Market Stats

The bounce off the February 5th low fits as a correction to the decline from the January high. It's been a matter of figuring out how high the bounce will go. As of this afternoon I was suggesting the market was hitting its upside targets and completing the bounce pattern. It was a good setup for a selloff to start tomorrow. I thought if opex pinning continued through Friday we might not see the selling kick in until Monday. The Fed may have answered that question.

After the market closed the Fed announced a hike in the discount rate by a quarter point to 0.75% and the minimum bid rate for the term auction facility is now 0.5% (instead of 0.25%). The discount rate is the rate the banks can borrow from the Fed and this change doesn't really affect the banks much. The banks can still borrow very cheap from the Fed and make money by simply buying U.S. Treasuries. But it's the act of raising the rate that spooked the market and equity futures tanked while the dollar spiked higher (spiking the metals down in the process).

As an editorial comment, I don't understand why the Fed feels the need to make these kinds of announcements either pre-market or after the market closes. It seems they're intentionally going for max effect by announcing during the most illiquid times of the day. They should do it during normal business hours so that the majority of the players can take appropriate steps to mitigate losses or take advantage of the news. Maybe they felt they had done a good job spiking shorts out of the market this week and now was the time to drop the market without them on board. We all know they despise short players. Un-American you know. End of editorial comment.

The Fed says they haven't changed their outlook for the economy or economic policy. They will continue to leave the main rate at low levels for "an extended period". The purpose of the change is to encourage banks to go to the private market for their borrowing needs. To me it's indicative of confidence on their part that the worst for the banks is over. I think otherwise and I predict it won't be long before the Fed reverses this decision. And at that point the Fed will lose further credibility (part of the process of the bear market). But for the time being, the market is not going to like the news that their punch bowl is being taken away from them and will likely start selling off on Friday.

I've said it before and I'll say it again, if you want to see what the Fed is going to do, look at the bond market. The Fed follows the bond market and not the other way around. This from reader Scott:
"How can anyone be surprised by the Feds move in their discount rate? All you have to do is watch what the bond market's been up to and you'll see the Fed is just following them. Just like all the charts you have shown us, the Fed follows the market; it doesn't lead the market. I've been wondering why they haven't done this sooner, the longer they wait the more credibility they lose (if they have any to begin with, I suppose there are enough unthinking people who still believe in them). Australia's central bank was forced to raise their rates this past year also, because of their bond market. The timing is the only thing that should surprise people not the act itself :-) IMHO"

The timing, as Scott mentions, is what is spooking the market in after-hours and will likely create some concern tomorrow. While the Fed hinted at their last meeting that this was move coming, most assumed it would be announced during their March meeting. The fact that the Fed felt a sense of urgency to announce it now says they're worried about things like inflation getting out of hand too quickly. Plus with the shorts pushed out of the market this week, what better way to have the train leave without them. A gap down tomorrow would leave a lot of frustrated bears on the sidelines wondering when it will be a good time to jump in.

There is of course plenty of time for big money to drive futures back up during the overnight session. But if they manage to do that I'd be real careful trusting any positive open. It could be good enough to get a good settlement price on the European-style options and then let it go. I would think there will be a strong effort to protect SPX 1100 for a settlement price.

There has been a lot of news in the past few weeks about Greece and the problem that the EU (European Union) has in trying to figure out how to solve the problem (considering the moral hazard of bailing out one country but not others, etc.) The EU is stuck between a rock and a hard place and there are literally no good options. Greece is not the only European country experiencing distress with large deficits and everyone knows it. The survival of the EU, and therefore the Euro, is dependent upon the success of solving this problem of "wayward" countries.

Being a part of the EU has many benefits for countries, not the least of which is easy and relatively cheap access to money. Like the U.S., the implied guarantee of loans by the EU provided much needed support to countries needing outside financing. But now the EU is struggling with how to back up those implied guarantees. For one thing they have to decide whether the countries experiencing difficulties with debt abided by the rules each member must abide by. One of the rules is that each country must maintain their debt level at or below 3% of their GDP. But as shown in the following chart, there are several countries that have not been holding up their end of the bargain.

Projected European Budget Deficits for 2010

The list of countries includes the PIIGS (Portugal, Italy, Ireland, Greece and Spain) but unreported in the news is the fact that France and Poland are also expected to exceed the 3% limit this year. The UK is shown on the chart even though they're not part of the EU (a decision that may look rather prescient in a few years). But the UK is in just as much trouble as the worst offenders.

