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Market Wrap

Rally Day, Maybe

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The major indices rallied today but looks can be deceiving. The market breadth was pretty poor although the up volume beat out the down volume and advancing issues beat out declining issues. But it wasn't a stellar day. And the new 52-week lows swamped new highs 417 to 95. The Nasdaq (COMP) ended the day in positive territory while the tech big caps (Nasdaq-100) closed marginally in the red. Some of the big tech names like AAPL, RIMM and BIDU closed well off this morning's spike highs and finished in the red. So to say today was a mixed bag is an understatement and it's hard to take anything away from what it meant.

Thursday prior to opex week has often been a head-fake day where Thursday's move often gets reversed into opex. This has typically meant a down Thursday (or a down morning) that then gets reversed, setting a bear trap. Today's decline into the lows this afternoon may have set up the same thing so traders need to stay aware of that possibility. In other words, trying to discern market direction based on price action on Thursday prior to opex has often been met with frustration, unless you've anticipated the reversal.

Occasionally the move does not get reversed until Monday or Tuesday of opex so fading Thursday's move is not a slam-dunk trade. However there were enough signs at today's lows that suggest we could get a rally into next week and I'll review the setups on the charts.

There was a little spiky price action in the futures this morning following the 8:30 AM economic reports and they pulled back some but the market was set up for a gap up opening. This followed of course a hard down day on Wednesday that closed at or near its lows. The reversal has been very typical and I would say more often than not when you see the market rally hard and close near or at its highs you can expect a down day (or at least the morning) the following day. If it declines hard and closes at its lows you can expect an up day (or morning) the following day.

When the shorts cover into the close after a strong rally, or longs cover into the close after a strong decline, it appears there are no more buyers or sellers the following morning and therefore no follow through. Watch for this and plan accordingly in the future as I think we'll see it happen a lot during the bear market declines and short-covering rallies.

So we got the gap up open but then there was no follow through after the first 15 minutes. The market tried to hold onto its highs for the rest of the morning but then I noticed some of the big cap tech stocks starting to let go and mentioned it in the Market Monitor as a heads up for a coming decline. Without the big caps, especially in the techs, it's a warning that the move may not get the institutional follow through that it needs. The NDX led the market down this afternoon, busted to a new low, followed by the S&P 500 to a marginal new low and the DOW to a test of the low. A bounce into the close broke this afternoon's downtrend lines and left bullish divergences on the 30 and 60-min charts so I think the chances of a bounce on Friday are good.

It's particularly interesting where the DOW found support yesterday and today. I had shown a long term chart last week and the uptrend line from 1974 and mentioned that's where the January and March lows found support. Bulls do Not want to see this major long term uptrend line break and so far it hasn't.

DOW chart, Monthly

The bold green uptrend line is the very long-term uptrend line from 1974, the final low during the 1970s. Along the way higher the DOW used this trend line for both support and resistance as I had shown on a chart last week. The 2000 high at 11750 was clearly a support level as well so it's no surprise the January and March lows found support where they did. Yesterday's decline, and then retest of yesterday's low today, found support exactly at this uptrend line. Therefore a break of it would likely have the DOW quickly dropping down to retest the 11750 level again.

It's unusual to find a triple bottom (or top) since the 3rd test usually results in failure. The fact that the DOW is back below the February high is a bearish failure of the January-March double bottom. The rally above the February high in April was considered by many as bullish confirmation of the double bottom. It's quite possible we'll only see a minor bounce off support here followed by a break lower (dark red).

Or it could bounce a little higher into July, perhaps up to the downtrend line from October that's near 12800 (pink) before heading lower again. That would create another H&S topping pattern with the left shoulder being the February high. Whether it breaks down from here or after another bounce back up first, the initial downside projection is to just below 10600 where the decline from October would have two equal legs down.

DOW chart, Daily

The uptrend lines from 2002/2003 have been broken and I've drawn in a parallel down-channel for the decline from May 19th. The top of this channel is currently near 12300 so the bulls need to get the DOW above that level to break the downtrend. If the DOW instead continues directly lower, watch for support at the bottom of the shallow up-channel from January, currently near 11930. A break below 11900 would be confirmation of the break of the longer-term uptrend line on the weekly chart and the uptrend line from January. That could not be interpreted as anything but bearish.

