Market Stats

The DOW closed 2009 at 10428 and today's close was 10390. Other than the explosive rally out of the gate on January 4th, each trading day saw only incremental gains and then got very whippy this week with a final closing high of 10730 on Tuesday. The two weeks' worth of gains was given back in two days. How frustrating for the bulls. The bears on the other hand were rewarded for their efforts in trying to short this market.

What's that Mr. Bear? You say you weren't short for this 2-day decline? I can tell you one thing--you're not alone. This week alone smacked more bears, and bulls, for trying to trade a position and by the time the market dropped I'd hazard a guess and say there were an awful lot of frustrated bears on the sidelines, missing something they fought so hard to get. Get used to it and get over it. Every new day is a new trading opportunity. The minute you get angry and feel like you have to get the market back is the time it will turn on you and blow you out of your account. Anyone ever stick with a losing trade too long because you missed the previous opportunity and by God you're not going to let the market spike you out again? No? I guess I'm the only one (smile).

If you look at previous highs in the past year you'll see a very similar pattern. The tops are not v-shaped but instead choppy affairs. They look like bullish consolidation patterns, similar to the long one we had in November/December. It gets the bulls climbing aboard, ready for the next leg up. Then the bottom falls out. Look at October 2009, and September before that, and August before that and June before that. See the pattern? This week was no different. The hard part of course, like what happened in December, is not knowing whether or not it really will resolve to the upside. But when it breaks the bottom of the trading range it tends to let go hard as all the new bulls bail in a hurry. Today was no exception. I thought it was going to let go after Friday's break but then "they" jammed the market back up again, flipping the bears out of their positions.

After what looks like a completed wave count to the upside, today's breakdown looks important. It looks like the kickoff to what should be a strong decline over the coming months. It will of course not be straight down (although it might feel like it at times) and there will be plenty of trading opportunities. Do not rush an entry, on either side, but instead let the market come to you in a setup that you define. Hopefully I'll be able to show you a couple to watch for. And as I'll review with the NDX chart later, there is still the possibility the bulls are not done messin' with the bears. So if you're short, don't get complacent.

The market, except for many of the banks, was down this morning but then it got some news that jolted some bulls out of their positions. At 11:40 AM, there was a news flash: "OBAMA SAYS NO BANK SHOULD RUN PROPRIETARY TRADING OPERATIONS" and "OBAMA PROPOSES NEW LIMITS ON THE SIZE OF FINANCIAL INSTITUTIONS"

The rats scrambled to get off the USS Bankship as fast as they could. The larger-cap banks took it on the chin as investors feared the golden goose (their proprietary trading operations) was about to get cooked and the "too-big-to-fail" banks were about to be made smaller. Obama said "While the financial system is far stronger today than it was a year one year ago, it is still operating under the exact same rules that led to its near collapse." He went on to say "Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers."

The mere threat of breaking up the banks is all it took to knock the wind out of the sails of Goldman Sachs and the other big banking centers that rely heavily on their trading operations for their massive profits. GS reported before the bell and said it earned $8.20/share against expectations for $5.20. It rallied initially out of the gate but then stumbled and immediately sold off and was already in the red when the Obama announcement was made (rumors were already flying). So it once again appeared to be a sell-the-news reaction, a very common reaction this earnings go around. At market tops good news gets sold; remember that. At market bottoms bad news gets bought.

It appeared by midday that money was making a run for it into other smaller regional banks, knowing the bigger trading bank centers will see investors fleeing. The BIX and BKX were both up nicely for the day but couldn't hold onto their gains this afternoon. In the BIX the stronger banks included Comerica, Fifth Third Bancorp, Huntington, Bankshares, Keycorp and SunTrust Banks. I don't see any banking centers among that group (the ones with their own proprietary trading desks making the bulk of their income, such as GS, JPM, BAC and C). The BKX includes the same banks listed above and also Zions Bancorporation. I noticed a number of these banks, including Well Fargo, rallied strong after the late-morning announcement. But by the end of the day the strong across-the-board selling also took down these banks and most finished the day down.

As part of the mood shift that affects the stock market, the concerns about public debt and the shenanigans in Congress and the Senate (more backroom deals and more spending) is starting to take its toll on social mood. This shift will manifest itself in another down year for the stock market so it's important to look for these signs. Witness the surprising (shocking?) win by Republican Scott Brown in Massachusetts. People who haven't voted for a Republican in their entire life (some being interviewed talked about 50+ years of voting) voted Republican. This is a strong indication of a significant change in character to social mood and it's likely to get worse. The anti-tax tea-parties will gain momentum.

