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As you can see in the table above, the past week was brutal for everyone. Each of the indices in the table was down for the week and I highlighted those that were down greater than -10% (with several others very close to -10%. It was a bad week to be in anything other than cash and short positions. In the first table you can see how truly lopsided the new 52-week lows continue to be against new highs. This clearly reflects the selling is hitting all sectors. It's also significant to note that commodities, housing and transports took the brunt of the selling. As I'll show later with the chart of the Transports, this index made a significant closing low this week.

In Thursday's newsletter I closed by saying I expected a small bounce on Friday and then a new low to set up a rally into next week. It's amazing what a day can do to your expectations. We did get the bounce but the small bounce turned into a 300-point rally in the DOW. That's a rally, not a bounce (although in this market lately it does border on a bounce). And then we got the new low but I did not expect a 450-point decline on the DOW from its high. Amazing volatility.

So now the question is what the heck was that? As always I've got a couple of ideas about what is setting up--one is scary (if you're long the market) and the other essentially sticks with the idea I proposed on Thursday that we'll see a rally this coming week (maybe right away on Monday or after another relatively minor new low by the end of the day Monday. Even though Friday's reversal from the pre-House vote high looks rather bearish, and potentially is significantly bearish, I like to look for what-ifs and that's what we'll review in this weekend's charts.

The day started off with a sharp reaction to the negative jobs number report. A loss of 159K jobs was worse than had been expected. The following chart shows the trend in job losses does not look good:

Nonfarm Payrolls, June 2007 - September 2008

There's no denying it's an ugly trend and this kind of loss of employment has always coincided with a recession. It's just a matter of officially recognizing it to be so. The initial reaction in pre-market futures was a quick drop lower but then they magically got spiked back up to a high for the pre-market session. The cash market then opened with a big gap up that was then followed by a strong rally for the rest of the morning to a high near 1:00 PM, just before the announcement of the House vote on the Big Bank bailout bill.

Following the House passing the pork-laden bailout bill the market sold off hard. This prompts the obvious question "what else does the market want?" When is enough enough? For big money of course the answer is enough is never enough. And to those politicians who scared Americans into supporting a yes vote by telling them the stock market crash on Monday was a result of the House not passing the bill, what do you have to say for yourselves now? You've been duped into the biggest robbery of the American taxpayer and it won't make a bit of a difference in the credit contraction but it will make a few powerful people incredibly wealthy. Way to go Mr. Representative (who clearly does not represent the people). You will surely not get my vote next time. I only hope Americans, once they realize they've truly been lied to, stay angry enough to get the bums out of office. Our political system is broken and I hope we're at the cusp of making some significant changes. Pain results in doing something different and that will be the only good thing that will come out of the pain we're about to experience as a country (actually globally).


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Linda has done a great job at covering the TED spread in previous newsletters and a Traders Corner article. I've shown charts recently to show how the spread continues to widen. This reflects bankers (un)willingness to lend money. They want a higher return for it because they feel they need a higher compensation for the risk they're taking. Think of it as another measure of fear. For about the past 20 years and up through the middle of 2007 (before the first crack in mortgage-backed assets), the TED spread was consistently running at or well below 1.0 and below 0.5 for most of the 2000s. So bankers were only looking for 0.5% above the 3-month T-bill rate. This spread was running at a historically low rate which indicated unusually high levels of complacency (which usually leads to a "dislocation event" to shock people back to their senses that there really are risks out there). But notice what happened when problems started to arise in August 2007:

TED Spread, 2004-2008

After the initial spike up in August 2007, to a high near 2.4 points, it mostly bounced between 1.0 and 2.0 as the market tried to settle down, thinking the Fed was going to save us. But then the market began to realize that the problems are bigger than the Fed. Even after the bailout bill was passed the TED spread closed Friday at its highest level ever recorded. This is a clear indication that fear is mounting and bankers are becoming more and more reluctant to lend their money. No amount of taxpayer money will change this (it will only end up in the hands of powerful bankers).

