Market Stats

The equity futures had rallied strongly last night, which followed the strong rally off yesterday's low. It looked like we might have put in a bottom and started at least a correction to the past week's decline. But by the time the opening bell rang much of the overnight rally had been given back and the selling continued. The major indexes made new lows, led by the techs. NDX declined more than twice as much in percentage terms than did the blue chips and it declined more than the Nasdaq, showing the tech big caps (the generals) were leading the way down--not a good sign. It was a frustrating day for bulls hoping for a bottom to form so that they can at least get a bounce to lighten up positions. But if you feel bullish about the prospects for our market then you got an even better buy today.

Earnings have continued to impress (although it hasn't been difficult when comparing to the disastrous 4th quarter of 2008) but investors have not liked what they're hearing. Cost cutting rather than revenue growth and tepid forecasts have reduced the enthusiasm of many. And of course there is the sell-the-news reaction that we're seeing consistently right now. We got a big earnings run into this month's reports and traders are simply pulling their money off the table once the company reports. Remember the earnings and stock split runs years ago? Sort of reminiscent of those times. Ah, those were the times, times when we were all geniuses (not to be confused with a bull market).

Are you ready to be a genius in a bear market? It should be no different than trading a bull market. Hold your charts upside down and trade it the way you would in a bull market, but just the opposite. Buy puts instead of calls and use your trend lines, moving averages, patterns, divergences, etc. just the way you would in a bull market but in reverse. Easy, no? If only.

Bear markets are more violent and more difficult to trade. Things happen faster and it's easy to get emotionally overwhelmed (I strongly recommend turning off CNBC--they're way too emotional and distracting). If you haven't played the short side much you should by all means start off small. Don't worry about missing big moves--the market will always be here. If you miss the bus because you were late to the bus stop there will be another bus that comes by shortly, and another, and another... That's the beauty of what we do. We can leave and come back and pick up again with what the market gives us.

So start off with small positions, paper trade (understanding your emotional reactions will be nothing like when you have skin in the game) and be completely comfortable seeing the world upside down from the way you normally trade. I think we're going to be in a bear market for years to come so it's a good idea to practice and see what you can do about turning some lemons into lemonade.

I see a bounce coming (I thought it would start today and maybe it did this afternoon), perhaps retracing 38%-50% of the past week's decline and maybe into Tuesday/Wednesday, and that should be a good setup for playing the next leg down. More on that later.

I've often referred to social mood when it comes to the stock market. We human beings have cycles that we go through and the longer-term Kondratieff cycle (about 54 years) is one commonly known cycle. I always found it interesting that Greenspan wanted to be known as the man who stopped the Kondratieff cycle (not too pompous). He hasn't. At any rate, as social moods swing from ebullience to despair we see it reflected in excessive risk taking at the top and isolationism and depression at the bottom. The bad news is that I think we're heading for the bottom of the cycle. The good news is that once it's over (by the end of this decade) we'll be back on the upswing. Our job is to trade what the market gives us, not what we wish it would give us.

The stock market happens to be one of the best, if not the best, social mood meter that we have. On the upswing in the cycles, when we are upbeat and positive about the future, we're willing to risk more, borrow more, spend more and we're bullish the stock market. And then just the opposite on the down swing. The last major down swing, on a global basis, was the Great Depression in the 1930s. There are many interesting correlations between then and now.

Kevin Depew from Minyanville often talks about the socioeconomic shifts and the impact on us. Bob Prechter has written some excellent books on the subject. In a recent article Depew (Peppy is his nickname) pointed out a film clip from a 1932 Marx Brothers film, Horsefeathers, in which Groucho sang "Whatever it is, I'm against it." Groucho Marx "I'm against It." This summed up the political feelings of the people at the time, as the country was entering a long and difficult depression. Divisiveness was, and now is again, the name of the game.

When you think of the political situation that we have now, would you concur there are similarities between then and now? An article in the Washington Post, written by Joel Achensbach yesterday, "The Audacity of Nope", started off with the following statement, "The state of the union is obstreperous [hostile, defiant]. Dyspepsia [indigestion, heartburn] is the new equilibrium. All the passion in American politics is oppositional. The American people know what they don't like, which is: everything." Later in the article he refers to an "againstness epidemic".