People are generally getting very frustrated now with the amount of out-of-control spending and the feeling our non-representative Representatives are not listening to us. The current backroom deals trying to hammer out a healthcare bill is really what propelled Scott Brown into the Senate. By this summer I predict a number of Congressmen and Senators will announce they're not going to seek reelection, knowing how angry their constituency is. I hope Pelosi is booted and that's as far as I'll go with my own political comments.

While consumer debt dives for the floor, public debt is increasing at a parabolic rate. First, take a look at the latest consumer credit numbers:

Consumer Credit

The top portion of the chart shows consumer credit since 1994 and August 2008 it has been in negative territory (except for January 2009). With the slowdown in Christmas shopping this year, the slowing in home sales and auto sales, I think there's a good chance we'll see the lines continue downward. Consumers are rapidly trying to get themselves out of debt (either by paying it off or walking away from it). This is very important to the longer-term health of our country, and even for helping out with the public debt problem. As foreign investors fade away it's going to be up to us to fund our debt and without consumer savings we won't be able to do it. That would create a nightmare scenario if the Treasury is presented with a failed auction at sometime in the future.

We are coming at this the opposite of how Japan did it. When their depression started, which they're still in, the government had the citizens' savings to tap to fund their debt. But that savings has been depleted and Japanese citizens are getting more into debt. Japan faces a very significant crisis as early as this year and may be forced to default on its debt. But we're starting off from a negative savings rate and quickly heading positive. U.S. citizens will be in a position to fund the government's debts when the foreigners slip away. So it's not at all a bad thing what we're seeing happening with the significant decline in credit and an increase in our savings rate.

That's not to say we're happy about all the government's debt (which of course is our debt). We want some fiscal control back and the politicians are finally starting to get the message. Well, except for Pelosi. The following chart graphically shows our debt situation, and includes all the years from not long after the birth of our country:

U.S. GDP vs. Debt as a percent of GDP, 1792 to 2010

GDP is the brown line and you can see it has gone parabolic since the 1970s. Hmm, what happened in the 1970s? Oh yea, Nixon took us off the gold standard in 1971. From then on we could print all the money our little hearts desired and create massive amounts of credit, fooling ourselves into thinking we were expanding our economy. As a percentage of our GDP, the green line shows it spiked during WWII (naturally) and bottomed close to the start of the bull market in 1982. Since that time, even though we were in a bull market, we started getting deeper and deeper into debt as a percentage of our total GDP. That's because GDP has become a farce. We don't produce the products like we used to and instead we measure GDP through financial engineering and even government spending.

Currently, the debt-to-GDP percent is approaching 100%. But even this is conservative. Not measured in there are all the unfunded liabilities our government has (Medicare/Medicaid and Social Security to name just two. If these are included then the actual debt-to-GDP percent is closer to 800%! Now we're about to enter the worst part of the depression cycle and we've got very little wiggle room for more government debt. Without having a sense of the greater cycles at play, or even the threat of a deeper recession (depression), people have a keen sense of the debt trouble we're in. It probably has to do with the recognition of our own personal debt issues and knowing we have to fix that. Now we want the government to fix it as well. Congresswoman Pelosi, are you listening?

Many worry about what the debt load will do to interest rates. As long as U.S. citizens, corporations and some foreign investors save money and want to invest in the safety of U.S. Treasuries we should have no problems selling our debt. Yields should stay low for the year (contrary to the cries of inflationists). That's the benefit of personal and corporate savings rates improving. As I've mentioned in the past, I keep my eye on TIPS (Treasury Inflation Protected Securities) and so far I'm not seeing any concerns about inflation).

With that let's get to tonight's charts. This week I'll start with a view of the RUT, from its weekly chart to its 60-min chart. After completing a 5-wave move down from 2007 to 2009, which is impulsive and therefore tells us the primary trend direction, the rally from March 2009 is a correction to that decline. It made it up to its downtrend line from 2007 (log price scale) and almost up to its 62% retracement of the decline (at 657.44 while the high on Tuesday was 649.15). Weekly RSI and MACD show negative divergence at the January high and threatening to roll over. A break of the uptrend line on RSI would be a strong sell signal from a weekly perspective. And as you can see, price is close to testing its uptrend line from March through the late November low (a line drawn through the November 2nd low has already been broken).

