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On Tuesday I had pointed out the chart of the banks (BIX) because of the setup that I saw that calls for a new annual low this month. The BIX gave up almost 10% today and broke its uptrend line from the November 21st low, after leaving yet another 3-wave bounce (correction). So far the pattern for the banks says we should follow the money and get bearish from here. At the very least we should be very cautious about the upside. But the broader market indices held support today and hint of a rally leg for Friday and into Monday. Whether the rally leg will hold, especially if the banks don't participate, is the bigger question.

I had discussed the credit spread problem that's still present in the market and that it's a reflection of continued fear in the financial markets. I showed the chart of credit spreads widening while the stock market has been rallying and that the rally was therefore suspect--built on more hope that things will get better. Therefore today's hard decline in the banks is a warning shot across the bow that the bounce off the November 21st low may in fact be just another bear market rally (+20-25%) before heading lower again. That's the risk but doesn't necessarily mean we're going to head back down now.

I also see the potential for the market to be entering a larger consolidation pattern that will basically have us marking time while the market figures out what's next. In the meantime I thought I'd cover a little more material about this credit market and why it's a doozy to deal with now. I showed a chart on Tuesday of the widening corporate credit spreads (inversely charted so it was dropping lower) laid over the top of the S&P decline over the past year. The following chart is next to impossible to read because I had to squish it so much to fit but I'll explain what it's showing:

S&P 500, Volatility and Credit Spread (1929-2008), courtesy Ned Davis Research
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The top chart is the S&P 500, the middle chart is the 100-day moving average of the absolute change in volatility and the bottom chart is the credit spread (between Moody's Baa bond yields and 30-year Treasury yields). The spike in the credit spread and volatility in 1929 and the early 1930s, corresponding with the steep decline in stock prices, is a warning that we may see something similar again. The volatility index (100-dma) has spiked up near the previous spikes in 1987 and 2003 but nowhere near the spikes in 1929, 1933 and 1938. The decline in the stock market is also not nearly as dramatic (in percentage terms) as what happened in the 1930s.

So the logical question out of all this is whether or not we'll have a repeat performance to what happened in the 1930s. So we'll compare the credit creation between then and now:

Total Credit Market Debt as Percent of GDP, 1929-2007, courtesy Elliott Wave International
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Again, this chart shows credit as a percent of U.S. GDP since the 1920s to today. Leading into the 1929 stock market crash there was a big buildup in credit but what's interesting is the huge (some would say ginormous) credit boom following the stock market crash. Then the credit collapse from about 1933 to the bottom in 1951. You can see we completely dwarfed the prior period as credit expanded during the last bull market (it's what made it the strongest bull market in history), providing more money than people knew what to do with it and consequently bid up every asset known to man, and created countless bubbles that have been popping for several years.

As the Fed tries to re-inflate the economy they're attempting to create more credit to counteract the credit collapse that has already started. There's no way to know what kind of correction we'll have from the huge run up in credit into the peak in 2007. I think we can safely assume it will come down as hard on the back side as it went up on the front side. To think that the stock market will simply shake this off and get back to "normal" business of leveraged buyouts and another alphabet soup of new derivative tools is simply na´ve. This market has some serious correcting to do over time.

But the key is "over time". Nothing moves in a straight line and while it will take a while to work out the excesses we will see plenty of trading opportunities in both directions, even some bullish ones that last months, if not a year, before heading lower again. The more the government fights the correction the longer it will last. Just ask Japan how well government interference has worked for them. It worked so well (not!) that we're now trying to same things, except more aggressively. The law of unintended consequences from the government's actions is what worries me most.

But we're here to trade. Long term buy and hold is dead, long live the trader. It's what our newsletters have always been about and now we'll do our best to help steer you through the treacherous shoals as the tide recedes further.

S&P 500, SPX, Daily chart
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SPX closed on the trend line across the highs of November 14th and 28th (the neckline of the potential inverse H&S pattern that many are watching) so that's still potentially bullish. The uptrend line from November 21st is slightly lower at 863 so watch for a possible tag of that line first thing in the morning followed by a renewed rally. If SPX drops below that uptrend line it could be a quick trip back down to the 818 low on December 5th. If that breaks then the downside targets are 800, 768 and then possibly as low as 661 if things really turn nasty this month.

Right now I'm leaning towards the short-term bullish depiction (dark red) that calls for a leg up to the 940-950 area early next week (although the after-hours futures have me wondering about that). SPX 943 is an important Gann level and it coincides nicely with the downtrend line from October 14th (possible top of the large sideways triangle pattern for price to consolidate into February) and the top of a possible rising wedge pattern for price action from the November 21st low. Higher than 950 would have the next upside targets of 973, 1005 and 1050 in play. Otherwise a quick rally higher into early next week should be followed by another trip back down inside a large sideways triangle pattern.

