Market Stats

James will be with you tomorrow night as he and I switched nights this week as I prepare for my return to my "winter" office.

The day started out with another gap down, like Tuesday but then, like Tuesday, the dip buyers rushed in (or at least someone did) and pushed the market back up into the green. We've seen this movie before and it usually occurs at market tops. A lot of energy goes into getting the market back up into positive territory and essentially all that buying power is merely holding the market from dropping. It ends up frustrating the bears who can't seem to make a short play stick. The bulls start to get uneasy and start to sell a little more quickly. Consequently we get these choppy tops. It's also what makes the market vulnerable to sudden whoosh to the downside as there's very little to support the market and the bears end up chasing it down and the bulls start dumping stock en masse.

This kind of price action created the choppy top in August and once the topping process completed there was a big drop on August 11th. If you go back in time you'll see very similar market action at tops. It looks like a bullish consolidation at the time and bulls start getting into position for the next leg up. Failed patterns tend to fail hard and that's why we typically see a strong down day when it finally breaks. I'm anticipating seeing the same thing again if the market is able to hold up for another few days but not make any serious headway to the upside.

The pre-market futures were already slightly in the red before we got our morning economic reports which only added to some selling pressure out of the gate. The NY Fed Empire Manufacturing Survey dropped to 4.1 from 7.1 in August. The slowing in manufacturing supports those who say our economy is slowing and may be headed for a double dip recession. Those who believe this have been drowned out lately by those saying there's no chance of that happening. We'll see about that.

Industrial production and capacity utilization numbers came in close to expectations so there wasn't much of a market reaction to those. Even though the July number for industrial production was revised lower to 0.6% from 1.0%, that was just more bad news for the bulls to sweep away. It was a "less bad" number. The market did like the fact that capacity utilization rose slightly from 74.6% to 74.7%, which is the highest it's been since September 2008. But anything under 80% shows we've still got a slack economy. Depending on how you look at the numbers you'll see a weak economic or a less weak economy.

So the S&P dropped about 6 points out of the gate, made its low in the first 10 minutes of trading and promptly roared back to life and drove right back up to close the gap and climb another point. It then took the rest of the day to tack on another 4 points to finish up about 4. It was just enough to keep the bears away. So let's jump right into tonight's charts to see what's setting up--I think we're nearing, from a price and time perspective, a very important turning point for the market.

Until I see evidence to the contrary I've changed the primary wave count for the move since the April high. I could still get away with calling it an impulsive move down and a series of 1st and 2nd waves to the downside (as long as the August high isn't exceeded, which it came very close to doing on Tuesday) but I'm going with what it looks like for now. And that's an a-wave down to the May low and a triangle b-wave since then. It shows more clearly on the daily chart but essentially it calls for another leg down equal to or greater than the first leg down (I'm depicting a greater leg down for several reasons).

S&P 500, SPX, Weekly chart

If the 2nd leg down from here achieves 162% of the 1st leg down we get a downside target near 840. I'll get into the H&S topping pattern later but it projects down to about 860 and the July 2009 low was near 869. So I think the 860 area makes for a good downside target once the selling begins again.

If the bulls can keep the rally going for a little longer there is an upside target near 1158. This is where the bounce off the July low would achieve two equal legs up (for an a-b-c bounce) and it would also hit the downtrend line from October 2007 at the same level. I consider the market to be set up nicely for a short play here but if stopped out with a move above 1135 I'd look to try it again near 1158.

The daily chart below shows the sideways triangle idea more clearly. Triangles typically have a 5-wave move inside them but each leg is corrective and that's one of the things that has me leaning towards this triangle idea--we haven't had any good clean impulsive moves for months. The rally from late August is the 5th wave inside the triangle pattern (wave-e of an a-b-c-d-e move) and therefore we should be looking for the end of the triangle pattern now. Tuesday's high tagged the top of the triangle just about to the penny. It's common to see a small throw-over and therefore we might not have seen THE high for this leg up yet. But I would not chase any move higher at this point. While it could go to 1158 it could also go to 1135 and turn on a dime and come sharply back down.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1130 to 1158
- bearish below 1091

This morning SPX dropped out the bottom of a small parallel up-channel for price action since September 7th. This channel should identify the last leg up for the rally from August. After dropping out the bottom it spent the rest of the day scurrying to get back inside but was unable to do any better than nuzzle the underside of it into the early afternoon. And end-of-day push (jam) had SPX right up against the broken trend line for the 4th touch of the day. It also came within a point of the top of its triangle. On the 60-min chart below I also show a larger parallel up-channel from the August low and it should signal an end to the rally once it breaks below it, currently near 1121.50.