It's just another small example of the patterns that we repeat and the consequences we'll see manifested in the stock market, which is of course what we care about. Other than trying to stop our own moods from turning negative with the crowd, the stock market's reflection of the mood shift is what we want to be able to understand and trade as best we can. This includes day traders to longer-term retirement investors.

A longer and deeper recession (depression) is not a foregone conclusion but all the signs are pointing in that direction. And if that's true then it's important to understand that the same pattern as the 1930s means our stock market is headed for much lower lows in the future. Those are the odds, not a certainty. But considering the odds it's a reason I keep pounding the table to get your money out of the market, or at least don't be a buy-and-holder. We at OIN want to help you trade the market and with luck and success you will be far better off when we come out of this, which we will.

Kicking off tonight's charts we'll start with the SPX weekly chart. At its January high it came close to its upside price projection at 1158.76, for two equal legs up from March (the high was 1150.45), and poked slightly above its downtrend line from October 2007, and topped out only a week later than the 62% time projection (62% of the time it took for the 2007-2009 decline, a typical time for the first correction within a primary trend). It was a very good setup for a reversal and at this time it's looking like we have exactly that. It's still slightly early to make that call but we've seen one of the stronger declines n the past week follow that setup so it's now for the bears to lose.

S&P 500, SPX, Weekly chart

The break of RSI below its uptrend line from March is a strong indication the top is in. I've seen many times where price will run back up for a retest, even to a slightly higher high, while RSI tests its broken uptrend line so that remains the risk for bearish plays. But at the moment, the price pattern supports the idea that we'll see a bounce that retraces some portion of the decline and then continue lower into February.

The daily chart below shows today's decline poked below the uptrend line from August-November. It looks like a completed leg down from last week but it will need to start rallying tomorrow otherwise the break of horizontal support and the uptrend line near 1085, both near 1085, could spell serious trouble for the market. If a bounce does get started, a typical correction of the past week's decline would have SPX back up to the 1115 area by next Tuesday/Wednesday. Any rally that stays below 1121 should be an outstanding setup for the next shorting opportunity. Between 1121 and 1131 I would be cautious and above 1131 would mean we'll probably see at least a test of the January high.

Based on the evidence I see, I am expecting the bounce to be just a correction to the decline. But you can expect to hear all the pundits come running out of the woods and onto CNBC and tell you what a great buying opportunity this dip has been and that we should now expect higher prices. I'll guarantee you'll hear most profess it. Listen to them at your own risk--I would rather fade the crowd and look to get short. As depicted on the daily chart, the next leg down could test the October/November lows (1020-1030) before February opex (much faster if it breaks down from here, such as in days).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1131
- bearish below 1121

For now I'm assuming the leg down from last week has finished as a completed 5-wave move down. That calls for a correction and as I'm showing on the 60-min chart below, we should see something like an a-b-c bounce (or something a little choppier) that makes it up to the 1114-1115 area by next Tuesday/Wednesday. If the market is very weak or too many bulls start bailing earlier (and bears start shorting earlier), then look for a lower bounce (1104-1106) that finishes as early as Monday. Ideally we'll see the bounce play out as depicted since it would be a MAPO (Mother of All Put Opportunities).

S&P 500, SPX, 60-min chart

The DOW bounced off support at the October highs (with a minor poke below it) and looks ready to correct the decline from last week's high. A 38%-50% retracement gives us an upside target zone of 10312-10392. In that zone is its 50% retracement of the 2007-2009 decline at 10334 and then slightly higher is its broken uptrend line from August-November, near 10345 by Tuesday morning. Slightly higher is its 50-dma at 10447. Now all it has to do is starting bouncing.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10400

I want to point out a couple of things on the NDX weekly chart that I think are significant. First, price breaking its uptrend line from March (log scale) is an important sell signal but we don't know how much of a decline it might portend. The break of the uptrend line by RSI is also good confirmation of the price break. But I think one of the more important signals is the weekly divergence in RSI at the January high followed by the breakdown. Only once before in the past decade have we seen this signal--at the March 2000 high. There was also a negative divergence at the October 2007 high but not to the same extent. Therefore I think the weekly setup is particularly bearish and tells us the breakdown will likely be more than a garden variety pullback correction.