Key Levels for SPX:
- cautiously bullish now above 8600
- cautiously bearish below 850
(either side is only for a quick trade)

S&P 500, SPX, 120-min chart
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I'm showing a potential rising wedge pattern which has slight bearish divergence on the oscillators thus supporting the bearish interpretation of price action here. As labeled in pink it's possible we've already completed an A-B-C bounce off the November 21st low. So far the pullback from Monday's high looks corrective and has formed a bull flag. I would normally expect a bullish resolution out of the flag pattern but recognize that the market tends to move quickly when a well recognized pattern fails. A drop out the bottom of the flag would clearly be bearish. Then the last line of defense for bulls is the uptrend line from November 21st, currently near 863. That's why a break below 860 would be bearish, especially if it then holds below the uptrend line on any retest. But assuming for now the bulls will get back in the game here, we should see another leg up to the 943 area before turning back down again.

Dow Industrials, INDU, Daily chart
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I'm showing the same rising wedge pattern for the DOW and the upside target for the DOW is the 9400-9500 area. Any higher than that and it will run into resistance at the 9700 level and then clearer sailing up to the 10300 area. Its uptrend line from November 21st sits near 8500 so watch for either a break or hold there. So far the 50-dma has acted as strong resistance, including today again. If the DOW breaks below its last low of 8118 I think we'll see new annual lows this month (dashed line).

Key Levels for DOW:
- cautiously bullish now above 8500
- cautiously bearish below 8100

Nasdaq-100, NDX, Daily chart
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As I've pointed out before, the blue chips give me the impression, if key levels can be held from here, that we've seen the lows for the year and we'll consolidate for a couple of months before heading lower again. But the techs have been weaker and continue to give me the impression that we're going to get another new low this month (a few other sectors give me the same impression, some of which I'll review below). I show, in dark red, the same sideways consolidation pattern as the blue chips but much tighter in the price range and potentially ending about a month sooner.

NDX found support at gap closure from Monday's gap up. A gap down tomorrow would clearly break that support level and could bring the previous low at 1096 into the bears' sights. If we do have a new low coming I think the 940 level makes for a good target/support level.

Key Levels for NDX:
- cautiously bullish above 1270
- cautiously bearish below 1096

Russell-2000, RUT, 120-min chart
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Rather than show the daily chart for the RUT, which is not much different than the others, I wanted to show the rising wedge pattern for price action since the November 21st low. Without looking at the after-hours futures I would look at this chart and be bullish for another 3-wave move up as depicted, with an upside target near 520 by early to mid week next week. The 120-min candle is a bullish hammer at support. It was a good setup to get long into the close. Now we'll have to see how the market opens in the morning to tell us whether we'll instead get a flurry of sell orders.

Key Levels for RUT:
- cautiously bullish above 520
- cautiously bearish below 423

I mentioned the techs look more bearish than the blue chips and I like to look at the semiconductors as somewhat of a tie breaker. A review of the weekly chart of the SOX is not encouraging for the bulls:

Semiconductor sector, SOX, Weekly chart
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I'm showing two parallel down-channels to point out what is happening with the first down-channel. The SOX broke below the bottom of the first channel in October and then more firmly in November. Oftentimes you'll see price bounce back up to the bottom of a parallel down-channel and give it a kiss goodbye. That may be what it's currently doing. The wave count for the move down also suggests it's got another leg down before a larger bounce into next year. I show the bottom of the slightly steeper down-channel near 120 in January. That would be another 40% decline for the semis and I would bet my bottom dollar that NDX would be following it and therefore the blue chips. I'll be watching this sector closely over the next week or so.

Banking index, BIX, Daily chart
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I showed the BIX chart on Tuesday because I felt it was at an important level where it could reverse back down and head for a new low this month. Today's decline (nearly -10%) led the market lower this afternoon and I don't see much bullish on this chart yet. It broke its uptrend line from November 21st and may be showing the way for the rest of the market. Between the techs and banks I have to say I'm feeling a little uneasy about my expectation for another leg up for the blue chips before rolling back over.

Back to another weekly chart to show the home builders and a pattern that also has me thinking a new low sooner rather than later (although it could bounce slightly higher over the next few days before starting lower again).

U.S. Home Construction Index, DJUSHB, Daily chart
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The final leg down from the March 2008 high looks to be putting in a descending wedge--a very typical pattern for the final move. The bullish divergences on the chart support the bullish interpretation of the pattern, but not yet. The bottom line is that the pattern still looks more bearish than bullish at the moment. As noted on the chart, the remarkable thing about the downside projection to about 60 would mean a 95% loss for this index from its 2005 high. A stunning loss.

