Market Stats

As has been the case with so many mornings in the past 5 weeks or so, equity futures were up in the overnight and pre-market session and the cash market gapped up at the open and ran higher in an effort to join futures. The unemployment numbers, out at 8:30 AM, showed some improvement (minus the usual higher revision for the prior week) with new claims dropping 11K to "only" 445K, which is lowest level since early July, and that sparked a ramp up in the futures. It turned out to be quite the pump and dump exercise that caught a few bulls in a bull trap while shoving a few more shorts out of the market.

It's very common for big money to do these little exercises. It's easy for them to create some buying pressure, especially in the futures market, as a way to create a lot of liquidity at the open. As buyers (including short covering) scramble into their positions (and shorts are getting out of their positions) the big-money players are selling into it. It's a way for them to unload inventory without driving prices down. I suspect we'll see more of that behavior as inventory is turned over to the masses who believe the rally will continue. The cry for dip buyers will continue so that big money can hand off more inventory.

Yesterday's rally was credited to the hope (that's that 4-letter word) that the central banks will be able to save the stock markets. Japan has promised to support the markets through the purchase of equities (through ETFs) and real estate (through REITs -- Real Estate Investment Trusts). What used to be hush-hush and shrouded in secrecy and something only conspiracy theorists talked about (the government's involvement in the capital markets) is now out in the open and traders cheer this development! Oh, the web we weave...

So the hope now is that the Greenspan put has morphed into the Bernanke bailout and that Bernanke, and other central banks, will do everything they can to support the financial markets. The money that is growing on trees behind the Fed's building will be used to support the markets in an effort to keep the sheeple happy. They believe buying in the stock market will reduce risk (but in fact just the opposite is happening as complacency about risk has returned to the market).

The problem with this theory is that the Fed can't single handedly support the markets. As we've seen with all government support programs, when the support is taken away there's nothing behind it to continue the buying. And institutional investors are fully into the market at this point. The cash levels as a percent of total assets in mutual funds are now lower than where they were at the tops in 2000 and 2007, currently around 3.4% (it may be lower after September's rally). They are more than fully invested.

In the meantime we're hearing reports about people, especially the baby boomers, pulling their money out of the stock market. Any increase in redemption requests to mutual funds will have to be met by liquidating stocks. Multiply that selling across the board, along with an absence of shorts to help support the market, and it doesn't take a wild imagination to see that the market is very vulnerable to the downside, no matter how much the Fed tries to support it. The market is simply too big for them and mass psychology is what will drive the market, not the Fed. Hope can turn to fear in a New York second.

With bullish sentiment hitting extremes not seen since the 2000 and 2007 highs, we're ripe, from a contrarian perspective, for a reversal. With the markets stretched to the upside and losing momentum, we're ripe for a reversal. What we have no idea about is what the catalyst will be to start the selling. And May's flash crash could be but a blip on the chart if we get hit with a Black Swan event, which is not an unlikely event considering the psychological makeup of the market along with the technical chart patterns. We still have multiple Hindenburg Omen signals that are good through the end of the year.

There seems to be a somewhat unanimous opinion that no matter what tomorrow's jobs report says it will be bullish for the stock market. If it's a good number that will mean the economy is improving and we don't need no stinkin' Fed. If it's a bad number then we'll need that stinkin' Fed who will jam more money into the market and that will be bullish for stocks. So with everyone thinking the reaction from the market will be positive no matter what the report says, might we be set up for just the opposite reaction? In other words, with the high expectations for the market to rally no matter what, we seem to be set up for a sell-the-news reaction.

But these are all cautionary notes in the midst of a strong rally. The only thing I've been advising traders to do is to be very cautious at this point. While shorts have been getting hammered the past month, I think it's wise to look for reversal patterns rather than continuation patterns. Could it continue higher? Absolutely. I'd rather miss a trade for an upside run from here than enter a long trade with the potential of seeing a strong gap down against me. If you're in a long position pull stops up tight underneath this rally. If you want to play the short side then have a plan for how you would like to participate. The price pattern is set up for a steep decline as the next major move so it could be a real money maker for those who grab a chunk out of it on the way back down.

Moving on to the charts, SPX has now rallied right up to its downtrend line from October 2007 through the April 2010 high. There's upside potential to the 200-week moving average near 1197 but it's got some serious resistance near 1174 before it can get there. In the meantime a turn back down from here would look bearish.

