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Market Wrap

DOW to New Annual Low

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The DOW breaking below the January low is the big news story of the day. Even though the DOW is made up of only 30 stocks and none of the other major indices have done the same, this is the one everyone still watches. As if the consumer mood wasn't sour enough, pretty soon they won't be opening their 401(k) statements for fear of what they'll see. This was very common during the tech crash following the 2000 highs--people just threw their statements away for fear of being upset when they saw their new (depressed) account balance.

Many people, especially those saving in their retirement accounts, have been repeatedly told to invest for the long term and to just buy and hold. Market timers are idiots and have consistently underperformed the market. Or at least that's what we've been told. And who told us this? The mutual fund industry. And yet their record of performance against the indices is generally terrible. One of the problems is that even while the indices have been doing well the average stock has not. Fewer and fewer stocks were participating in the rallies that we see reported in the various indexes. This has made stock picking very difficult and fund managers have consistently not done well, especially after deducting their management fees. Even bonds have outperformed the stock market if both were held since 1998.

The buy-and-hold mentality derived from the last 25 years when the stock market had been in a bull market and the recovery off the 2002 lows convinced many that it's absolutely true--hold onto your stocks and they'll always come back. Well, unless you were the proud owner of a tech stock since 2000 in which case you are unfortunately not even close to what you had back then. The market swings between secular bull markets and bear markets. Most investors today have never experienced a bear market. They simply don't know what it is. It's like most of us trying to understand what it was like during the Great Depression or understand public mood during WWII. It's all "out there" somewhere and we've read about it but can't know what it felt like.

I think we entered a secular bear market after the stock market peaked in 2000. For those who have been reading me for the past almost 5 years now I've made it abundantly clear that I believed we were going to get another leg down to at least match the 2000-2002 decline. Those who buy and hold stocks will not be happy with the next cyclical bear market if my analysis is correct. This one will not recover like the 2002-2007 bull market did. Those who don't want to look at their statements now will shriek in utter terror a year from now. After the pain of watching their houses lose value (which many had been banking on, literally, to provide their retirement), to see their retirement accounts drastically shrink in value is going to be extremely hard to stomach.

The S&P 500 is used by more money managers as a gauge for what the market is doing. So the fact that SPX has not made a new low, yet, below the January low, has a lot of fund managers crossing their fingers, toes and eyes in hopes it will hold. Consider the DOW's break below the January low as the warning shot across the bow. When SPX breaks that low it will be a direct hit on the USS Bullship. The March closing low was near 1273 on March 10th and the intraday low was 1257 on March 17th. Keep those numbers in mind.

Many fund managers have been doing a lot of buying in anticipation of a good year. After all, this is an election year and I think there's been only one in the past 100 years or so that hasn't been an up year. Don't quote me on that--it's probably an exaggeration but I don't think far off the mark. The strong buying in the techs and small caps was indicative of this strong belief in a 2008 rally. We're now seeing the RUT and NDX lead to the downside. Because of their outperformance to the upside the RUT and NDX are still well above their January lows. The DOW is the first to break below the January low but the techs and small caps are starting to out accelerate the others in the selling. This is indicative of fund managers doing a collective oh-shucks and heading for the door.

The move down from last October to January/March was the first leg down of the new bear market (wave 1). The rally into May was a correction of that leg down (2nd wave) and these corrections always get traders excited about surviving the scary pullback (to the January and March lows, especially with what looked like a successful double bottom) and they thought happy days are here again with an expectation that we'll rally to a new high again. Just like we always do. Then the 3rd wave down hits. It's called the "recognition wave" for a reason and it tends to be the strongest move. In this case that means strong selling and we may be just at the start of seeing it accelerate.

I'll review the setups in the charts so that we can see where our key levels are this week and use them to gauge where this market may be headed next.

Today's news was relatively quiet. Many will think today's selling was just an after-effect from the FOMC scaring everyone into thinking the inflation monster is going to have to be slain with higher interest rates. Keep an eye on the bond yields and we'll have a much better sense what the Fed will do next (rather than listen to the talking heads on CNBC). And then there was the new all-time high in oil today, $140, as just a little reminder of one of the reasons why inflation is so high. It was as if the oil market was just itching to poke the stock market in the eye one more time. Higher oil prices is depressing and that of course is what affects the stock market. Depressed, frustrated and angry people are not bullish people. Consumer sentiment is in the toilet and I've shown charts in the past how the stock market follows consumer sentiment. If consumer sentiment is making lows not seen since the early 1980s what does that portend for the stock market?

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We're not alone by the way in the selling seen in the stock market. The European markets are also selling off. The pan-European Dow Jones Stoxx 600 ended the day's session down -2.6% to 288.48 which is the lowest it's been since October 2005. Just for reference, the DOW was at 10200 back in October 2005, or about 1300 points lower than today. The FTSE, CAC and DAX were all down similarly.