Transportation Index, TRAN, Daily chart
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The transports could give us a heads up if they drop below the 3179 level on December 5th. Unless it's going to stay inside a tighter sideways consolidation before heading lower again, we could see this index head for a new annual low this month. Once again, if it does then I suspect we'll see the broader market follow.

On Tuesday I showed the oil chart and why I thought it was at or close to support. The $41 level is support and if that breaks then it should head for $34. Gold's weekly chart has me thinking more bearishly for the next couple of months and that could mean oil will also turn back down (it got a nice bounce today but failed to get above the bottom of its broken parallel down-channel).

Gold Fund, GLD, Weekly chart
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Gold could bounce a little higher to hit the top of its parallel down-channel for this year's decline, currently near $85. But notice that it continues to struggle with its broken uptrend line from July 2005. Gold made a new high for the month today but it was not confirmed by silver so it's suspect for now. Assuming we'll get another leg down, which I believe will happen, the downside target is near $63 where I'd be interested in buying gold.

Economic reports, summary and Key Trading Levels
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Today's initial claims data continues to show this recession is clearly worse than the previous one in 2001. The 4-week average has already spiked higher than what we saw at the end of 2001 and also now higher than we saw in 1991. The initial claims number of 573K is the highest in the past 26 years (1982). Most analysts now believe we're headed for the worst job market since the 1970s recession. And many are forecasting the worst market since the Great Depression. Going back to those credit charts I showed at the beginning of this report I'd say you can count on this recession being the worst since the Great Depression.

If we're heading into a deflationary environment, which we already are when you consider the deflation of all asset prices (and export and import prices dropped by a record amount in November, even excluding oil prices), then the situation will become more dire than anything we've experienced since the 1930s.

The good news, for our longer-term financial health (and a sign of true fear), is that Americans paid down their debt in the 3rd quarter for the first time since 1952. But there's a good news/bad news component to this report. The reason debt has been paid down is primarily due to people taking on less mortgage debt. The home equity ATM has been empty for a while and we all know how the housing market has dried up with fewer mortgages being written. The worse news is that people continue to pile up debt in credit cards and auto loans (even though auto sales are down more than 30% so it's more credit card debt than anything else). The big Kahuna when it comes to figuring out how to get deeper into debt? No surprise, it's our favorite uncle, the US government, which boosted its debt by a post-war record of +39.2%. My poor kids, and their kids.

After the market closed news came out about the possibility there may not be enough votes in the Senate to pass the bailout bill for the Big 3 auto companies. Futures are down hard as I finish this up (S&P futures are down -24 points). Whether the drop will hold into tomorrow's open is anyone's guess, especially if some good news leaks out in the morning. I think we all have to assume some kind of bailout plan will eventually be passed. Even if it's to escort them into bankruptcy and hold their hand through the process to make sure they stay a viable manufacturing company (if not a watered down version).

If the market drops much further Friday morning it will obviously look bearish. It could be a quick spike down followed by a fast reversal and rally into Monday. That's just a guess but let's just say nothing would surprise me in this market. As I had shown for the blue chips, the pattern would look best with another push back up to complete the bounce pattern from November 21st. SPX 943 is a good upside target if the bulls can take the reins on Friday and lead the cavalry to the rescue. Remember, we're heading into opex week and many times we've seen a quick spike down on Thursday or Friday prior to opex get reversed with a v-bottom recovery. Opex shenanigans by the biggest players.

Several other sectors, including the techs, give me the impression that it may be wishful thinking to expect any more rally this month and in fact point to new annual lows by Christmas rather than a Santa Claus rally. We'll have our own rerun of the Grinch Who Stole the Rally. In fact, even if we get a rally leg into early next week I don't think it will lead to a Santa Claus rally (unless it's from a lower level). I think we're due for a whippy couple of months and therefore look at each strong move as an opportunity to fade it. That's easier said than done since it's very difficult to identify the turning points. But that's what we'll continue to attempt to do and see if we all can't become better traders in one of the more difficult markets you'll ever trade.

Good luck tomorrow and next week. Just keep in mind that opex does funny things to this market. I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish now above 8600
- cautiously bearish below 850
(either side is only for a quick trade)

Key Levels for DOW:
- cautiously bullish now above 8500
- cautiously bearish below 8100

Key Levels for NDX:
- cautiously bullish above 1270
- cautiously bearish below 1096

Key Levels for RUT:
- cautiously bullish above 520
- cautiously bearish below 423

Keene H. Little, CMT
Chartered Market Technician

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