To put this spike up in the TED spread into perspective, look at it relative to the past 24 years:

TED Spread, 1984-2008, courtesy Elliott Wave International

The crises during the previous bull market, including the 1987 stock market crash, did not cause the kind of fear we're starting to see in this market. It's another sign of the bear. It's an indication of a major shift in public mood (reflected in bankers' unwillingness to lend money) and is all part of the credit contraction cycle. The Senate and House of Representatives have been duped by big money to spend taxpayer money to bail out the bankers and it will have no effect on the credit crunch. As happened with the S&L bailout in the 1980s, the only ones to make out will be those who get bailed out. It has been engineered and crafted by Hank Paulson, ex-CEO of Goldman Sachs and who is hiring a Goldman Sachs cohort to help him figure out how to dole out the $700B (and mark my words, they'll be back for more).

The other chart I've shown recently is how the stock market sooner or later follows the credit spreads. As fear of risk intensifies, reflected in higher spreads, the stock market soon reflects the same fear by selling off. The following chart is not a pretty one for bulls:

Credit Spreads vs. S&P 500, courtesy Elliott Wave International

The credit spread is shown inversely so the wider the spread the lower the curve. With the continued sharp decline in the credit spread curve (widening of the spreads) the more ominous it is for the stock market. It doesn't mean the stock market won't bounce back up along the way but as long as credit spreads keep widening the lower the stock market is headed. In other words it's far too early to be thinking about picking a bottom in stocks.

I'll cover the four main indices that I regularly cover but if there were no major changes on the charts for the other sectors from Thursday's updates I'll skip those charts (since I've got a lot I'm showing as it is).

S&P 500, SPX, Weekly chart

SPX dropped slightly below the bottom of its parallel down-channel from October and certainly looks like it could at least tag the 62% retracement of the 2002-2007 rally at 1077 and the Fib projection at 1073 (two equal legs down from May). On a weekly perspective that's certainly potential support but I think only for a possible bounce before continuing lower. As I've mentioned before about these parallel channels, a break out the top of an up-channel or out the bottom of a down-channel usually leads to an acceleration of the trend (down in this case).

There have been rumors of the Fed stepping in to help prop up the market with a surprise .5% rate cut. I'm not sure at this time how the market would react to that. The initial reaction would likely be positive (maybe) but then fear of the Fed's fear could spark even more vicious selling. Certainly a Fed-induced rally would be an outstanding short play setup. But as always we have to remain vigilant about the volatility around more government intervention in our not-so-free markets, especially if you're trading this market up and down.

S&P 500, SPX, Daily chart

As I had pointed out on Thursday night, when I thought we could get a minor new low followed by a bounce into next week, it is still a possibility as I look at this daily chart (shown in pink). A little lower is the bottom of a parallel down-channel for price action since May and it coincides with the Fib levels at 1073 and 1077. So certainly watch for that possibility as we could see a bounce back up to the 1160-1180 area over the next week before heading lower again. A break below 1066, which stays below, could see a fast move down to the 1000 area.

Key Levels for SPX:
- cautiously bullish above 1220 and bullish above 1265
- bearish below 1220

S&P 500, SPX, 60-min chart

I actually turned more short-term bearish on Friday (and remaining longer-term bearish). Obviously the reaction to the House vote looks bearish but also the EW (Elliott Wave) pattern has turned potentially much more bearish than I had been considering it before Friday's failed rally. The potential here is for a gap down on Monday and some very strong selling. As mentioned at the end of the day on the live Market Monitor, it's potentially the most bearish setup I've seen since the market started its decline last October. Black Monday comes to mind when I look at the bearish wave count on this chart. That's why the 1066 level is important--if that gets broken and not recovered very quickly, we could see a very bad day on Monday.

Dow Industrials, INDU, Weekly chart

The DOW has now closed below potential Fib and price level support in the 10400-10600 area, as well as below its parallel down-channel from October. The next Fib, price channel and longer-term uptrend support area is near 9500.

