow through to the post-FOMC afternoon move. We're at an interesting spot for the market and tomorrow could be a telling day, at least for what will happen over the next few days.

There were some things setting up today, and actually over the past week, that warned of danger for bulls. I made repeated comments on the Market Monitor about what I felt were bearish signs. While it's always hard to predict what the market will do following the FOMC announcement, I'm not surprised to have seen an afternoon selloff. Whether it will hold is a different story. One sign came from some sentiment measures such as the VIX, which I've been showing for a couple of weeks now.

Volatility Index (VIX), Daily

After breaking its uptrend line from June 2007 last week, the VIX dropped down to its uptrend line from December 2006 and has been bouncing along it for the past week. The tests of the low for VIX was showing some bullish divergence on the shorter-term charts and hinting of support holding and VIX bouncing. A bouncing VIX is of course typically bearish for stocks.

Another sentiment indicator that I've shown before comes from ISE.com and is the call/put ratio:

ISEE call/put ratio, Daily

Readings above 150 have been good times to cinch up your stops if you're long the market. Bullishness, measured in the excessive call buying, is hitting an extreme and in this case we were seeing a lot of people betting upside resistance (shown in the charts below) will break and that we'll see a bullish resolution from the FOMC announcement. Just yesterday the number hit 155.

While the number itself is high, notice how far it has stretched from the 50-day moving average and compare to previous instances when it "rallied" that high above this average. It's a measure of sudden and strong bullishness and from a contrarian perspective is a warning that those who want to be long the market are already in and just waiting for the rally. We know the market loves to disappoint and today might have been the start of that process.

I'll start tonight's review with a weekly chart of the S&P 500 for some perspective:

SPX chart, Weekly

This is an update to the chart I've posted in the past and shows the big H&S pattern last year, the neckline that was broken in January and the downtrend line from October. That broken neckline is currently near 1430 so if we see some more upside to this market that's the level I'd watch for resistance (there are actually several layers between 1400 and 1440). Note that I'm using the LOG price scale on the weekly and daily charts of the indices below because of the close correlation of the longer-term trend lines and price action.

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Currently price has been stalling near the February 1st high and could continue to consolidate in a big sideways pattern right into the summer. That would mean another pullback to at least the 1270 area before bouncing again. The other, more bearish possibility is that the bounce off the March low is correcting the October-March decline and once finished (possibly today) we will start the 3rd wave of the new bear market to much lower lows than the Jan/Mar lows.

The bulls want (need) to see a rally above 1450 to more strongly suggest we could be headed back up to last year's highs.

SPX chart, Daily

Today's rally came very close to the downtrend line from October (again, using the LOG scale) and poked just above the rising wedge pattern for price action since the March low (which may have been the throw-over finish with the collapse back inside the pattern giving us the sell signal). Because of the possibility we could see price pull back and then begin another choppy rise higher within the rising wedge, it takes a break below 1360 to tell us something more bearish is happening. A break below the April 15th low near 1324 is needed to confirm the high of the rally from March is finished.

Key Levels for SPX:
- bullish above 1442
- bearish below 1360 (confirmed with a break below 1324)

SPX chart, 120-min

With this afternoon's decline looking like an impulsive 5-wave decline (not visible on this chart), it can easily be counted as the start of something bigger to the downside, especially considering the plethora of other signals (resistance levels, VIX, heavy call volume, etc.). But it can also be considered the completion of an a-b-c pullback from Monday's high. That would set up another push to new highs and that's shown with the pink price depiction which calls for a high near 1414.

What I'll be watching for on Thursday is whether or not we get a bounce that then leads to new lows below today's or instead keeps pressing higher. Any rally back above a 62% retracement (1396), and especially above a 78.6% retracement (1400), would have me thinking new highs are coming. A choppy bounce into Friday to a new high remains a good possibility.

But if we see a bounce Thursday morning that then leads to new lows below this afternoon's low then that will be the signal that a high is in, at least for now. Because of the jobs number on Friday, if we see new lows on Thursday, whether or not we bounce into the close on Thursday, the price pattern would suggest a hard down day on Friday so stay aware of that possibility if you're long and hoping for just a pullback.

