Market Stats

James and I swapped wraps so I'll take his tonight and he'll be with you tomorrow night.

Today was a strong rally by most measures. The only real challenge continues to be lower volume during the rallies than the selloffs, including relatively low volume today, clocking in a little lower than yesterday's. As you can see in the table above, advancers handily beat out decliners in both numbers of issues and volume. It was actually a strong 90% up day with NYSE upside volume 94.4% of total volume. Normally that would be a good kickoff to a rally but we've had many 90% days this year, both up and down, which have not had any follow through. It's a manic-depressive market right now and today's rally smelled more like short covering than real buying (almost straight up without much in the way of pullbacks).

The program trading, especially by the quants, tends to drive the market hard in one direction once the bots know what that direction is. They're momentum traders and when the momentum stops they simply swing it the other way. It's one reason why I think we've had so many 90% days that haven't meant much to the longer-term moves in the market. It's simply adding to the volatility which drives traders crazy unless you're able to swing with the market (hard to do when many of the moves start in the overnight futures).

We've seen many times when the market closes on its high or low of the day a tendency for an immediate reversal the next day. I call them mini climaxes as one side or the other rushes to cover their trades, especially into the close like today, and then there's no more to continue in that direction the following day (since the buying or selling wasn't real but instead it was the other side covering their positions). Covering one's position to be flat by the end of the day, which many traders must do, is far different than wanting to buy a rally or sell into a decline but didn't get an opportunity before the close and will do so the next day. And that gives us immediate reversals of the previous day's move and is the setup for Thursday.

I've been wondering lately if opex maneuvering is starting a day earlier than the Thursday prior to opex, which was becoming known as the head-fake or misdirection day. I'm noticing the move that was happening on Thursday is now happening on Wednesday. If this month follows the new pattern then we could find that today was the misdirection day. One thing's for sure, equity options traders were believers in today's rally--the CBOE Equity put/call ratio closed at .52, the same low value that it was at the May 27th high. The previous lower close of .51 was at the May 12th high. The market suffered some strong selling right after those dates.

Helping today's rally were the financial stocks. The banking indexes rallied almost +6% today and much of the credit for that came from Europe. That strong a rally is usually a result of short covering rather than real buying and today's volume suggests the same (today's volume was lower than yesterday's). News of the European bank stress tests is expected to be released soon and while there is concern the stress tests were not stressful enough (sound familiar?), many are expecting the news to be favorable. That would relieve some of the stress that U.S. banks have been experiencing as well and that showed up in today's rally.

State Street bank (SST) also reported favorable earnings and that gave a further boost to banks in general. Too bad we can't trust what the banks are reporting. Peter Atwater at Minyanville wrote an article today (banks' earnings) that does a good job at exploring the problems with the way the banks are (not) reporting their true expenses and thereby fluffing their earnings. It's a joke really and we have no real sense about the banks' true earnings except to know they are not nearly as good as they say they are.

For one thing, the banks continue to be allowed to exclude their credit losses for bad loans, in particular housing loans. The banks have been excluded from the requirement to value loans, CDOs and derivatives at market value for some time now so we don't really know what they hold on their books. Now they're allowed to hide their unrecognized losses in more off-balance-sheet accounting. The hope of course is that the banks will never have to recognize the losses because as everyone knows, "it will come back."

Banks are allowed to defer credit losses for as long as it takes for the housing and employment conditions to improve. The trouble is the conditions are getting worse, not better, and these credit losses are mounting. But the banks don't have to report them. They have a huge liability that's not being subtracted from their income and balance statements and therefore their earnings are a banker's make-believe story for the market's consumption. This is also one reason why bankers have not been too excited about foreclosing on owners (or helping with short sales or remortgages). That would require the bank to disclose the loss on the original loan and take it out of make-believe financing and put it on their for-real balance sheet.

But this charade will not be able to continue much longer and therefore the rally in the banks is just another opportunity to unload their stocks and look for shorting opportunities in the sector. As the banks continue to make an effort to hide these credit losses they will be further hampering their own efforts to make new loans to generate income. For as long as these bad loans are on the banks' books (even if hidden) they will not have money, nor the incentive, to provide additional loans.

But foreclosed homes are building up to intolerable levels that even the banks can't stomach. The GSEs (FNM and FRE) have been processing foreclosed properties at an accelerating pace and the rest of the mortgage holders will need to follow suit unless they don't mind being the last one to hold the bag. We will likely see an acceleration of the number of foreclosed properties being reported, prompting many to question why all of a sudden the foreclosure problem seems to be getting worse. It's all part of the deflationary cycle as debt is destroyed and the credit bubble deflated. It's a necessary and healthy step towards improving our financial system to get it ready for the next growth phase in a few years.