Key Levels for DOW:
- cautiously bullish above 11400 and bullish above 12000
- bearish below 10700

Nasdaq-100, NDX, Weekly chart

NDX is still at potential support at the bottom of its parallel down-channel from October. The 1470 area is where I thought we could get a bounce and that's where it closed on Friday. By this measure we could see an immediate reversal of Friday's decline and get a rally started on Monday. It might only be good for about a week of bouncing around before heading lower again (pink) but the risk for anyone holding long put options is that we could see it hold up into opex so beware of that when considering holding any October puts if we get a rally on Monday.

Nasdaq-100, NDX, Daily chart

Support at the bottoms of the parallel down-channels can more easily be seen on the daily chart. Based on Friday's price action I'm thinking we could see an immediate breakdown from here but again, any bounce up on Monday should see a correction for at least for a week before proceeding lower again.

Key Levels for NDX:
- cautiously bullish above 1700
- bearish below 1600

Nasdaq-100, NDX, 60-min chart

A closer view of this week's price action is what has me leaning more bearishly after Friday's rally. The overlap between Friday's high and Wednesday's low means the leg down from Tuesday's high cannot be a completed 5-wave move (can't have overlap between the 2nd and 4th waves). That's a bunch of Elliottician gobbledygook to many but I mention it only because it had me relabeling the wave count. The best way to meet some EW parameters and rules calls for a very bearish wave count and that's why I warned of a possible gap down on Monday and strong selling to follow. But a rally on Monday would negate the immediately bearish wave count and would tell me the bottom could be in for at least a week so I'll know after Monday's price action what to expect for the rest of the week.

Russell-2000, RUT, Daily chart

The RUT's weekly candle is clearly bearish. It convincingly broke the longer-term uptrend line from 2002 through the March low. It could get a little bounce before pressing lower or just press lower from here. I think we'll see the RUT down to or below 550 sooner rather than later.

Key Levels for RUT:
- cautiously bullish above 768
- bearish below 678

NYSE, NYA, Daily chart

I've been keeping an eye on the NYSE because of the greater number of stocks and I think a better gauge of what's happening in the stock market (as compared to more heavily manipulated DOW and SPX). The daily chart supports the idea that it too is at support and ready for a bounce back up (pink) before turning lower again. But Friday's price action leaves me with the same problem as discussed for the NDX 60-min chart. Again, a breakdown on Monday could be very serious otherwise watch for a bounce that lasts about a week.

Banking index, BIX, Daily chart

Friday's big rally in the banks was given up by the close and left a bearish shooting star candlestick with a close just below its broken uptrend line from July. If the market manages a bounce over the next week I see the possibility for a rally up to its 200-dma again, currently near 223. Otherwise look out below.

For a different and potentially bullish perspective on the banks, look at the old down-channel from last year:

Banking index, BIX, Weekly chart

After breaking out of the down-channel in September the BIX has come back down for a retest and so far is holding. By this measure the banks look potentially bullish. At some point the banks will bottom before the broader market so I continually look for some evidence of that happening. Interesting chart here. But if they do turn lower notice MACD (I'm using a fast setting) just starting to curl over at the zero line. When MACD comes back up to the zero line after a bounce off a decline, or comes down after a pullback from a rally, and then reverses back in its original direction it makes for a very strong signal that the trend will continue. So in this case if MACD rolls back over at the zero line it would be a strong sell signal.

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

The home builders index closed below its uptrend line from July. It's obviously a minor break at this time and the price level at the 2002 lows has not broken. So a bounce back up is entirely possible (leaving a head fake break and bear trap in its wake). But considering the choppy bear flag pattern here I'd be looking for a breakdown rather than a rally.

Back in November/December of last year both the DOW and the Transportation index made new lows thus giving us a DOW Theory sell signal. Then in May 2008 the Transports made a new all-time high and many were exclaiming that it was a signal of a new bull market. There was one problem--the DOW needed to confirm the new high since the last signal was a confirmed sell signal. The DOW of course did not make a new all-time high thus leaving a bearish divergence. The past week has now confirmed the DOW Theory sell signal, as shown on its weekly chart:

Transportation Index, TRAN, Weekly chart

Friday's close gave us a weekly close below January's closing lows and that confirms the DOW's lower annual close (in July and again in October). This is receiving very little notice by the financial media but is a potentially significant signal that the next leg down in the bear market is upon us.