Nasdaq-100, NDX, Weekly chart

This morning's decline in NDX stopped just short of its uptrend line from August-November, near 1758 Friday morning, and the setup looks good for a bounce back up to at least Wednesday's high of 1823.80. That would be between a 38% and 50% retracement. Only slightly higher is its broken 50-dma at 1825, which has already acted as resistance this week.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1874
- bearish below 1850

This morning the RUT broke its uptrend line from July-November and then spent the afternoon trying to rally back up to it. It almost climbed back above it as we were heading for the close but it got rejected. That looked bearish (kiss goodbye). But with the bullish divergences on the shorter-term charts at this morning's low, and what looks like a completed wave count for the leg down from last week, it looks like a good setup for a bounce into early next week to correct this past week's decline. This morning's low needs to hold otherwise the price pattern turns a lot more bearish.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 641
- bearish below 634

The big banking indexes, BIX and BKX, have been holding up well this week, despite the selloff in the broader averages. But the financial sector ETF, XLF, has not done as well. It too has done better than the broader averages but not as well as the bigger indexes. I'm showing on its chart below that a slightly higher bounce into early next week could have it testing its broken 50-dma at 14.61 before turning back down. One other possibility, not shown, is for another decline to support near 13.75 before getting a bigger bounce back up to correct the decline. In any case, below 13.75 would be a stronger sell signal for this sector.

Financial sector ETF, XLF, Daily chart

The transports were leading the southbound parade today but the TRAN found support at previous lows near 3925. It looks like a good setup for a bounce back up to test its broken uptrend line from March-November and its 50-dma, near 4090 by next Tuesday.

Transportation Index, TRAN, Daily chart

The US dollar has started to rally again and has pushed above the December 22nd high and today closed above its 200-dma, something it has not done since breaking it on May 8, 2009. The more the dollar continues to rally the more it's going to create doubt in the minds of dollar bears and those who have been using the dollar for the carry trade. Once they start feeling more pain they'll be covering their carry trades which means buying back the dollar and selling other assets (stocks, gold, bonds, etc.). This is why a dollar rally is going to be bearish for other asset classes. It also fits the deflationary picture where the dollar will increase in value (and why holding other assets could be harmful to your financial health).

If stocks and commodities sell off then the commodity stocks themselves have little hope to rally. I showed a chart last week of the commodity related equity index (CRX) and pointed out the break of its uptrend line from March-July, which followed a classic topping pattern in a rising wedge. The little throw-over above the top of the wedge on January 11th was followed by a collapse back inside the wedge the next day and that was the first sell signal. The break below the bottom of the wedge last Thursday was the second sell signal. A bounce back up to the bottom of the wedge for a kiss goodbye would have been the 3rd signal but we haven't had that one yet. It could still bounce back up to it but at this point I think the 50-dma at 772.73 might be all it can muster. Any bounce back up from here followed by a new low would be another sell signal.

Commodity Related Equity index, CRX, Daily chart

Like the stock market, gold looks like it could be ready for a bounce back up to what should be resistance near 1121-1122 where it would run into its broken uptrend line from August and its new downtrend line from December. The wave count for the move down so far counts well as a 1st and 2nd in December/January and now a smaller degree 1st wave down and the next bounce would be a smaller degree 2nd wave correction. This is what I often refer to a 1-2, 1-2 setup because the next move down (after the bounce into next week) will be a 3rd of a 3rd wave down.

Gold continuous contract, GC, Daily chart

The 3rd of a 3rd wave down is what I call the "screamer" wave--the strongest of the 5 waves and the nickname for them is "wave of recognition" because it's when most traders get the idea that the move is real. There are a lot of gold bugs still looking to buy the dips and when the uptrend line from October 2008, near 1070, breaks it will cause many of those gold bulls to reassess, and sell. If the bounce into next week plays out as I've depicted, you'll want to short it. You can sell YG, the gold e-mini futures contract, buy puts on GLD, buy GLL (the inverse ETF) or calls on GLL (know which ETF you're using and whether you want to buy calls or puts).