S&P 500, SPX, Weekly chart

In addition to the downtrend line from October 2007 you can see on the chart below how SPX is pushing up against the top of its bear flag pattern (parallel up-channel for the a-b-c bounce off the July low). It has also achieved two equal legs up from July at 1158. Today's candle is a hanging man at this resistance level so a red candle on Friday would be a confirmed sell signal. If it instead gaps up and jumps over resistance near 1160 we should see it head for 1174. A drop below 1132 would confirm we've seen the high. The negative divergence shown on RSI is telling us the momentum to the upside is drying up. It's been a challenge to find the top of this rally but once the a-b-c bounce off the July low is complete the next big move will be a drop well below the July low. This is what makes the next short trade a real money-making opportunity.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1164
- bearish below 1132

An uptrend line from the August 31st low through the September 23rd low was broken last week, retested Friday and then retested again on Tuesday. Holding as resistance should be a bearish sign but so far the market continues to hold up. This morning's high hit the top of a parallel up-channel for price action since September 21st and if it's tested again on Friday we could see 1166. But after this morning's decline and a 62% retracement into this afternoon, any drop back down below 1151 would be bearish.

S&P 500, SPX, 60-min chart

With Tuesday's big rally it popped the DOW above the trend line running across the highs since June, which is the top of a rising wedge pattern. Today's decline brought it back down to that trend line and if it holds like it did today we could see a bullish continuation higher. If the DOW instead drops back below the top of its rising wedge pattern it would be a sell signal. A drop below 10711 would confirm we've seen the high. So we're close to a sell signal but the uptrend from August is also still holding (near 10860). Notice that the DOW is struggling with the level, near 10970, that acted as a shelf of support back in April. When it let go we got the big drop into the May crash. This is the first time that support-turned-resistance is being tested (and the odds favor resistance holding at least on the first attempt to break it).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,000
- bearish below 10,711

The DOW has found its 200-week moving average to be both support and resistance for the past several years, using it as support in 2004 and again in early 2008. Once it broke in June 2008 it was resistance in August 2008, which led to the crash of '08, and again in April 2010. It was again tested this morning at 10977 (this morning's high was 10998.53 so it almost rang the bell at 11K). A second failure this year would scare more than a few bulls away.

Dow Industrials, INDU, Weekly chart

The techs were on fire to the upside in September but NDX came to a screeching halt at the downtrend line from October 2007 through the April 2010 high. At the same level is a 161.8% extension off the previous swing down, which is the August decline. This Fib extension is often associated with the head of a H&S topping pattern so that's what I've depicted on its chart.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2030
- bearish below 1963

The RUT has formed a small rising wedge pattern for price action since the September 21st high. Negative divergence on RSI supports the bearish interpretation of the pattern but we still don't know where it will end. While yesterday's high may have finished its rally, it takes a break below 666 to confirm that. In the meantime we could see the RUT push marginally higher within the rising wedge. A 127% extension off the July-August decline crosses the top of the wedge on Friday so maybe a quick blast higher following the jobs reports and then a reversal back down. It's not a time to chase this any higher.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 695
- bearish below 666

The banks have been coiling for a while now while the rest of the market has raced on ahead without them. That should be enough warning to the hapless bulls frolicking in the fields, oblivious to the danger lurking at the edge of the field. Many will look at the ascending triangle (flat top, rising bottoms) that I've drawn on the chart as bullish and typically it is. But it has to be considered in context and the pattern following a move down into it usually leads to a continuation in the same direction--down. The pattern could catch a few traders leaning the wrong way if they're expecting a bullish breakout (watch out for a head-fake break and then reversal) and it breaks down instead.

KBW Bank index, BKX, Daily chart

I haven't reviewed the home builders index in a while so I thought I'd look at it tonight but step out a bit and look at the weekly chart since price has been consolidating in a small range since July. Once again, the little flag pattern following the drop April calls for a resumption of the selling once the consolidation finishes. The next leg down should be relatively strong and will likely take out the November 2008 low. And if the home builders are not doing well, nor is the housing market and that in turn means bad things for the economy and stock market.

U.S. Home Construction Index, DJUSHB, Weekly chart

The transports could push a little higher to a confluence of trend lines and a price projection in the 4650 area. With waning upside momentum I would not want to bet on price getting through that area of resistance.

Transportation Index, TRAN, Daily chart

The US dollar is one of the most hated currencies at the moment. The Daily Sentiment Index (DSI from trade-futures.com) is currently at only 4% bulls, lower than it was at the November 2009 and August 2010 lows. From a contrarian perspective the dollar is ripe for a rally. Today's candle left a bullish candle at Fib support. The 78.6% (and 88.6%) Fib retracement levels are often associated with double top/bottom patterns so in effect the current low is a test of the November 2009 low. The pullback from June is an a-b-c correction to the November 2008 - June 2010 rally and once it completes we should see a strong rally well above the June high. Today's candle may have marked the bottom of the pullback in which case the next rally leg is about to begin. That could have all other asset classes reverse course at the same time.

U.S. Dollar contract, DX, Daily chart

Gold may have spiked up to its final high. It's very common for the metals (and commodities in general) to see v-tops while it's more common for stocks to form rolling tops and v-bottoms. So when the metals started going parabolic, as they often do into their final highs, I've been watching carefully for a sign the rally is over. We might have received that signal today. After gapping up this morning and running up to a new high, gold then sold off sharply and created a bearish engulfing candle, which is a potential key reversal day.