S&P 500, SPX, 60-min chart

Before looking at the other indexes I want to talk a little more about H&S patterns because there has been a lot of discussion about them this year. We had (still have) a bearish H&S topping pattern from January and we have an inverse H&S bottoming pattern from the end of May.

Let's start with the bullish inverse H&S pattern that is now being widely discussed. In my opinion there are three strikes against this pattern (and therefore out):

1. When a technical pattern is widely discussed, meaning it's obvious to many, it's obviously wrong. That's not a given but it's been the way of this market lately that all technical patterns discussed by the media fail. When everyone sees and takes a position to trade it there is a high likelihood for failure and failed patterns tend to fail hard. The false break of the H&S neckline near 1040 into the July 1st low near 1010 (so a 30-point drop) led to a strong rally, starting with a huge up day on July 7th, into August. Might we see a 30-point rally above the current inverse H&S neckline (that would be to the same 1158 level mentioned above) that then fails and drops sharply lower, trapping the bulls? It's certainly possible.
2. The volume is very important when evaluating H&S patterns and the volume pattern since May does not support the inverse H&S pattern. Volume should be kicking up in the rally from August and instead it's dying. If SPX were to make it over 1128 (the neckline) it would need volume confirming the break but more importantly it would need to hold on a retest. But right now we're getting no volume support for this pattern. The chart below shows SPY because I can get volume with it and it shows the declining volume following the right shoulder:

S&P SPDR, SPY, Daily chart

3. H&S patterns are unreliable in the middle of a move. This bullish inverse H&S pattern is in the middle of a larger move up from March 2009 and is following only a pullback (a pullback in the eyes of longer-term bulls). That makes it an unreliable pattern to use. H&S patterns should be at the end of a longer run in order to be effective.

Based on the above I do not believe we'll see an upside projection based on an inverse H&S pattern, which projects up to SPX 1250. I don't believe it for a second. While we could get a higher rally, such as to the 1158 target, do not trust it to go far and certainly not to 1250. This market has been full of head-fake breaks and a break of the 1128 neckline would very likely fail and trap a lot of bulls.

Now we'll look at the H&S topping pattern, with the left shoulder in January, head in April and the right shoulder is between the August and September highs. The neckline can be drawn across the lows that do not include the July 1st low (near SPY 104, SPX 1040) or it can be drawn through the July 1st low. The lower neckline would of course have a much lower price projection but using the 104 neckline we get a downside projection near 86 (SPX 860). As noted on the chart, bears will want to see increasing volume on the decline from the right shoulder and an explosion of volume on the break of the neckline. The head-fake break and bear trap can clearly be seen with the July low.

S&P SPDR, SPY, Daily chart, 2009-2010

Moving on to the other indexes, the DOW continues to struggle with its downtrend line from April, which SPX and NDX have broken (the RUT has not reached its downtrend line yet), but today managed to marginally close above it. It will be important for the bulls to make the break stick and not let it close back below it, now near 10523, otherwise we'll be left with a throw-over finish of its triangle pattern. If the bulls can push the market up a little further the DOW could tag its Fib projection near 10620 (where the 2nd leg of the bounce off its July low would equal 62% of the 1st leg up). I don't see it happening but two equal legs up from July would be up to 11042. I think the more likely move will be down (even if it starts a few days from now) and once below 10332 it would confirm the end of the months-long consolidation pattern.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10620
- bearish below 10332

The techs have been relatively strong this past week. NDX climbed above its August high on Monday and its June high today. I've got a slightly different EW (Elliott Wave) count on the NDX because of the new high above June's. It counts best as wave A down to the July 1st low and then an a-b-c bounce up to the current position. Two equal legs up from July is at 1966 and the top of a parallel up-channel from July (bear flag pattern) is currently near 1950, only 8 points higher than today's high. But notice where it stopped yesterday and today--right at the broken uptrend line from March 2009 through the May 25th low. You can see how that line was used as support in early August before it gapped down below it on August 11th. Coincidence? Perhaps. We'll know soon enough. The next move out of this pattern is exactly the same as the sideways triangle shown for SPX--a strong decline in wave C. If it were to drop the same amount as the April-July decline we get a downside projection to about 1580. I think it will go deeper than that.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish to 1966
- bearish below 1851

The semiconductors have been acting somewhat out of synch with the broader tech indexes but the rally on Monday and Tuesday certainly helped. The move up from the August 31st low is now an a-b-c bounce and it would have two equal legs up at 337.42. The 50% retracement of the July-August decline is at 338.41 and the 50-dma is at 339.40. If the SOX makes it up to the 337-339 area, stalls and turns back down it would be an outstanding shorting opportunity (use SMH). Whether it makes it up to that level over the next few days is the question. It made a high of 335.12 yesterday.