Silver can be even more fun to play if you get on the right side of the trade. It can also hurt you if you let it go too far against you. Stop management in the metals is critical. I see the possibility for silver to drop a little lower to its uptrend line from October 2008 and its 200-dma, both near 15.70. But it could get a bounce a little earlier, especially if the dollar pulls back for a few days. The December lows around 17 make for a good upside target for the bounce and then it would have the same setup as gold--a 3rd of a 3rd wave down would be due and it should be a screamer. Dropping to the July low near 12.43 should happen quickly (on its way to much lower lows). You can short YI, the e-mini futures, buy puts on SLV or buy the inverse fund ZSL or its calls.

Silver continuous contract, SI, Daily chart

Oil is struggling to hold onto its uptrend line from February 2009, having poked below it the past two days but closing on it. It too looks ready for a bounce before heading lower. But if it continues lower, with a solid break of its uptrend line from February, look for a quick drop to its 200-dma near 69.80, maybe lower to the December low of 69.51.

Oil continuous contract, CL, Daily chart

Real estate is another trading idea. But you don't want to own it; you want to be a seller of it. Commercial real estate has taken a bath in the past year and the only reason we're not hearing more about it is because no one wants to report the problem. The banks carrying the commercial real estate loans keep quietly renewing the financing or looking the other way (with Fed approval) and not reflecting true (market) value on their books. A lot of dead inventory is now on the banks' books and they don't want to call in the defaulting loans, or sell the property, because then they'd be forced to recognize the actual value and would have to take the write-down. Many of the bank failures in the past year are due to these defaulting loans without sufficient reserves to handle the write-downs. And because the banks can't do anything with these loans they can't free up the capital to make available to other more productive ventures. It's part of the reason why so little money is available for lending--it's literally locked up.

But sooner or later many of the commercial properties will have to be sold and many commercial property holders will no longer be able to carry their properties without sufficient income to cover their costs. Many larger commercial real estate holders, including big banks like Morgan Stanley, are simply walking away from their properties. Think of it as jingle mail on steroids. So what will this do to REITs? If you think they're going to suffer badly, as I do, there's an ETF for you. First, look at a weekly chart of the DJ REIT index, DJR:

DJ REIT index, DJR, Weekly chart

The uptrend line (log scale) from March was broken in the first week of January. Maybe some folks were simply waiting for the 1st of the year to start unloading some REITs. It's only a small break so far and assuming the high for this index is in, it's a good place to climb aboard for the trip back down, using a stop at a new high (190.25). The inverse REIT ETF is SRS so you could buy it or calls on it (go out longer term with the calls though, even LEAPS). Its weekly chart shows how much it has dropped while DJR rallied the past year:

REIT index inverse ETF, SRS, Weekly chart

At the same time that DJR broke its uptrend line SRS broke its downtrend line from November 2008. There's some serious upside potential in this index but you'll have to give it lots of time to work. I don't think the real estate losses will be quickly recognized and that could hold SRS down for a long time.

Tomorrow's reports include an advance look at GDP and as you can see in the chart below, expectations are for +6.8% growth, up from +2.2% last month. That sounds really great on the surface and I think it will spark a rally in the stock market. Digging into GDP to see how they derive the numbers makes it a bogus number but that won't stop the pundits from pounding the table and telling you to buy the dip in the market because we're headed for growth. Call me a skeptic.

Economic reports, summary and Key Trading Levels

The formula for GDP is GDP = C + I + G + (X-M), where:
C = Private consumer consumption
I = Investments, which includes business investments but not investments in financial assets
G = Government spending (salaries, military, and investments, but no transfer payments such as welfare, social security or unemployment benefits)
X = Exports
M = Imports

What's missing from the formula, and which should be a detractor, is debt. If we the people or our government go on a massive spending spree and do it all with debt, we have assets on one side of the balance sheet and debt on the other. But the government does not exclude debt from the calculations of GDP. Only the spending counts, which is again like saying we can spend our way to wealth.