These countries have been able to borrow the money they need at relatively low rates but that's starting to have an impact on CDS (Credit Default Swaps) prices, which is essentially the price of insurance on the loan. When you look at a chart of CDS prices for various countries it's an eye opener as to what's happening around the world, not just in the EU.

CDS Prices for Countries

The one that's been in the news, Greece, is circled. Its current CDS price is 410, which is a big jump in the past six weeks from 283 at the end of 2009. This means it costs $410K per year to insure a $10M note for five years. And look at where it was at the start of 2008--22. The U.S. is shown as a comparison with a relatively low number of 56 but interestingly the CDS price has had a larger percentage increase than Greece since the end of 2009 (49.4% vs. Greece's 44.7%). And from a percentage increase, meaning more fear about the increasing likelihood for default, Portugal gets the prize--its CDS price has jumped +145.5% in the past six weeks!

Dubai (just above Greece on the chart) has also been in the news and while there was some relief after Abu Dhabi provided a $10B backstop, there has been mounting fears that the Dubai loans will default anyway. The way to know this is to look at the rapid increase in the cost of the CDS on Dubai's loans--647.

But hey, our friend Hugo Chavez is putting all the European countries to shame--the CDS price on Venezuela's loans is currently 1051, 2-1/2 times more than Greece. And Argentina is spooking loan holders as well--nearly 1065. All in all, comparing today's prices to where they all were six weeks ago, and especially compared to the start of 2008, shows you that there's a lot of worry out there about more than a few countries that are in trouble. This more than anything, and certainly more than the stock market, tells you the financial system is in deep systemic trouble.

And the problem isn't just for countries. Our own states within the good ol' US of A are rapidly running into trouble. We hear stories about California and Illinois and their debt problems but you need to look at the cost to insure their municipal loans to get an idea what the financial market thinks about them. The following chart shows why you do not want to be invested in municipal bonds (which many like for the tax-free status).

CDS Prices for CA and IL Municipal Bonds, chart courtesy elliottwave.com

After dropping last year, with an increased willingness to hold riskier paper, the CDS prices have been on the rise since last October. This shows a reduced willingness to take on risky assets and a willingness to pay more for insurance against loss. This move away from risky assets will show up more in the stock market as well.

The CDS price increase, pretty much across the board for most loans, tells us a lot about the shift in investor mood. And it's this shift that causes the waves of buying and selling, including the stock market. With the shift away from a willingness to hold risky assets we will see a reluctance to hold stocks and an increase in the fear level. That will be reflected in a higher VIX, which can be thought of as the cost of insurance on stocks (to buy put options), and more selling of stocks. This all fits the larger picture that I have for the stock market for the next few years.

So moving to the stock market, I was asked to review again the longer-term projection that I have. It's always a good idea to take a step back, and sometimes a big step back, to look at the market from 30,000 feet and get a sense of the bigger movements. From there you keep dropping down to get a closer and closer look at the price patterns, keeping in mind how the various time frames fit together.

So I'll start tonight with the 30,000-foot view of the SPX, looking at the monthly chart and a price projection into 2014-2015. It's no surprise to know that I'm bearish for the next few years as we wring out the excesses of a huge credit spike and all the bubbles it spawned. I may not be correct in my projections but at least you know where I'm coming from when you read my analysis, which should be only a part of your own.

Projection is of course another word for guess. My crystal ball has been known to be snowed out at times, especially after shaking it to see if it still works. I base my projections on historical patterns, cycles, EW (Elliott Wave) analysis, Fibonacci ratios, trend lines and a few other technical tools. Throw in a little socioeconomics, fundamentals and little hocus pocus and voila, a projection is born. But these are just tools to help predict where markets might be in the future. We of course have no way to predict the future but it doesn't stop us from guessing. So with that disclaimer out of the way, let's look at where I think the market is going.

On the monthly chart I'm showing the move in SPX from 1994 to present and then a projection into 2015. I've placed a parallel down-channel on the chart as a guide since the market often sticks to these channels. The basic premise for the projection shown on the chart is that the 2000 high completed the bull market from 1982 and we've been in a bear market since. The first leg down to the 2002 low was either wave A or wave (1). The rally into the 2007 high was wave B or wave (2). That puts us into wave C or wave (3) down. In an EW pattern it is the c-wave or 3rd wave that is the strongest of the moves. Some are calling the move down to the March 2009 low as the completion of the c-wave and that we've been in the first leg up of a new bull market since that time. I've got it labeled differently:

S&P 500, SPX, Monthly chart

To assume that the March 2009 low is THE low of the bear market is to ignore history and the fact that we have some very fundamental financial problems to solve and the worst is yet to be seen in that regard. If that assumption is true then the move down to the March low was only the 1st wave of what will be a 5-wave move down from 2007. That's when it gets scary to think about what's next.