Semiconductor index, SOX, Daily chart

As mentioned earlier, the RUT has been relatively weak as related to its sideways triangle pattern but it wouldn't take very much for it to get up to the top of it near 664 (Tuesday's high was 654.32). It takes a break below 628 to tell us the high is already in place.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 665
- bearish below 628

The volatility index is right back down into the danger zone and has dropped to the bottom of a descending wedge pattern, with positive divergence supporting the bullish interpretation of the pattern. It can still drop lower though and it takes a push above 25 to suggest a bottom for VIX has been made (and a top for the stock market). We're still in the sell window that I mentioned last week with the VIX first closing below the bottom Bollinger Band and then closing up inside it. The previous times gives us a window for a market high through September 22nd, which turns out to be a turn date by various cycle studies.

Volatility index, VIX, Daily chart

If bond prices drop a little further it's going to look like they might have topped out. Looking at the weekly chart of TLT, the 20+ year Treasury ETF, the Fed might be losing the battle to hold down interest rates. There are rumors that the Fed is getting ready to announce yet another program to pump a trillion dollars into the economy by buying up mortgage-backed securities in an effort to hold mortgage rates down, which are largely driven by the 10-year yield. I've said it before and I'll say it again, the market drives rates, not the Fed. It will be another failed program from the Fed if this chart is correct (as bond prices decline, yields will rise).

20+ Year Treasury ETF, TLT, Weekly chart

But it's possible the up-channel for TLT will hold and that this week's minor break will not result in a breakdown. What looks bearish about the chart is that the 3-wave bounce off the June 2009 low had the 2nd leg up (April-August rally) achieving 162% of the 1st leg up and the whole bounce looks like a correction that achieved a 62% retracement. It does not look like an impulsive move to the upside. This supports the idea that another leg down is coming (and could tie in with the idea that all markets--stocks, commodities (including gold and silver) and bonds--will sell off together in the next bear market leg down.

But I don't think it's a slam dunk that bonds will sell off from here. While the shorter-term chart supports that view I continue to watch the longer-term chart of the 10-year yield and wondering if we're going to see a rate closer to 1% before we get a bottom in yields. It would mean the economy continues to slow, the Fed continues to pump and loans go begging for borrowers. Lack of demand for loans could continue to drive yields lower (and bond prices higher) into next year. It takes a rally in the 10-year yield above 4% before we'll know for sure.

10-year Yield, TNX, Monthly chart

The KBW bank index could make it a little higher to tag its 200-dma at 48.45 before it's ready to tuck tail and run back down the hill. A break below 46 would be a bearish heads up and below 45 would confirm the top is in. Follow the money over the next week as it should lead the way.

KBW Bank index, BKX, Daily chart

For the TRAN, two equal legs up from July is up near 4663 so that remains upside potential for now. But if the price pattern is a sideways triangle similar to SPX (not drawn on the chart but it is labeled in dark red) then we should be getting a high very close to the current level. All those topping tails on the daily candles over the past week is a sign of exhaustion by the buyers and sellers starting to get stronger.

Transportation Index, TRAN, Daily chart

The US dollar has pulled back a little more than 62% of the bounce off the August low. If it drops below 80.90 (78.6%) I'd say we'll see lower lows for the dollar over the next few weeks. It broke its 200-dma yesterday and bounced back up to it today. Notice it did the same thing in early August and then blasted higher. The wave count calls for the same result again.

U.S. Dollar contract, DX, Daily chart

Last week I showed the commodity related equity index (CRX) and pointed out the upside target near 793, which is a Fib projection as well as the top of a rising wedge pattern. Like the sideways triangle shown for SPX and the RUT, this one has an upward slope but they're basically the same pattern and both bearish in the larger price pattern. Yesterday's high of 790.22 came close to the upside projection but as with the others we could get a little throw-over above the top of the wedge. If that happens and it then drops back down inside the wedge pattern it would create a sell signal. The risk from here is for a quick move back down (rising wedges are completely retraced in less time than it took to build them, typically much less time). I fully expect commodity stocks to follow, if not lead, the broader stock market in its next decline so those who are interested on commodity stocks may want to wait a while if I'm correct on this pattern.

Commodity Related Equity index, CRX, Daily chart

Keeping the longer-term pattern in view on gold, it has nearly made it up to the top of its rising wedge pattern that has been playing out since December 2009, currently near 1285 (yesterday's high was 1276.50). If gold blows out the top of this wedge, meaning it's not the correct pattern, then the next upside target is nearly $100 higher. The bearish divergence does not support that kind of move but I'm also aware of the propensity for the metals to make a blow-off top so be careful if looking for a short entry. By the same token I think it's too late to be looking for a long entry on gold, considering the downside risk potential (and when it breaks down it will likely go fast and overnight).