Russell-2000, RUT, Weekly chart

The daily chart of the RUT shows a closer view of price action around the key trend lines. After breaking its uptrend line from late November, it bounced up for a retest of it (it did this a couple of times) and tagged its downtrend line from October 2007. The uptrend line from March-November is currently near 625, which is also the September and October highs. Therefore a break below 625 would be significant. The RSI break of its uptrend line from the end of October is forecasting that we'll see price do the same.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 657
- bearish below 625

On the daily chart above, I'm depicting what a typical 5-wave decline would look like with my expectation for a sharp decline into February. The retracement of the rising wedges on the indexes should mean a fast retracement of them and that means down to the November 2nd lows faster than it took for the wedges to be built. Keep in mind that the decline could happen faster than what I've depicted.

Not shown on the daily chart is an uptrend line from July-November that's currently down near 605. I think that's where the RUT could be headed over the next few days if the selling becomes strong as I suspect it will. The 1st wave down on the daily chart (wave i) is shown as a 5-wave move down on the 60-min chart below, which would complete that 1st wave. If at any time this pattern gets interrupted, especially with a rally back above 644, I'll revise the wave count but so far the decline continues to look impulsive to the downside which supports further selling.

Russell-2000, RUT, 60-min chart chart

On the SPX daily chart below I'm showing a faster decline to the November 2nd low than I showed on the RUT's chart. That low near 1029 could be tested as early as the 2nd week of February. I want to point out this possibility in case you're sitting on some bull put spreads. The break of the rising wedge pattern could easily be followed by a strong breakdown as depicted so be careful if you're in long positions. The bullish sentiment is extreme and therefore the selling could become extreme if many of the new bulls quickly bail (those who bought into the dream of higher highs this year, especially based on the old saw about the first 5 days of January blah, blah, blah). The only reason those fairy tales about January work (as goes the first 5 days so goes January and as goes January so goes the year) is because the stock market is generally bullish. In a bear market those statistics are turned on their heads.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1159
- bearish below 1115

SPX tested the December 31st low of 1114.81 and at the same time it tested its 50-dma at 1114.67. The bounce off both support levels was less than stellar and that speaks volumes about the market. We have a change in character. It remains possible for the market to turn back around and head for another high, depicted with the dashed line on the daily chart above, but that possibility has diminished drastically. A move above 1142, shown on the 60-min chart below, would revive that possibility.

S&P 500, SPX, 60-min chart

The break below SPX 1129 turned the price pattern bearish, and it stays bearish until the bulls can drive it back above 1142. Now it's a matter of determining what kind of pattern will play out to the downside and what I'm showing on the 60-min chart is a 5-wave move down from Tuesday to an expected low on Friday which will complete the next larger degree 1st wave down on the daily chart (wave-i on the daily). If we get a new low on Friday followed by a bigger bounce into Monday/Tuesday as depicted you'll want to short it for what should be a very strong decline to follow.

The DOW broke below the highs of the November/December consolidation. That means the bullish consolidation pattern has failed after a head-fake break above it into the January high. A failed bullish pattern tends to fail hard (same in reverse) and that in combination with the drop out the bottom of rising wedges across the board has me believing we're going to see a strong decline into February. As depicted on the DOW's daily chart below, we could see a drop back to 9700 by the 2nd week of February. Again, if you're in bull put spreads, think about how you want to manage/hedge/exit those plays. Don't become a dear in the headlights.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10730
- bearish below 10423

Now we come to one of the few indexes that has me thinking we could still see a new high into the end of the month. The sideways/down chop in the NDX pattern for this month keeps open the possibility that it's a bullish consolidation pattern. If we get another leg up after all of this chop there is an upside Fib projection for a 5th wave for the move up from November 2nd near 1943. A rally above 1897 would tell us that's where it's headed. A break below today's low near 1842 would confirm a break of the uptrend line from March-November and tell us the top is already in. So the bulls need to rally immediately on Friday and keep it going.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1897
- bearish below 1842

The semiconductor index should provide some clues as to where the techs are headed next. The move down from the high on January 11th looks like either a corrective pullback (a-b-c move down) or else it's a very bearish wave count that supports the idea that we're about to see some serious selling hit the market. If the SOX breaks above 356 look for another run higher into the end of the month. If it breaks down instead, and especially if it drops through the bottom of a parallel down-channel, currently near 335, look for a continuation of a hard selloff.

Semiconductor index, SOX, 60-min chart

While the broader market sold off hard almost immediately this morning, the two banking indexes, BIX and BKX, were rallying strong. But the selling soon caught with them and they too succumbed to the selling pressure. The financial sector ETF, XLF, sold off the entire day--more in synch with the bigger banking centers than the stronger regional banks. XLF remains a good shorting candidate (or buy the inverse funds such as SKF and FAZ).