The 1st wave down to March 2009 has been followed by a 2nd wave correction into the January high. That means we're about to start the 3rd wave down. This will be the 3rd of the big c-wave or 3rd wave down from 2007. It will be the screamer wave or what's commonly referred to as the wave of recognition. It will convince most that the fundamental problems afflicting us are real and will take more time to correct. It's the wave down that will break the March 2009 low.

The monthly chart above is using the log price scale, which is better when looking at longer-term charts with big price moves. It makes the moves towards the bottom look large but points-wise they're smaller moves. From a percentage standpoint, the moves are still significant. Switching between log scale and arithmetic scale will significantly change how the chart looks, especially trend lines. It pays to switch back and forth and see where trendline support might be. For example, on the monthly chart, the uptrend line from 1990-2002 (shown in gray), acted as support in July-September 2008 but was then broken when the market dropped hard in September 2008.

In the past I've been showing the weekly SPX chart using the log price scale. Looking at it now with the arithmetic scale shows the trend lines in a little different place. First, you can see the same 1990-2002 uptrend line, that was discussed above (shown in green on the weekly chart), acted as resistance in November 2008, was broken to the upside last fall (after cycling around it for awhile) and then acted as support at the recent February low.

S&P 500, SPX, Weekly chart

The downtrend line from 2007, using the log scale, was resistance to the January rally (it poked slightly above it) and is currently near 1110, which could be resistance again if reached. But using the arithmetic scale, you can see that that downtrend line acted as support for the drop into the February 5th low, along with the 1990-2002 uptrend line. A lot of bulls are looking at that downtrend line, and the successful retest of it, as the reason to be bullish. So far I don't disagree with their logic, if that's all I was going by. A break below the February 5th low near 1044 would obviously be a significant break down and from there I'm depicting a decline into April before a larger bounce to correct the leg down from January (with the possibility, shown with the dashed line, that we'll see another leg up for a larger A-B-C bounce off the March 2009 low). I'm showing a break of the March low around the fall but the whole decline could happen faster, including the first low in March rather than April as depicted.

Switching back to the log scale on the daily chart, the downtrend line from 2007 is now being tested from below. A further rally on Friday could be potentially bullish although I have my doubts that it would make it much higher. There is of course the possibility we'll get a retest of the January high, or even a minor new high with lots of negative divergence (as it did in October 2007). That's the risk for short players. But until proven otherwise, I think the market will experience some hard selling next week, once we get through opex pinning.

I'm depicting a 5-wave move down into April (with the 3rd wave down showing its own 5-wave move) and this would be a typical pattern. It could happen faster than depicted and finish in March and then set up a stronger bounce shown on the weekly chart as wave (ii), perhaps bouncing from the 870 area back up to 975-1000 by May/June. A drop below 1080 would suggest the next leg of the decline is underway.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1110
- bearish below 1080

With the market being held up for opex (allows big money, i.e., the big trading desks like Goldman's, to collect their premium on sold put options), the big question is how much higher it might go. As of today's close we might have seen the high for the bounce off the February 5th low. In addition to the trend lines referenced on the weekly and daily charts, the move up from February 5th reached the top of a parallel up-channel for the move (a bear flag pattern).

S&P 500, SPX, 60-min chart

Since yesterday's high today's new high has been met with a negative divergence, confirming it should be the last wave up for the c-wave, which is the move up from last Friday. Confirmation of the finish to the rally will be a break below 1080. If it only pulls back in a choppy sideways/down kind of move then we can expect it to move higher, so the next pullback/decline will provide the clues needed to help figure out whether the next big leg down is starting.