Key Levels for DOW:
- bullish above 12611
- bearish below 11930

DOW chart, 60-min

The 60-min chart shows a potentially bullish setup for a bounce into opex week. The descending wedge pattern, with bullish divergences, suggests a coming rally. Descending wedges are typically retraced relatively quickly and that means a rally back above 12600 faster than it came down since that high on June 5th. That would clearly be a break of the downtrend line on the daily chart and back above 12600 would set up a more bullish path into July. So this is clearly a warning to bears. However, a break below 12K would negate the descending wedge pattern. Just as we saw many strong rallies following a failed rising wedge pattern in previous years, we could see a strong decline following a failed descending wedge pattern.

SPX chart, Daily

If the DOW can rally back above 12600, which is equivalent to 1404 for SPX, it could set up a bullish price pattern into July/August and I'm showing that possibility in pink on the SPX daily chart. I've bolded the trend lines along the highs and lows (using today's low) to show what could be a large rising wedge pattern off the January low. This is a bearish pattern but it could mean another choppy rally leg into the summer as SPX heads back up to 1460-1480. It would be a MOAP setup (Mother of All Puts) for a strong decline into the fall but obviously I'm way ahead of myself on that one.

The bulls first need to break the downtrend line from May 19th, currently near 1390 and then the key level at 1404. In the meantime we're in a downtrend and therefore that's the best way to trade this market until proven otherwise. If the market continues lower we should see SPX work its way back down to 1270 before a bigger bounce in August (which again would be a very good setup for a long play into August and then a short play into the end of the year.

Key Levels for SPX:
- bullish above 1390, confirmed with a break above 1404
- bearish below 1330

SPX chart, 60-min

The bearish wave count on the chart is very bearish--it means expect a waterfall decline to really kick in here and we'll see the Fib projection at 1295 reached in a heartbeat. But like the descending wedge I showed on the DOW 60-min chart, the same potential exists here. A rally above 1367 is needed by the bulls otherwise any bounce is a shorting opportunity

Nasdaq-100 (NDX) chart, Daily

NDX finished at the flat line today and gave us a doji cross. If this is followed by an up day on Friday it will create a morning star reversal pattern. Today's high found resistance at the broken uptrend line from October 2002 so that line bears watching if NDX bounces back up to it on Friday (near 1958 on Friday)

Key Levels for NDX:
- cautiously bullish above 2056
- bearish below 1943, confirmed bearish below 1885 (the April 7th high)

Nasdaq-100 (NDX) chart, 60-min

The NDX 60-min chart shows the same potential descending wedge pattern I showed on the DOW chart. If it's the correct pattern we should see a strong rally back above 1988. Conversely, a drop out the bottom of the pattern would be very bearish, so play the break either up or down.

Russell-2000 (RUT) chart, Daily

If the market can rally into next week I see the possibility for the RUT to bounce at least back up to its broken uptrend line from March, perhaps up to the 750 area. Otherwise if the market is breaking down I suspect the RUT will be leading the way, along with the NDX.

Key Levels for RUT:
- cautiously bullish above 763, more bullish above 775
- bearish below 720

BIX banking index, Daily chart

The banking index has broken marginally below the bottom of the descending wedge. If that's the correct pattern for the decline from January then it's a potential ending pattern, but only if it can bounce immediately back up inside the pattern. Typically an throw-under like this, followed by a reversal back up inside the pattern, is a buy signal and therefore we have a heads up for that potential.

From an EW (Elliott Wave) perspective I do not like this low as an end to its decline because it looks to me like it needs at least one more bounce followed by a new low (dark red). So it might be bullish but only for a bounce back up to the top of the pattern. The throw-under here may only be mirroring the throw-over in early May (a common thing to see). If the BIX continues to sell off here then it becomes a bearish failure of the descending wedge pattern and could potentially turn very ugly in the market if that happens.