Financial Sector SPDR, XLF, Daily chart

By breaking below the December 31st low near 4098, TRAN gave a sell signal as well today. It closed just above its 50-dma near 4089 and could get a bounce on Friday but the damage has been done and it should continue lower. It takes a rally back above 4200 to suggest we haven't seen the final high yet.

Transportation Index, TRAN, Daily chart

The U.S. dollar looks like it's ready to rumble to the upside again. The pullback from December 22nd to January 13th retraced between 38% and 50% of the leg up off the November low and now looks ready to start the 3rd wave higher. If so then get ready for a strong rally in the dollar over the next several months, which will make it above last March's high of 89.71.

U.S. Dollar contract, DX, Weekly chart

A strong dollar rally will not be good for commodities (or the stock market). If you're in commodity stocks it's time to pull the plug on them, or certainly hedge your position. Looking at the commodity equity index, CRX, today it broke its uptrend line from March and closed below its 50-dma. It's done the latter but not the former before this. You can see how many times that uptrend line held as support, defining its importance. Therefore today's break is potentially very important. I say potentially because a quick recovery back above the line, near 780, would leave it as just a head-fake break. It could bounce back up and retest it. If a retest is followed by a new break lower you'd have confirmation of the break. You won't always see a retest. On the weekly chart (not shown), RSI has now broken its uptrend line from March as well.

Commodity Relate Equity index, CRX, Daily chart

Looking at gold's weekly chart with the log scale shows the uptrend line from October 2008 is where gold is currently finding support. If gold can hang on and chop sideways a little longer it would be a good setup for another run higher to about 1300. While it takes a break below 992 to negate the upside potential I think any break below Thursday's low of 1088 will likely usher in strong selling since the wave count for the move down from its high of 1163 on January 11th is setting up a very bearish move.

Gold continuous contract, GC, Weekly chart

As with gold I see the possibility for another leg up to complete oil's rally off the January 2009 low but the wave count can be satisfactorily counted as complete at this time. It takes a break below 69 to confirm we've seen the high for oil, with a break below its channel near 73 providing a bearish heads up.

Oil continuous contract, CL, Daily chart

The market is paying more attention to earnings right now rather than economic reports. This morning's reports did not help matters but in reality they were pretty much ignored. There are no major economic reports Friday morning so the market will only have earnings reports to react to.

Economic reports, summary and Key Trading Levels

Google reported its earnings after the bell today and they looked great. In fact they were so good that investors couldn't stand it and sold the stock hard after hours. Go figure. Revenue was slightly better than the expected $4.92B, coming in at $4.95B and earnings were $6.13/share, up from $1.21/share a year ago. Excluding special items GOOG's earnings were $6.79/share against expectations for $6.48/share. Sounds like they're running on all 4 cylinders. The stock closed at 582.57 and was trading down $30 near 553. Can you imagine if they had disappointed? Like I always say, it's not the news that matters, it's the reaction to the news that's important. At market highs you'll see people selling good news (if it's not better than much better than expected) and at market bottoms people will buy bad news (if it's not as bad as expected or already priced in).

As for additional earnings tomorrow, more financials are reporting before the bell--BBT, GE (it trades like a financial), MBFI, STBC and STI report before the open. Schlumberger (SLB) also reports before the bell and could provide some sense of the industrial sector.

For Friday I expect to see another leg down. SPX 1100-1102 is a downside target (so another 14-16 points lower) but then it should be ready for a bounce into Monday/Tuesday to correct this week's decline. If it plays out that way you'll want to short that bounce. The bounce should be a 2nd wave correction and the next leg down later next week will be a strong 3rd wave. This is where the bulk of the initial move down will be made so if you'd like to try the short side of the market and missed this week's decline, early next week should provide a very good opportunity.

There is the risk for an immediate and hard decline tomorrow and into early next week. If SPX drops through 1100 at a high rate of speed then we'll know that's likely playing out. In that case we could see SPX drop down to 1085 support in a heartbeat before we see it stair-step lower from there. I'm not leaning that way but it's currently a risk at the moment. For a better entry we want to see a new low tomorrow (assuming we'll get a new low) that's marked with bullish divergence against this morning's low and then a bigger bounce into next Tuesday. That's the setup that will make it easier to get into a short position. But will the market accommodate the bears?

Good luck and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1159
- bearish below 1115

Key Levels for DOW:
- cautiously bullish above 10730
- bearish below 10423

Key Levels for NDX:
- cautiously bullish above 1897
- bearish below 1842

Key Levels for RUT:
- cautiously bullish above 657
- bearish below 625

Keene H. Little, CMT