I've often discussed the idea that we're going to see selling across the board in the next bear market, that very few areas will be spared. When commodities, including gold and oil, were racing for the moon we heard many people talking about limited supplies, excessive demand, etc. as reasons for continuing to invest in commodities. A funny thing happens when people become afraid and start to sell--funnymentals go out the window. In the past I got caught too many times holding on during rough times because the fundamentals were so strong (or that the company itself was so strong, had lots of cash, low P/E, etc.) and sat there dumbfounded that the market didn't agree with my assessment.

When a bear market takes over, which is a sign of fear by market participants, the baby can get thrown out with the bath water. Commodities may be a good long-term investment but even they will get hurt as people start to sell everything in order to raise cash levels. And if we're entering a deflationary period, as I believe we are, everything but cash will lose value. The monthly chart of the commodities index shows what's happening:

Commodity Related Equities Index, CRX, Monthly chart

The increasing steepness of the uptrend lines since 2003 told us the rally was going parabolic and usually the 4th uptrend line (the shortest one starting at the beginning of 2008) will be the last one. Once the steepest line is broken it usually means the run is over and it broke in July. The oldest uptrend line was broken last week so the run up is officially over and there's very likely more pain ahead for commodities holders. But right now there's hope (dare I use that word?) as the index has dropped to both the 50-month moving average and a 50% retracement of the 2002-2008 rally.

As part of eSignal's efforts to frustrate QCharts users I am not able to pull up the data on the US dollar since September 30. They're dropping the feeds on certain symbols for version 5.1 users and forcing people onto version 6.0 which is not as capable and they want more money for it. I haven't decided yet whether I'll switch to the new version or switch to a new package altogether. I'm not at all happy with eSignal and while I love QCharts I'm undecided whether I'll continue with it.

So without an updated chart I'll just say the US dollar has rallied to a new high above its September high of 80.375 and closed at 80.403 on Friday. The new high completes a 5-wave move up from March and that's significant because it tells us the trend has reversed and the dollar should become even stronger as we head into 2009. Fear will drive people into the perceived safety of the US dollar (probably into Treasuries). But for now the 5th wave up from the September pullback is leaving a bearish divergence against the September high and we should see a more significant pullback over the next couple of months before the rally resumes next year. That might help put a floor under the current decline in commodities. I emphasize might put a floor under commodities because we could be entering a period where we'll see a disconnect in the direct relationship between the US dollar and commodity prices (where both could decline together next).

Economic reports, summary and Key Trading Levels

Next week will be a quiet one as far as economic reports go. There are no major reports on Monday. Tuesday might be affected by the FOMC minutes but I don't think the market is worried about any surprises. The rest of the week's reports are likely not market movers.

Summarizing the week's charts, and especially after Friday's price action, I'm left with the sense that the market is on the verge of collapse. I think it's possible that in the next trading day or two we could see a market crash and I don't use that word lightly. First of all, it's almost always a very bad bet to bet on a market crash. It's a very rare event. The market has been held up through intervention and interference by the government and the Fed but each time they try something it seems to last for less and less time. The bailout bill didn't even last a nanosecond. People are getting scared and scared people do not make for a bullish stock market. So the sense of despair following blatant government efforts to prop the market up actually leaves the market more vulnerable to panic selling. Letting the market decline when it needs to decline, sometimes in a big way, is actually much healthier so that corrections can be finished and people can once again become more hopeful.