The DOW's rally this week brought it right up to its broken uptrend line from August-October today. If there's any follow through to the downside following the after-hours selloff in the futures it's going to leave a bearish kiss goodbye at that retest. Isn't it amazing how news breaks once the price pattern sets up for it? A drop back below 10140 would confirm the high is in (unless there's to be a larger a-b-c bounce following the pullback but I'm not expecting that).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10460
- bearish below 10140

As with the other indexes, NDX has bullishly rallied back above its 20 and 50-emas. It did that after breaking back above its broken uptrend line from August-November and its downtrend line from 2000. This all looks bullish and has more than a few chasing the market higher. But it tagged its 62% retracement of the decline from January and has provided a good setup for the completion of the 2nd wave correction and should now start the 3rd wave down. If it manages to instead push above 1827 I'd want to watch for a bit and see what it might be up to.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1827
- bearish below 1768

One of the reasons I remain bearish the NDX, even though it looks like it's in breakout mode, is because of the pattern in the SOX. When it was nearing its February 5th low I had warned that it should be finding a bottom and then bounce to correct the decline from the January high. The wave count for the decline was a clean 5-wave move. This told me two things: one, a 5-wave move will be followed by a correction of it; two, once the correction of the move down is complete it will be followed by at least one more 5-wave move down. The initial 5-wave move down from the January high will not stand by itself--it needs to be followed by another one. Therefore it's a matter of looking for an end to the bounce to get short the semis again and I think yesterday's high was a good finish.

Semiconductor index, SOX, Daily chart

The SOX ran right up to its broken uptrend line from March-November to ring the bell and promptly fell away, leaving a bearish kiss goodbye in its wake. The decline so far is not clean and leaves open the possibility for another push up to test the broken uptrend line again, and perhaps run up to its 62% retracement at 347.77. But it's not required and considering the next move will be a 3rd wave down, which should be a strong move, looking for any more upside potential in the SOX would be a fool's game (imho). The better play is to look for a shorting opportunity and keep your stop tight until the move down gets going.

The Russell 2000 index is either in breakout mode after today's rally or else it's going to be a bull trap. We'll know more tomorrow. The break above resistance at 625 (previous high/low price level, downtrend line from 2007 and broken uptrend line from July-November) clearly looks bullish. The RUT had been hanging out just under 625 for the past two days and then late this afternoon it busted higher, hitting all the stops parked just above that level. Masterfully done I must say--get the shorts out of the market before its starts its selloff. Did someone know what the Fed was going to do after the bell? Just askin'. Again, if there's no follow through to the upside, especially after taking out a bunch of shorts and sucking in some longs, look for a fast reversal. Failed breakouts tend to fail hard to the downside. Otherwise a continuation higher on Friday would put the RUT on a path towards new highs, or at least a test of the January high.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 597

The banks were laggards today, barely closing in the green. In fact they've been laggards all week and another reason to remain suspect about the rally, especially when it may be just opex driven. The S&P bank index chopped up and down around its 20 and 50-emas all week but could not close above its 20. It's a choppy mess on the daily chart and that's what makes it look more like a correction to the sharp decline from the late-January high. If the wave count is correct, look for a strong decline into March.

S&P Bank index, BIX, Daily chart

Another reason I kept a bearish opinion about the banks this week is shown on the 60-min chart below. The choppy price action resulted in a perfect a-b-c bounce with two equal legs up. I've noticed over the years that this index in particular tends to nail its Fibs and price projections. Two equal legs up from February 5th is at 132.53 and the high on Wednesday morning was 132.53. That's pretty good even for government work. While it could certainly chop its way higher, this is a classic a-b-c bounce correction that should lead to further selling, starting on Friday.

S&P Bank index, BIX, 60-min chart

The transportation index left two potentially bearish candlesticks between yesterday and today. Yesterday's was a spinning top doji at resistance (its 50-ema) and today's is a hammer at its 50% retracement. They're both reversal signals but need a red candle to confirm it. If tomorrow provides the red candle then we'll have a sell signal from the Trannies.

Transportation Index, TRAN, Daily chart

The Fed's announcement after hours spiked the dollar. Dollar bears were not happy with the news, especially after the dollar's strong rally yesterday. Following yesterday's strong rally there was a spike back down this morning followed by a spike back up and then a drop into the close. I'm sure there were some dollar bears leaning on it thinking it's ready to decline. In EW terms what we had was a 1st wave up from Wednesday's low, a sharp 2nd wave pullback today (nicknamed the sucker wave) which pulled in the dollar bears, and now the after-hours spike up should be the start of the 3rd wave up for the move up from Wednesday's low. On the daily chart it's simply the start of what should be a much larger 3rd wave up into March.

U.S. Dollar contract, DX, Daily chart

Gold is currently battling with a couple of trend lines and depending on which one wins will determine the direction over the next couple of weeks. Bullishly it broke its downtrend line from December and yesterday and today (after hours) it has retested it for support (along with its 50-dma and 20-dma). If the gold bulls stay strong there is the potential for a strong push higher to a Fib projection for the move up around 1186. From there it should start the bigger selloff. But that's a big if considering what the dollar is doing.