So take today's strong rally in the banks with a grain of salt since it's another hope-filled rally that's not based on reality. The hard part for us traders is trying to figure out how long a hope-filled rally can extend and of course we can only guess at that. But we have some charting tools to help us figure out support and resistance levels and watch price action around them. The current bounce should be a correction to the decline and therefore I'm looking for resistance levels where the market could run out of steam and provide another shorting opportunity.

Since breaking below support near 1038 last week SPX has been cycling around this level for the past few days. Today's close back above the broken H&S neckline looks bullish but it's too early to tell whether last week's break down was a head fake and bear trap, like it did back in July 2009, or if instead this week's bounce is going to be a bull trap. By several measures it would appear that it's possible we'll see SPX bounce up to the 1070 area and that's also where the longer-term broken uptrend line from 1990-2002 is located. Once this bounce has finished we should see the market continue on its southbound journey towards much lower lows. Many are looking for the 943 area but if the bearish wave count is correct that level should be no more than a speed bump on the way down to the 860-870 area.

S&P 500, SPX, Weekly chart

The recovery back above the H&S neckline should be considered bullish and will be especially so if it comes back down and uses that level for support now. But as shown with the dashed line, that may only be good for one more leg up for a slightly larger bounce into next week at the latest. At 1074.57 it would close its June 29th gap so anything higher than that would be another sign of bullishness. A drop back below the neckline near 1038 would be a bearish heads up and below 1018 would confirm the next leg down has likely begun.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1075
- bearish below 1048

You can see in the above chart that the 50-dma has crossed down below the 200-dma, which happened on Tuesday, and this is known as the Death Cross. I've heard different takes on this signal and one person even identified it as the bottom of a market pullback on several previous occasions so take it for what it's worth. Many money managers use this signal as their timing method. Some say you should use the ema's for the moving averages and the chart below shows a longer time frame using the 50 and 200-ema's. If you look carefully you can see that it has in fact provided longer-term buy and sell signals so this week's cross will be taken seriously by many.

S&P 500, SPX, Daily chart, 1990-2010 with 50/200 crosses

SPX achieved a 38% retracement of the decline from June 21st, at 1056.87, and looks like it has its sights on the 50% at 1071.07 if the rally continues on Thursday. As currently counted, the bounce off last Thursday's low could be considered complete, which makes it all that more important what the market does tomorrow. Considering the market closed at its high today, a sharp reversal back down could be a kickoff to a serious decline in a 3rd of a 3rd wave down. That's why a break below 1018 could be serious. If there's more work to be done to relieve the oversold nature of the market we could see another down-up sequence into Friday, or early next week, to complete the correction of the leg down from June 21st.

S&P 500, SPX, 60-min chart

The DOW had done a better job at holding onto its H&S neckline by breaking it only marginally. The strong rebound back above it today looks bullish. If the rally continues even a little higher on Thursday watch to see how the DOW handles its 20-ema, which often acts as support and resistance in a strong move. It will be near 10052 on Thursday (SPX 1067) and is one of the reasons why I have 10055 as a key level to the upside--it will be potentially bullish above that level. Otherwise a move back down below 9659 would suggest the bounce is over and the next serious decline is underway.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10055
- bearish below 9659

NDX had dropped even more significantly below its H&S neckline so today's recovery back above it is even more impressive. Amazing what a little short covering can do. Its 20-ema is a bit higher than the others, near 1810 tomorrow so watch that level if the market rallies a little further. It would close its June 29th gap with a rally up to 1836 and anything higher than that would be potentially bullish.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1836
- bearish below 1719

The SOX rallied hard today, up +5%, and that certainly helped the tech stocks as well as the overall tone of the market. Between a strong SOX and strong banks there wasn't much hope for any bears trying to muzzle their way in today. But the SOX has a very similar pattern and the current bounce looks like a correction to the decline from June 21st. Once the correction is over, which could be today's high or it could be after it fills its June 29th gap at 354, we should see hard selling kick in.

Semiconductor index, SOX, Daily chart

The small caps were not getting much love yesterday or this morning but once traders felt a little more comfortable with the rally they started buying the RUT (and shorts got more nervous and started covering). The RUT is now nearing its H&S neckline again, near 614 (it was resistance yesterday). As shown with the dashed line, we could see a pullback and then another new high into early next week before the next wave of selling hits. I'm showing a slightly different possibility on the RUT than I show on the others, which is for a new low around 560 to finish the leg down from June 21st and then a larger bounce into the 3rd week of July before heading much lower into August. It's a little difficult to reconcile the differences between the RUT and the other indexes at the moment so it will be worth watching the bottom of the channel on the RUT to see if it finds support or not.

Russell 2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 614
- bearish below 596

By the size of today's white candle I don't need to tell you the banks had a strong day today--BKX was up +5.6%. But notice where it stopped--right at its broken 200-dma and the setup is for an immediate reversal back down. It could pull back and then head higher to the top of its down-channel, currently near 49.40. Between that, its price level resistance near 50 and the 50-dma coming down towards 50, it would be some tough resistance if it manages to rally back up to that level.