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

The home builders index has dropped to the bottom of a shallow parallel up-channel from January (looks similar to the DOW's) and is very close to the Fib projection at 272.06 where the 2nd leg down in the decline from the April high is 162% of the 1st leg down. It would be a very logical place to bounce. If it bounces I'll be watching for what kind of price pattern develops (strong rally vs. a choppy sideways/up correction) to help gauge what the next move will be (pink or dark red price depiction). For the life of me I don't know what would drive a strong rally (pink) back up to the 450 area but I don't argue with price. I'll let it show me the way. The first warning here is for bears since we could be facing a reversal of sorts, be it a large bounce or minor.

Transportation Index chart, TRAN, Daily

After making its new high in May, unconfirmed by the DOW (therefore a bearish DOW Theory signal), the Trannies have broken down fairly hard. Until the TRAN breaks below 4828, the February 4th high, the potential remains for another leg up, shown in green. Keep an eye on the uptrend line from January if it drops a little further, either from here or after a bounce into next week.

The US dollar has been in the news a lot recently as both the Fed and Treasury try to boost it. They've been out in force trying to convince many that this time they really mean it (as opposed to the other times when Paulson talked about supporting the dollar but everyone could see he was just moving his lips and doing nothing to back up his words). So I thought I'd take a longer-term view of the dollar to see where it's been and where it could go, starting with the monthly chart:

U.S. Dollar chart, Monthly

The move down from its January 2002 high shows the bounces since 2005 have been held down by the downtrend line. Drawing a parallel downtrend line, attached to the May 2006 low, shows the dollar found support at that line, essentially a parallel down-channel from 2005. The current bounce off the March low looks pretty puny and has barely made a dent in the decline. It certainly hasn't broken the downtrend line from 2002 yet which is currently near 77 and the dollar rallied to a high of 74.038 today. But if it breaks down I show a Fib projection at 67.88 (2nd leg down = 62% of the 1st leg down) if the dollar decides to take a trip back down inside its channel.

The daily chart zooms in on that down-channel and the small up-channel from its March low (bear flag?):

U.S. Dollar chart, Daily

The overlapping highs and lows for the bounce off the March low, within the parallel up-channel, makes it look like a bear flag. It could obviously continue to chop up and down before making it up to 76 where the top of the flag pattern meets the longer-term down-channel in July. Clearly a break of the longer-term downtrend line would be bullish for the dollar and would suggest investors are flocking to the US dollar (which would mean the euro would likely be taking a hit, which would cause more inflationary problems in Europe, but that's for another discussion). If we start to see a global recession, as I believe we will, the US dollar will still be viewed as one of the safer currencies to be in. The euro is untested in times of stress which the European Union would clearly be in if there's a significant economic slowdown and the countries start clamoring to do their own thing to protect themselves (giving the EU the well-recognized sign of protest).

Helping the US dollar are the Fed heads who have been out in force recently talking about their concern about inflation. They've been indicating that they are now more worried about inflation than economic growth (or the banking crisis which they're not talking about). In my opinion this is more jawboning the market to do their work for them. The bond market has been selling off recently as yields make new highs in the bounce off the March low. The Fed follows the bond market (not the other way around) and that has many thinking the Fed will soon be raising rates, especially if they really are worried about inflation and have to start raising interest rates to combat it.

But raising interest rates will further hurt the housing market which is already a big thorn in the side of the banks. Higher interest rates will kill any hopes of recovery in the financial sector and with the credit crisis still in full bloom, the Fed can hardly tolerate further risk. If they're willing to bail out a Bear Stearns from bankruptcy, which would take down a slew of other banks, they're going to be hard pressed to put more banks at risk. So they jawbone--they talk about their fears of inflation, talk up bond rates and hint of the need to raise the Fed funds rate.

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There's a bit of a war of words going on between ECB's Trichet and Bernanke. Each is saying they're worried about inflation and feel they might need to raise interest rates. Neither wants to see their currency drop in value and the US dollar can least afford it. So when Trichet says they'll have to raise interest rates to keep the euro from sinking (at the cost of the US dollar), out come the Fed heads and Treasury Secretary talking louder about the need to raise rates and support the value of the dollar (higher interest rates attracts money to that currency for investment).