Today's market breadth was clearly negative with down volume and decliners handily beating out up volume and advancers, as can be seen in the today's numbers at the top of this report. New 52-week lows was nearly 10:1 over new highs and that actually looks like capitulation. But volume was low which does not indicate capitulation. VIX climbed but remains below the June high. That's not capitulation. Many look for volume to confirm a move and in a rally that's true--without it means the rally is suspect. But it's just the opposite in a decline. You can get days on end of selling if the volume stays low. When you see heavy volume with selling then it's often a sign of capitulation. So today's low volume is actually supportive of further declines.

Let's go to the charts and see what kind of technical damage was done today.

SPX chart, Weekly

Last week's candle closed on the 200-week moving average but broke it this week. That's a bearish sign but Friday's close is obviously the important close. SPX needs to rally back up to 1318 to hold onto that average (and would produce a bullish hammer in the process. Weekly MACD has curled over, crossed and is back below zero. All bearish.

SPX chart, Daily

Today's decline had SPX dropping out the bottom of its parallel down-channel from the May high. If it was to be a pullback correction to the rally from March it should not have broken out the bottom. This is a sign of accelerating selling and is typically a bearish sign of more selling to come. A bounce back up to it will often act as resistance so watch for that possibility on Friday, shown better on the 60-min chart below.

Key Levels for SPX:
- cautiously bullish above 1336
- bearish below 1300

SPX chart, 60-min

Depending on whether we see a bounce right away or after a little more downside first that will determine where the bottom of the broken down-channel will be located. I'm showing a drop to the March 10 close near 1273 before a bounce back up and in that case the bottom of the channel will be near 1295. A rally all the way back above 1336 is needed before the bearish wave count is negated.

DOW chart, Daily

The DOW closed at the bottom of its down-channel from May, which is steeper than the one for SPX. So we know which has been the weaker index to date. As noted on the chart, the wave count supports the idea that we could be on the edge of a <u>crash</u>. But betting on a crash scenario (by playing the short side with a big position) is a very low-odds probability. Having said that, this is the first time in a long time that we've had the setup for it and I've been warning subscribers all week on the Market Monitor to be very careful with long positions right now. The market may not accommodate you and come back to let you out at a better price. We're into the part of the pattern where surprises could be of the nasty variety which will cause a gap down right in the middle of a hard decline and not come back for a very long time to fill the gap. Be very careful here.

But all is not lost yet. The bulls have a chance to right this ship and get her sailing again. The 60-min chart shows how the DOW stopped right at the bottom of its down-channel so it's do or die time for the bulls on Friday.

Key Levels for DOW:
- bullish above 11970
- bearish below 11450 (potential crash leg)

DOW chart, 60-min

You can see by the parallel lines that the DOW has been trading well technically. So a bounce off the bottom of the channel is expected and shown on the chart. A bounce back up to the bottom of the narrower channel, which supported price since early June, could see the DOW rally back up to 11600 where it would be typical to see if find resistance (broken support becomes resistance). It's a setup to watch for on Friday since it could set up a humdinger of a decline from there.

Nasdaq-100 (NDX) chart, Daily

NDX is approaching both the bottom of its parallel down-channel from the June high and 1840.88 where it would close its April 17th gap. If 1840 does not hold then the next gap to fill is just under 1795 from April 15th. This is also near the uptrend line from October 2002

Key Levels for NDX:
- cautiously bullish above 1965
- bearish below 1885

I like to watch the semiconductors since they often lead the other techs. The semiconductors holders (SMH) closed on its uptrend line from January today. Keep an eye on it to see to see how it behaves here.

Semiconductor Holders (SMH) chart, Daily

Obviously if SMH breaks down any further it will break its uptrend line from January and that would indicate the 5-month rally has ended. Play the short side or protect long positions in that case. But you can clearly say the uptrend is still intact and until broken one should be playing the long side. I'd rather not but that's me.

Russell-2000 (RUT) chart, Daily

In early June the RUT had found support at the 38% retracement of the March-June rally but the 50% retracement did not offer the same kind of support. Slightly lower is the 62% retracement near 689 which coincides with the uptrend line from October 2002. The RUT needs to get back above 720 to negate its bearish wave pattern.

Key Levels for RUT:
- bullish above 720
- bearish below 717

BIX banking index, Daily chart

The banks held up reasonably well today and the pattern continues to support the idea that the selling in this sector could take a rest while the sellers go after the other sectors. Potential support is 174-180 which is from the bottom of a parallel down-channel for price action since January and a Fib projection for the leg down from May 2nd. BIX did not make a new low today (but it did make a new closing low) so the chances for a bounce continue to be good. Remember, the banks found a bottom back in March 2000 just as the rest of the market started its swan dive. I expect to soon see a disconnect between what the banks (and possibly home builders) do and what the broader market does.