KBW Bank index, BKX, Daily chart

The Baltic Dry Bulk index, which tracks shipping rates for dry commodities, continues to decline. It has dropped 29 days in a row and fell -5.1% today. This is clearly a sign of economic contraction instead of growth. The slowdown in demand from China is getting much of the blame and the Shanghai Composite index (SSEC) shows there's lots of concern from investors in China's immediate future.

The SSEC has been showing relative weakness since its high in August 2009. In April it broke its uptrend line from November 2008 and declined sharply from there. And then in May it broke below its September 2009 low and found that level to be resistance before dropping lower again. There are some small hints of bullish divergence at the most recent low so we could see a bigger bounce in the Chinese markets. But this chart is telling us the Chinese economy is slowing down and those who have been pinning their hopes on China to support a global recovery are starting to realize it's not going to happen.

Shanghai Composite index, $SSEC, Daily chart

Shipping is slowing down and economies are slowing down so it doesn't take a rocket scientist to realize transportation stocks will likely be heading down. But the short-term pattern for TRAN isn't clear enough to suggest an immediate short play in the sector or to wait and see if we'll first see a larger bounce (dashed line). A drop below yesterday's low near 3872 would suggest there will be no more bounce and the wave count is the same as the others, which calls for a 3rd of a 3rd wave down and therefore hard selling.

Transportation Index, TRAN, Daily chart

The dollar and equities have been inversely related in the past few days and that could continue if the dollar gets a bounce off support (its uptrend line from December) and the stock market starts back down. There are a number of ways a pullback correction in the dollar could play out and I'm only showing two that I consider at least more likely. Once the current leg down from the June high has finished we should get a multi-week rally for wave B of a large A-B-C pullback to correct the November 2009-June 2010 rally.

U.S. Dollar contract, DX, Daily chart

Gold might have finished its leg down from the June 28th high, in which case it should get a bounce back up to at least its 50-dma near 1216 before heading lower again. Or it might first work its way lower to its uptrend line from October 2008 near 1165 before trying for a larger bounce correction, which is what I've depicted on the chart.

Gold continuous contract, GC, Daily chart

No surprise, the gold miners look similar to gold which looks similar to the other stocks. GDX did find support at its uptrend line from February and could make it up to its 50-dma or 20-ema near 51 before rolling back over.

Gold Miners, GDX, Weekly chart

If the bounce in oil can get a little higher it should find resistance near 75 where it will run into its 20-ema and then 50-dma. Once the current bounce finishes it should start down in earnest as a 3rd of a 3rd wave down unfolds (just like stocks).

Oil continuous contract, CL, Daily chart

There were no significant economic reports this morning and tomorrow's reports are not likely to have much of an effect on traders' moods. The market is expecting a sharp drop in consumer credit which is all part of the credit collapse that's in motion. Once the stock market participants really start to understand this, the selling will come in stronger waves.

Economic reports, summary and Key Trading Levels

Other than some minor differences I see in some of the charts, such as between the RUT and the blue chips, most indexes remain in synch. After the decline from June 21st it appears we're bouncing to correct that decline. Internal market measures are strong but volume remains tepid at best. Volume picks up when the selling begins so this remains a caution flag out on the field. Bulls are just trampling over the flag at the moment but the ref will not take kindly to that.

Whether the bounce finished today or finishes early next week (after a pullback and then another leg up), it's important to understand the very bearish wave count setup that we currently face. If the bearish wave count is correct then we'll soon start down in multiple degrees of 3rd waves. The 2009-2010 rally was a large 2nd wave, and then the bounce into the June 21st high was another smaller 2nd wave and now today's bounce is another smaller 2nd wave. These are pointing to a 3rd of a 3rd wave within a larger developing 3rd wave. It sounds confusing but the bottom line is we're about to see some serious selling once the current bounce completes.

Since 3rd waves are the strongest of a 5-wave impulsive move, having nested 3rd waves about to unfold means a really strong move is coming. I could be very wrong about the wave count and that's why I have the key levels to the upside--above those levels could mean something at least short-term bullish playing out and I'd want to see how the pattern develops before getting all bearish again. But as of now, the bearish setup is there so be looking for shorting opportunities until the market proves otherwise. Playing the long side right now is to trade against the current and you'll need to keep 'em tight. Downside surprises are right around the corner now.

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

Key Levels for SPX:
- cautiously bullish above 1075
- bearish below 1048

Key Levels for DOW:
- cautiously bullish above 10055
- bearish below 9659

Key Levels for NDX:
- cautiously bullish above 1836
- bearish below 1719

Key Levels for RUT:
- cautiously bullish above 614
- bearish below 596

Keene H. Little, CMT