DOW chart, Weekly

Today's high poked marginally higher than the downtrend line from October but on the weekly chart I drew the trend line from October through today's high. I wanted to create a parallel down-channel to show a possible time and price path for another leg down (if that's what's going to start from here). Two equal legs down from October would be at 10330 and it would hit the bottom of the channel at the end of August/early September. As you can see, that would also be a break of the 2006 lows.

If the bulls can push the DOW back up for a little more, the 50-week moving average is currently near 13106. I have the key level for the upside noted on the daily chart at 13100 and this is one of the reasons. A push back above 13100, that holds, would be a strong indication that we're probably going to head for new all-time highs. But as you can see on the daily chart, there's pretty much a brick wall between here and 13100:

DOW chart, Daily

The bulls will look at this chart and see a mine field between 12850 and 13000. In this area are the broken uptrend lines from October 2002 and March 2003, the downtrend line from October and the top of the rising wedge from March. If the bulls can navigate that mine field they then have to contend with the 200-dma at 13057. Todays's high at 13010 was a brave move by some poor souls who may be sitting in that mine field waiting for someone to come rescue them (i.e., the post-FOMC rally might have been a bull trap. The daily candle is a nasty looking gravestone doji which is a more bearish form of the shooting star. This candlestick, at resistance, is a strong hint of a reversal. A down day tomorrow would confirm it.

Key Levels for DOW:
- bullish above 13100
- bearish below 12270
-
Not shown on the daily chart is a parallel channel for price action since the January low (there are enough trend lines on the daily chart). The top of that channel is shown in bold blue on the 120-min chart:

DOW chart, 120-min

The DOW has been bumping its head against the top of this channel (just another mine in the mine field) since last Friday. Each low since last Friday was slightly higher and it was forming a small rising wedge at the top of the larger rising wedge from March (shown on the daily chart). A rising wedge at the top of a larger rising wedge, with the bearish divergences present on this chart, was a recipe for failure (of the rally). Closing back below both the bottom of the wedge and the October downtrend line sets a bearish tone for Thursday.

Nasdaq-100 (NDX) chart, Daily

The NDX shows a very similar setup as the DOW and SPX--it is finding the downtrend line from October to be resistance. It has been trying the past week to get back above its broken uptrend line from October 2002 but closed marginally below it today.

NDX ran into an even stronger brick wall this afternoon than the DOW. At 1953.90 is the 50% retracement of the October-March decline. It shifted at the close but during the day the 200-dma was showing 1953.60 (it closed at 1957.75). Today's high was 1953.59. Another reason for resistance here is the 50-week moving average at 1950.76, shown on the weekly chart below.

Key Levels for NDX:
- cautiously bullish above 1954
- bearish below 1777

Nasdaq-100 (NDX) chart, Weekly

The 50 and 200-week moving averages have been influential for NDX and you can see the bounce in March off the 200-wma and now the pullback from the 50-wma. The first test of a major moving average like this, after it's been broken, generally fails. Therefore at least a pullback from the 1950 area can be expected.

Nasdaq-100 (NDX) chart, 120-min

The parallel up-channel from March shows price has been holding at the mid line (dotted) on each of the pullbacks this week. A break below 1894 would confirm a breakdown and point to at least the uptrend line from March, currently near 1850.

Russell-2000 (RUT) chart, Daily

Different index, same pattern--the RUT is struggling with its downtrend line from October after failing at the top of its rising wedge pattern. It has not been able to test its February 1st high near 732 and it takes a rally above it to show that it is breaking through a few layers of resistance.

Key Levels for RUT:
- bullish above 732
- bearish below 685

Russell-2000 (RUT) chart, 120-min

The RUT clearly shows what looks like a 3-wave pullback from Monday's high. That's why the sharp decline this afternoon might have been the completion of that 3-wave pullback rather than the start of a more serious decline. For this reason I mentioned earlier I want to see what kind of bounce we get on Thursday and whether or not it leads to new lows below today's. If we get the new low after the bounce then we have something more bearish in play. But the potential for another choppy push to a new high (pink) remains a real possibility. It would also offer up an even better short play than today's. It could coincide with a retest, and failure, of the February 1st high (so a double top).