While it's certainly possible the Fed will be forced to raise interest rates a quarter point at their June 24th meeting, I think they're forced to stand still and hope the swirling winds around them die down instead of turning into a tornado. And the value of the dollar will probably be as good an indicator as any as to what the Fed is going to do. Therefore the current bounce off the March low needs to continue higher otherwise the Fed could be forced to back up their words with action (and they hate it when they have to do that) and raise interest rates, and take the consequences of what it will do to the economy and financial sector. You don't want to be long stocks (or bonds) if that happens.

With the battle of the wills between Bernanke and Trichet, any move by the Fed to raise interest rates will be matched by the ECB. That would not make the US dollar any more attractive to investors and therefore would be a wash. Higher interest rates without a higher dollar would be a bad combination for the Fed. Their only weapon at the moment is to jawbone the market and get the bond market to raise rates for them. So far it's working. But a review of the chart of the 10-year yield shows there may not be much more room to run higher:

10-year Yield (TNX), Daily

Today's rally in TNX (selloff in bonds) has it nearing the top of a parallel up-channel from March, currently near 4.25%. Slightly higher is the 50% retracement of the decline from June 2007 at 4.3% and then a little higher is the Fib projection at 4.39% where the 2nd leg up in the bounce off the January low will be 162% of the 1st leg up (the January-February rally). Therefore there should be some tough resistance for TNX between 4.2%-4.4%. So far the negative divergence at new highs is holding. A Fed that stays on hold at its June 24th meeting could have rates spiking lower once they realize the Fed is all words, no action.

Oil chart, Oil Fund (USO), Daily

Oil refuses to break down and the consolidation pattern (price spiking up and down) this week is usually a sign of a coming rally (shown in green). If it breaks down instead, then this week's pattern is instead topping action. We should soon get our answer.

Oil Index chart, Daily

Although weaker looking, the oil stocks have the same setup as the commodity. My guess on the OIX pattern is that it's going to break down since it found resistance last Friday at its broken uptrend line from August 2007, and at its broken uptrend line from March. But any push back above 985 would be bullish whereas a drop back below 921 would be bearish. Now we let price lead the way.

Gold chart, Gold Fund (GLD), Daily

After breaking its uptrend line from August 2007 on Tuesday, it bounced back up to it for a retest on Wednesday and then continued lower today. That's all bearish price action and I continue to believe gold will work its way lower, possibly accelerating lower, to the 80 level where there could be support from its uptrend line from July 2005 and the apex of a sideways triangle that formed in November-December 2007 (just off the chart on the left side). Any rally back above the Monday's high of 89.24 would be bullish but really not until it breaks its downtrend line from March, currently just below 90.

Economic reports, summary and Key Trading Levels

The CPI numbers could certainly move the market tomorrow. The market is already on pins and needles about what the Fed is going to do at their June 24th meeting. A high inflation number could tie the Fed's hands to follow up words with actions and force them to raise the Fed rate. That would be a negative for the market. If the number is benign, or no worse than expected, there might be a relief rally. Certainly the short term 60-min charts that I showed are primed for a rally tomorrow. So be ready to rock and roll to the upside on Friday and into next week if we get a positive start to the day (which I think will hold this time if we get it). Whether or not that leads to a hangover after opex can only be speculated at this point. I'll at least have a chance next Thursday to make a call on what I see.

In the meantime I'll try to keep up with this market on the Market Monitor. These are interesting, and tough, times for the market. Good luck and I'll be back with you on Thursday.

Key Levels for SPX:
- bullish above 1390, confirmed with a break above 1404
- bearish below 1330

Key Levels for DOW:
- bullish above 12611
- bearish below 11930

Key Levels for NDX:
- cautiously bullish above 2056
- bearish below 1943, confirmed bearish below 1885 (the April 7th high)

Key Levels for RUT:
- cautiously bullish above 763, more bullish above 775
- bearish below 720
 

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