In addition to the sense of fear and foreboding that's creeping into the market I get a sense from the EW count that we're either at the edge or only a couple of steps away from the edge of a cliff. In EW analysis a strong move in the direction of the trend is called an impulsive move and consists of 5 waves. The 1st, 3rd and 5th waves are in the direction of the impulsive move and are themselves impulsive waves (so each of them is made up of 5 smaller waves). The 3rd wave is usually the strongest of the 5. As the 3rd wave develops, down in this case, it has a smaller 3rd wave and that 3rd wave has a smaller 3rd wave. Pretty soon you reach a point where the EW count is ready to "unwind" these multiple 3rd waves and that's where we are now. The unwinding process is usually marked by gaps in the direction of the trend. You get your breakaway gap, your continuation gap (or two or three) and then finally the exhaustion gap. The move is usually powerful and seemingly never ending. So needless to say I don't think it would be prudent to be in any long positions right now (look at the second table at the top of this report and see how many survived this week's carnage) and don't be looking for a bottom if the selling kicks off this week.

Having said all that, it's still possible we're going to see a rally this week and into early next week. I believe it will be relatively short-lived but again, October put holders may not want to let a correction play out in time since it will eat up your time premium. If you're looking to play the short side with puts and want to hang on through another bounce you should be in November or December puts.

If you're a spread trader I think selling bull put spreads is asking for trouble. The relatively small credit you take in for the spread is, I think, completely dwarfed by the risk involved in that play at the moment. Even bear call spreads are risky since we know how quickly and violently strong rallies can completely overrun your spreads (but at least tend to be relatively short-lived). Credit spreads are good for non-trending markets and right now we're in a strong downtrend that I believe is about to get stronger. Be very careful with spreads in this environment.

I used to trade options exclusively until about 2004 when I switched to futures trading. The slippage and relatively small movements in the markets was making it a real challenge to trade options. I've switched back to primarily options as I find I don't have the stomach to tolerate wide stops and large swings against my futures position. If I have confidence in where the market is going I'm playing it directionally with options and I let the intraday noise try to not to spook me out of my position. I tend to go a couple of months out at a minimum. Sometimes I'm right on direction but completely wrong on timing and going out a few months keeps the time-decaying monster at bay.

Bottom line, this continues to be a wickedly difficult market to trade and make money consistently. Profits are returned on a daily basis. Losses wipe out profits every other week and many are feeling frustrated just breaking even after working so hard at their trades. Others of course have been forced over to the sidelines after busting their accounts. The huge number of hedge fund failures should tell you something. If you're not an experienced trader (meaning a few years to experience ups and downs) then take it easy in this market--trade very lightly and do lots of paper trading. Many brokerages enable you to open a simulated trading account that gives you an opportunity to trade for real but not with your money. I highly recommend it but remember it's not like trading your own money. Throw your own money into a trade and suddenly emotions take over instead of rational thinking. And mostly remember that flat is a position.

I'll close with a link to an interesting video that many will think is pure conspiracy theorist crap. I'll let you be the judge but based on what I've learned about the markets and the big banking industry over the years, and watching how our political system has been manipulated by big money I must admit I'm becoming a believer. Even last week's news about Citigroup suing Wells Fargo and Wachovia to prevent their joining after Citigroup's failed attempt at picking up Wachovia for a song starts to make sense after watching the video.

As part of a coming social revolution in the next generation (part of the long historical swings as studied in socioeconomic theory) combined with the age of the internet, we could start to see a swelling of public anger at what's happening within our government and banking system. The people will want to take their country back. Plus you know I don't like the Federal Reserve and what they do. Ron Paul is looking better and better (wink). Anyway, enjoy (or not), and be sure to watch the three parts.

Another video (42 minutes long) is also a great educational piece about the Federal Reserve and the fact that it's really a non-government bank that's essentially a cartel. At the 6:30-minute mark it specifically states the purpose of this cartel is to pass along the losses of the banks to the taxpayers (which should sound familiar about now).

Good luck this coming week and I'll be back with you on Tuesday and Thursday. It could be an active week so I'll have an opportunity to review the action with you along the way.

Key Levels for SPX:
- cautiously bullish above 1220 and bullish above 1265
- bearish below 1220

Key Levels for DOW:
- cautiously bullish above 11400 and bullish above 12000
- bearish below 10700

Key Levels for NDX:
- cautiously bullish above 1700
- bearish below 1600

Key Levels for RUT:
- cautiously bullish above 768
- bearish below 678

Keene H. Little, CMT
Chartered Market Technician

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