BIX banking index, Daily chart

Not much of a change to report on for the banks. Price remains trapped inside a potential descending wedge that needs to work its way lower to finish. Downside potential for the banks (and home owners) is not as good as other sectors (for those who want to play the short side) since most of the price gains (for shorts) have been wrung out of this sector. But it remains too early for a bottom call.

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

The banks are in a descending wedge and the home builders look to be in a rising wedge. Both portend further downside but like the banks I do not see a whole lot of downside potential left in the home builders. Of course as a percentage move, a drop from 360 to say 220 is nothing to sneeze at. At least that's the downside potential that I still see for this sector.

Transportation Index chart, TRAN, Daily

Today's candle is a bearish shooting star at resistance. While it could certainly press a little higher to the top of its parallel up-channel for price action from January (near 5300), the Trannies are flashing a warning sign here. Today's high was a brief throw-over above its rising wedge for price action since March and then dropped back inside the pattern for the sell signal. It closed marginally back below its broken uptrend line from March 2003 after closing above it yesterday. Combine this with that shooting start bearish reversal setup and I would not want to be long the Transports. You can play IYT with options if you'd like (use today's high as your stop).

U.S. Dollar chart, Daily

The US dollar is keeping me guessing here. I'm still not sure if the current rally leg is the completion of a 3-wave bounce off the March low or the start of something bigger to the upside. The patterns in the commodities have me thinking we've seen the high for them and that would support the idea that the dollar has seen its low. A rally above 74 would go a long way towards pointing to a much stronger rally for the dollar (and decline for commodities).

Gold chart, Gold Fund (GLD), Daily

With the break below its April 1st low the decline in gold looks like it has further to go. I show downside potential to 79 which is where the decline would have two equal legs down from March and be at the apex of the sideways triangle that formed in November-December (a common support level).

A lot of institutions trade gold and one of their favorite charting tools is the P&F chart. The chart, courtesy stockcharts.com, shows gold on a sell signal after printing 89 in April (the red '4' on the chart in the column of O's):

Gold chart, Gold Fund (GLD), P&F chart, courtesy stockcharts.com

It gave another double-bottom sell signal with yesterday's decline to 86. It remains on a sell signal with a P&F bearish price objective of 79 which ties in perfectly with the potential support shown on the daily chart. I would consider buying gold there to see what kind of bounce develops but be careful since commodities in general, including gold, could experience a nasty selloff after finishing their own bubble rally.

Oil chart, Oil Fund (USO), Daily

There is still the possibility for another push higher in oil (pink) with an upside target at 98.62 but it's not a sure thing. The rally in oil (and other commodities) has either ended or is very close to ending with one more push up.

Oil Index chart, Daily

Oil stocks could lead the way here so watch for either a minor new high, probably under 950, or a break below its last low near 889 and the signal that this index has probably seen its high.

Economic reports, summary and Key Trading Levels

You can see that there are several economic reports that could be market moving tomorrow. Construction spending and the ISM report both come out at 10:00 so watch the market carefully at that time.

With what appears to be a complete 5-wave move down this afternoon I'm expecting to see at least a bounce first thing Thursday morning to correct the decline. If the decline finished a larger pullback then we'll see the market work its way higher, probably into Friday. If the bounce is followed by a drop to new lows below today's you'll want to be short (or at least out of your longs). It's too early to tell how far it could drop but the potential is for a strong decline to start kicking into gear so don't hold onto longs hoping it will be just a pullback.

If we do get a new push higher, keep watching it for failure to test the short side as I believe the setup is very good for a position trade on the short side.

Good luck and I'll be back with you on Wednesday.

Key Levels for SPX:
- bullish above 1442
- bearish below 1360 (confirmed with a break below 1324)

Key Levels for DOW:
- bullish above 13100
- bearish below 12270

Key Levels for NDX:
- cautiously bullish above 1954
- bearish below 1777

Key Levels for RUT:
- bullish above 732
- bearish below 685
 

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