Gold continuous contract, GC, Weekly chart

Oil's bounce off the August low looks complete as it struggled to get through its 200-dma this week but failed. If the bulls can make another stab at pushing it higher I see upside potential to about $80 before the bounce fails. The next leg down is expected to see strong selling.

Oil continuous contract, CL, Daily chart

Tomorrow morning we'll get the unemployment numbers and it has the potential to upset the bulls. Last week's number had estimates for nine states (due to the holiday) and if those estimates were low we could see a revision higher. If the number of newly unemployed also climbs it could be a double whammy. But if the number comes in lower than expected it could be what the market needs to pop over resistance and that could have us off to the races for another 30-point run in SPX. Or it could be good for 5-10 points and an immediate failure. Just be careful chasing any news-related rally higher at this point as it's a typical way for a rally to finish.

Reader Steve T. hit the nail on the head describing what could happen from here:

"If you cannot breech OHR [overhead resistance] normally, as we all know that markets have a hard time fighting obvious OHR where we have real supply waiting (called over head resistance), these markets take another route as if you're a market manipulator getting huge Fed-handouts of free and easy money (you guessed it they are called primary dealers, who run huge prop-desk and program trading desks) they have the juice. It's called the ability to orchestrate up-grades and manipulate the futures and options, especially the new weekly options players...they create the gap-run scenario. They ignore the data, the technicals and indicators, as in a thin market environment they are in complete control! They just gap over OHR, trap the bear-cub shorts and keep running the markets higher and then force other funds to chase (especially at the end of the secession) as GREED is a huge inducement. And if you're a fund manager that failed to buy the September lows you're underperforming again, and the end of the quarter is only 11+/- trading days away. We ended today just 6+/- points away from the 1,131-1,132 level of OHR. If the numbers are decent tomorrow for initial claims the futures ramp-o-rama players will induce a GAP-over support and then the Short squeeze will be on!"

Tomorrow morning we'll also be getting the PPI numbers before the bell and the market is expecting to see minor inflation (indicating in their minds that the Fed is winning the battle against deflation). There will be trouble when those numbers start coming in negative because the market is building this rally on the hopes (there's that bad word again) that the Fed will be able to create some inflation and fight the dreaded deflation. At 10:00 AM we'll get the Philly Fed index, which came in at a dismal -7.7 for July. For August the market expects to see a big goose egg, as in 0.0. Maybe "less bad" will spark a rally.

Economic reports, summary and Key Trading Levels

In summary, and using SPX as our market proxy, the consolidation just underneath resistance (the trend line along the highs from June-August, which many are viewing as an inverse H&S neckline) can be viewed as bullish. If it does resolve bullishly I would be very careful about the long side from there since I believe an upside break (even if it runs 30 points) will be a head fake. The break back down from whatever high gets put in should be fast and sharp.

I completely agree with reader Steve's take on this but I think it's time for buyer beware. We should be close to a reversal back down and a gap up n go scenario could be quickly followed by a quick reversal--stop a bunch of shorts out, trap some bulls and then stop them out with a break back below the OHR line (SPX 1128). Played right (and the big boyz do) and you could make a ton of money with that kind of move.

There are a few cycles, including the Bradley Turn Model, which point to September 22nd, +/-, as a turn date. Therefore if the market holds up into that date I would be looking for a shorting opportunity. Past patterns (fractals) point to the unique vulnerability of the market right now. A market crash is still very possible if not likely. The long sideways consolidation since May (or the a-b-c bounce off the July low) is setting us up for the next leg down and it should be a stronger decline than the April-May decline. It's entirely possible we'll be at SPX 870 before October opex. If we get a crash leg down it could be worse.

There is of course no guarantee that the market will crash. It is after all a rare event. But with the liquidity of the market drying up, the shorts being driven out of the market, bullish sentiment hitting extremes (ISEE hit 150 again today and the Daily Sentiment Index from trade-futures.com is up to 83% bulls, the highest reading since the April high), HFT (high frequency trading) and quote stuffing becoming more apparent (and the SEC not knowing what to do about it), with the trading machines taking over most of the trading and the flash crash in May being a precursor of things to come, I think the risk is as high as I've seen it for quite some time (since August 2008).

It's simply a time for caution by both sides. Bears are getting fried and bulls are feeling complacent. It's all part of the market cycles and they'll soon reverse positions. Good luck with the rest of opex week and early next week. I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1130 to 1158
- bearish below 1091

Key Levels for DOW:
- cautiously bullish above 10620
- bearish below 10332

Key Levels for NDX:
- cautiously bullish to 1966
- bearish below 1851

Key Levels for RUT:
- cautiously bullish above 665
- bearish below 628

Keene H. Little, CMT