China is a master of deception when it comes to GDP. It's doing a lot of spending right now and it shows up as a high GDP growth rate for the country. But false spending can be worse than no spending and China may be heading for a bad crash. For an example of out-of-control spending in China, this video clip is an eye opener: China's empty city

Last week I showed a chart of debt vs. GDP and the fact that it was approaching 100% (much much higher if unfunded liabilities such as social security and Medicare/Medicaid are included). Two top economists, Carmen Reinhart and Kenneth Rogoff wrote last month: The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies...

So when high GDP numbers are reported without taking into consideration the level of debt to achieve it, we are only fooling ourselves. When the increased GDP is reported tomorrow it will be important to understand how worthless the number really is. It doesn't properly describe what the typical family or business person is feeling. A robust GDP number will get a lot of attention and proclamations that the recession has ended (with two consecutive quarters of growth) but in reality the debt-derived growth is a veil over the more significant problems affecting our economy--a reduction in spending by businesses and consumers as we collectively tighten our belts, reduce our credit lines and increase our savings rate. Believing the pundits about what a great thing it is to see an increase in GDP will set us up for more disappointment later. All of the trillions that our government is spending is only saddling us with more debt. But the pundits will spin it differently tomorrow. Guaranteed.

Summarizing my expectations for the next few days, I think the market is ready for a bounce to correct the past week's decline. If the market instead sells off below today's low it could get nasty. The market is short-term oversold and therefore looking ready for a bounce. But remember, crashes come out of oversold conditions, not overbought. I do not think the market is ready for a crash but I do know that with the trend shifting to the downside that's where the surprises will be--down. Therefore a break of this morning's lows would be potentially very bearish.

But going with the odds here, and assuming we'll see some kind of bounce start, we should see a bounce into Tuesday/Wednesday and retrace at least 38%-50% of the decline (perhaps less of a retracement and only into Monday if the market remains very weak). Once the bounce finishes it will be an ideal time to get shorty. The next leg down in the decline should be a strong one and if you want to play the short side you've got one of the best opportunities coming up.

Playing the short side is more difficult than playing the long side. Things happen much faster and therefore you must have a trading plan. Know exactly what you want to do, which vehicles you will trade, where your stops will be (most important), and where your price targets are. When your price targets are hit you can trail your stop down, take partial profits, or just get out and call it a good trade. No seller's remorse (from taking profits too soon). If it was a good trade, be happy with it and drop your line in again if you think the fishing is still good. Use partial profits for your bait.

I've provided some upside levels on the charts that will tell us if the bounce is getting too strong, indicating a move up to new highs may be in progress. In the meantime I would favor the short side of the market now rather than looking to buy the dips. Buying the dips is now a counter-trend play and you should consider it as such.

Two weeks ago I referred to Tom DeMark's TD Sequential indicator and the confirming setup into the January high. Basically this indicator uses a proprietary formula for counting the bars on a chart and when it hits 9 you look for a possible reversal. If the move continues then the count then starts again and goes to 13 and if it still continues it starts again and goes to 9. After a 9-13-9 count it's a particularly strong setup for a reversal. I showed the weekly chart of SPX with the Sequential count on it, which has a 9-13-9 count. Sure enough it has reversed and has now started a count to the downside, confirming the reversal setup.

SPX weekly chart with DeMark TD Sequential setup

This weekly setup concurred with a monthly count that hit 9 this month so we've got confirmation from one more indicator that this month's high is potentially a very important one, and one that we probably won't see for a very long time. Have I mentioned lately it's a good time to be in cash and just trading for a living? And OIN can help in that regard!

Good luck during the coming week and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1131
- bearish below 1121

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10400

Key Levels for NDX:
- cautiously bullish above 1874
- bearish below 1850

Key Levels for RUT:
- cautiously bullish above 641
- bearish below 634

Keene H. Little, CMT