Gold continuous contract, GC, 720-min (approximates daily) chart

If the bears are taking over gold then the retest yesterday of its broken uptrend line from October 2008, and the kiss goodbye that it left behind, is a sell signal. (Notice how it did the same thing against its broken uptrend line August 2008 at its previous high on February 3rd). It also achieved a Fib projection for an a-b-c bounce off the January 28th low at 1128.64 (the high was 1128.70). Any continuation below today's low of 1098.10 should confirm the bears are in control which will lead to a very strong selloff in gold.

I noted on the chart that the 3rd of a 3rd wave down is nicknamed the "recognition wave". There are many gold bulls that will begin to recognize that something is seriously wrong with their argument for higher gold prices based on inflation. In a deflationary environment, which we're in regardless of short term blips in inflation, the argument for holding gold begins to look suspect. In a dollar rally, the carry traders will be forced to sell their other assets, including gold and stocks, when they have to buy back the dollar. At least that's the bear argument for gold (mine). We'll let price answer the question but in the meantime I remain bearish gold.

Oil has a pattern similar to gold's in that the bounce off the January 29th low formed a type of a-b-c bounce called an expanded flat correction (where the b-wave drops lower than the start of the a-wave). In this type of correction the c-wave, which is the move up from February 5th, typically achieves 162% of the a-wave, which is the first leg up from January 29th. That projection is at 78.58 and oil overshot it a little (common for commodities) by running up to 79.29. In so doing it came very close to hitting its broken uptrend line from February 2009 and its 62% retracement at 79.59. It's a good setup for a reversal back down in a 3rd wave. (Are you noticing the common patterns across various sectors and asset classes by now?).

Oil continuous contract, CL, Daily chart

The Fed's after-hours announcement on the hike in the discount rate has me wondering if the CPI data coming out tomorrow morning, which the Fed already knows about, will spike up. That would prompt the Fed to make a pre-emptive move as they've done. We'll know soon enough.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, even without the Fed's announcement, I was looking at today's rally as putting the finishing touches on the bounce off the February 5th low. As I commented on the Market Monitor at the end of the day, it never ceases to amaze me to see a chart pattern set up for a reversal and then the news comes. The pundits will be all over a selloff tomorrow, if it occurs, and blame it on the Fed. To which I say phooey. The market was ready to sell off and the news simply became the catalyst. If not for the Fed the market would have found another excuse to start the selling. The news follows the charts, not the other way around. The Fed follows the bond market, not the other way around. But you wouldn't know that by listening to the bobbing heads and teleprompter readers at CNBC.

We're at a very significant point for the market and traders need to be careful here, no matter which side you've picked. With the charts set up for a reversal to the downside and hard selling to follow, if it doesn't sell off then the market will be not just talking to us but will be yelling at us. A continuation of the rally from here has the potential to at least retest the January high. Think of the price action in the summer of 2007 and the new high in October 2007. I remember thinking at the time that the market was never going to sell off. It could happen again so bears beware of that possibility. And a rally tomorrow will be explained away by the pundits that the market thinks it's bullish that the economy must be growing strong in order for the Fed to feel the need to start raising the discount rate (even though the Fed says nothing has changed in their outlook for the economy or their economic policy). Be ready for some potential volatility, especially if there's to be some opex related hedging/selling/buying.

If the market starts to sell off tomorrow you should also be aware of the possibility that Monday could be real ugly. I think it's a little early to be worrying about a Black Monday but knowing that the markets are entering their 3rd waves down, a downside surprise is right around the corner. Be careful with whatever positions you carry over the weekend, especially long positions.

Opex Fridays tend to be boring days but when they're not they tend to see strong moves. At this point I'm thinking the strong move will be down but I've been fooled many times before, especially in looking for a big move based on after-hours futures. Only the cash market, where everyone has a voice, matters so let price tell us what it's going to do.

Good luck closing out whatever February positions you might have and good luck with the rest of your trading into next week. By this time next Thursday we'll know who's winning the battle and I'll be back with you then.

Key Levels for SPX:
- cautiously bullish above 1110
- bearish below 1080

Key Levels for DOW:
- cautiously bullish above 10460
- bearish below 10140

Key Levels for NDX:
- cautiously bullish above 1827
- bearish below 1768

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 597

Keene H. Little, CMT