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

I thought the home builders might consolidate for a little longer before heading lower again and I show that possibility with another rally leg up to perhaps the 317 area before dropping back down. But a drop straight from here would likely have this index targeting the 216 area for what I think could be at least a longer term bottom (perhaps with the banks).

Transportation Index chart, TRAN, Daily

The Trannies were holding up so well, relative to the rest of the market but they too broke important support today by breaking and closing below the uptrend line from January. We may not see it but a bounce back up to it, currently near 5000, would be a potential setup for a kiss goodbye. In the meantime watch for this index to drop down to its 200-dma near 4823 and probably lower after perhaps consolidating for a bit on the 200-dma.

U.S. Dollar chart, Daily

The US dollar is still technically short term bullish by staying inside its parallel up-channel from March. But the price action, as choppy as it's been, is hardly bullish. But until it breaks below 71.82 it remains in an uptrend. The longer-term trend for the dollar is down. The euro is also at an interesting spot here:

Euro chart, Daily

The longer-term trend for the euro is up and the sideways triangle consolidation pattern is potentially bullish. But ideally for the triangle to be bullish it needs another move back down before it's ready to rally to a new high. But a rally above 1.5763, the June high, would suggest the next rally leg has already begun (in which case we should see the dollar break down).

But there's a way to interpret the pattern since the April high as a topping pattern and therefore I actually like the setup today for a short on the euro. The stop can be kept very tight (just above 1.5763) and even if the larger pattern is bullish we should see the euro back down to the 1.53 area before rallying again.

Oil chart, Oil Fund (USO), Daily

Oil poked its head above the consolidation pattern that it's been in since the early-June high. If it can keep going this time we should see oil rally into a high in early July. For upside projections for USO there are three: one, I have a Fib projection target at 118 for the final 5th wave of the rally pattern (meaning final high for oil which will be followed by a decline and break of its uptrend); two, the projection out of the sideways consolidation pattern (using the width of the pattern) would take USO to 120; and three, the upper trend line along the highs since March is currently near 122. It takes a break below 105-106 to suggest we've seen a top.

Oil Index chart, Daily

The oil stocks are weaker than the commodity itself and that's a warning to oil bulls. If oil stocks do not follow oil to a new high (assuming oil will continue rallying to new highs) then we'll have bearish non-confirmation of oil's rally. A break below 921 would suggest we'll see the oil stocks sell off harder.

Gold chart, Gold Fund (GLD), Daily

Because of the price patterns in the dollar and euro it leaves a question mark as to what's next for gold. The most likely setup in my opinion is bearish. After the decline from March I'm interpreting the sideways triangle as a bearish continuation pattern and today's rally should be very close to completing the triangle (Fib projection target at 90.91 was missed by only a few cents. If this is topping out here and we see gold start to sell off, the downside projection is to 75.22 where the move down from March will have two equal legs. This matches up with the uptrend line from July 2005 in the 1st/2nd weeks of July which happens to be a cyclical bottom for gold, which runs about 15-18 weeks. Obviously it would be a hard selloff in gold to reach that level in essentially 2-3 weeks. A rally above 93.71 would negate the bearish pattern and point to new all-time highs in gold coming.

Economic reports, summary and Key Trading Levels

We've already had the Fed heads telling us they're worried about inflation so the economic reports coming out tomorrow will probably not be that influential. If the numbers show a drastic reduction in growth, even negative, it could be argued that it would make it easier for the Fed to justify another rate cut. But again, keep an eye on what the bond yields are doing for a better sense of what the Fed will do next.

We're into a potentially very bearish wave count that calls for accelerated selling and that deserves caution if you're long the market and hoping for a bounce to get out of some positions. I'll say it again though--betting on a crash scenario is a low-odds proposition and I'd be very careful playing the short side of this market. We've seen what bear market rallies can do. It's even possible we'll see a successful retest of the January and March lows by SPX. The fact that SPX has not made a new low yet can actually be considered bullish non-confirmation of DOW's low.

I showed enough support to suggest we could see a bounce on Friday, at least in the morning. But if the day opens up gap down then I would not be looking for a place to get long. A gap down in the middle of the kind of pattern we're in could be confirmation of a crash leg coming. We've entered a vulnerable period for the market as most begin to recognize that the Fed hasn't been able to save the day, that the credit crisis is as bad (actually worse) than it's ever been, it's not self-contained and the consumer is one unhappy individual. This is not the recipe the bulls need for a rally. The recognition is starting to hit and the selling is a result. Only time will tell how bad it gets. Just keep your eye on those key levels to help guide the way.

Good luck and I'll be back with you on Wednesday (switching with Robert next week).

Key Levels for SPX:
- cautiously bullish above 1336
- bearish below 1300

Key Levels for DOW:
- bullish above 11970
- bearish below 11450 (potential crash leg)

Key Levels for NDX:
- cautiously bullish above 1965
- bearish below 1885

Key Levels for RUT:
- bullish above 720
- bearish below 717
 

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