Gold continuous contract, GC, Daily chart

Gold dropped down to its steepest uptrend line from September 28th and also to the top of a parallel up-channel for price action since July. So the rally can't be called complete yet, even though that's the warning here. The warning would likely be confirmed with a close below 1330 and then stay below the two trend lines. Confirmation that gold's rally is finished would be a drop below the September 28th low near 1276.

The weekly chart below shows gold came close to achieving an important price projection at this morning's high. The 5-wave move up from October 2008 would have the 5th wave achieving equality with the 1st wave, a very common relationship, at 1371.20. This morning's high was 1366.00. As depicted on the chart below, I see the possibility for a little more rally into the end of the year but a break of its uptrend line from October 2008 and the high in June 2010, both near 1266, would eliminate that possibility.

Gold continuous contract, GC, Weekly chart

Silver's daily chart shows an even more pronounced bearish engulfing pattern with a drop of more than 2% today. Silver's weekly chart below also shows a very good setup for a reversal. The rally from August has been practically straight up--a classic blow-off finish for silver. The last time it did this was back in March 2008. When it cracked it dropped over $4 in a week (-20%). I'm expecting to see the same kind of thing this time around. There are two Fibs I've been eyeing for silver: the first is the 113% extension of the previous decline (the March-October 2008 decline), which is often associated with a momentum reversal and that's at 23.13; the second is where the a-b-c move up from January achieved two equal legs at 22.93. This area is also the top of a parallel up-channel for price action since October 2008. This week's rally popped above this level but the week's close will be important. If the $23 level holds as resistance there's an excellent chance that silver's rally has completed.

Silver continuous contract, SI, Weekly chart

Oil also had a key reversal day with its bearish engulfing candle. There were two Fibs that I was watching, practically on top of each other. As I mentioned for the dollar, the 78.6% and 88.6% retracements are often associated with the double top-bottom pattern and the 88.6% retracement for oil is at 84.54. For the final a-b-c move up from August the c-wave achieved 162% of the a-wave at 84.53. Today's high for oil was 84.43 so it missed the mark by about 10 cents. It then proceeded to give up $3. The combination of the Fibs and the key reversal day has me thinking we've seen the end of the rally for oil. And if oil, gold and silver (and other commodities) reverse back down, along with a rally in the dollar, I believe the stock market will also be heading back down.

Oil continuous contract, CL, Daily chart

Other than the unemployment claims this morning the only other economic report was consumer credit that was reported this afternoon. It shows the consumer continuing to shrink from his/her responsibilities. Doesn't everyone know that it's their civic duty to continue to rack up debt and spend spend spend? Come on people!

August consumer credit declined by -$3.3B vs. an expected decline of -$3.0B but not as much as the previous month's -$4.1B (which was revised lower from -$3.6B). What I'd like to know is how come economic figures are always revised to be worse than originally reported? Just wondering. Revolving credit shrank by -$5.0B, making it the 23rd consecutive month of declines. The consumer appears to be in permanent retrenchment mode. Interestingly, the chart below shows a pop in consumer credit in the fall, which I guess can be attributed to back-to-school shopping (and tuition bills). Following those periods we've seen credit fall off sharply, most especially in 2001 and 2007. The current pop up could lead to the next round of reduced spending.

Consumer Credit Year/Year%, 1995-2010

Friday's economic reports include the Wholesale Inventories but obviously the market really only cares about the payrolls numbers.

Economic reports, summary and Key Trading Levels

I had mentioned the loss of upside momentum in the rally from August and the chart below shows the NYSE making new highs in September but it wasn't accompanied by new highs in the advance-decline line. Especially with the new price highs at the end of September and into October you can see the negative divergence. This pattern has been the same at all previous market highs and I strongly suspect we're seeing another one.

NYSE vs. Advance-Decline line, Daily chart

For the month of September there haven't been many technical indicators working very well, not even the MPTS. The market has been under some other kind of influence (called the Fed and our money) other than the moon phases but here we are at another one (new moon tonight). Will it work this time to mark a turn in the market? With all of the other factors shown on tonight's charts I must say the chances look good this time.

SPX MPTS, Daily chart

Lastly, I came across the chart below that shows an analog of price action between now and 1937. It compares the period of May 1936-February 1938 to July 2009-present. Analogs work until they don't so you can't take this to the bank but again, with all of the other technical indicators, Fibs, trend lines, time and even the MPTS, it does cause one to ponder the possibilities. This chart says look out below so caveat emptor if you're still interested in the long side of the market.

Analog of DOW's pattern, 1937 vs. 2010, chart courtesy Donald L. Luskin

Good luck as we head into opex next week and be careful of increased volatility after tomorrow's report. I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1164
- bearish below 1132

Key Levels for DOW:
- cautiously bullish above 11,000
- bearish below 10,711

Key Levels for NDX:
- cautiously bullish above 2030
- bearish below 1963

Key Levels for RUT:
- cautiously bullish above 695
- bearish below 666

Keene H. Little, CMT