Market Stats

I'll be filling in for Jim for tonight's wrap.

The stock market started with yet another gap up to start the day but unlike yesterday it didn't immediately give it back. The initial rally was over in 20 minutes (not much was added to the gap up) but after a pullback to around 10:30 AM the market started inching its way higher again, with techs leading the way. NDX continues to make new highs but the others have not been quite as strong. SPX tested yesterday's high which was a test of the October 25th high but both the DOW and the RUT remained short of the October 25th highs. Essentially the market has been in a consolidation/topping pattern (depending on your perspective) since mid October and is pressing the high side of the trading range. Pressing higher into a major news announcement (tomorrow's FOMC) is usually a recipe for disappointment but obviously we can't know for sure how the market will react.

Many market pundits now believe we'll see a sell-the-news reaction to the election and FOMC announcement. That alone should have us doubting that expectation. Have you heard anyone say the market is going to rally on the news? We could see the market rally into Friday and then sell off on the jobs report. It's something to think about for your own trading plan this week.

While there's great interest in how the elections turn out, the market has already factored in gridlock in our government. It's sort of a non-factor at the moment (unless there's a major election surprise, such as the Democrats keeping both Houses). Instead the market is now focused on what the Fed might share with us tomorrow. Everyone knows the Fed will implement a second round of Quantitative Easing (QE2) but everyone's guessing how much, now quickly and what securities will be purchased. So the market is essentially on hold, at the high side, while it waits for the Fed to come down from the Mount.

Last Friday there was an article in the Bloomberg news, Fed Polls Dealers, about the Fed essentially asking bond dealers and investors what they should do. Never mind that the Fed is supposed to make fiscal policy decisions based on what it believes the monetary system and economy require. Never mind that the Fed has always and consistently stated publicly that they don't make policy decisions in order to influence the stock market. It is now abundantly clear that the Fed is making policy decisions to support the stock market (while worried about the bond market's reaction). Any notion of a free market should now be considered dead -- the Fed is in control of the stock market now. Well, that's what they'd like to believe anyway.

But think back to the days when Greenspan would constantly deny any interest in what the stock market does and that Fed policy did not take into account how the stock market would react. Everyone knew it was a lie but no one seriously challenged the Maestro about this. Now we have the Fed fully admitting that their interest is in how the markets will react to the creation of trillions of dollars. In reality this should come as no surprise to anyone but it is a bit surprising how blatant it has become for both the government and the Fed to manipulate the markets. And it will always be a bit unnerving to understand the fact that the Fed now believes it should influence how the stock market behaves. It goes against the whole premise of a free market.

Consumer sentiment is influenced to a large degree by the people's perceived wealth. The value of their homes and stock holdings (whether it's only in their retirement plans or more actively managed funds) will have an impact on whether people feel bullish or bearish the economy and that of course affects their spending habits. The Fed does not care about people and their savings accounts. The Fed cares about people spending their money. In fact the Fed, with the historical low interest rates, has made it very clear they do not care about people who have to live off their savings. They want people to invest in stocks instead of bonds, even though stocks are riskier, and they want them spending instead of saving.

So when it comes to the next round of QE, the Fed is very concerned about how the market will react. This is very much like a politician polling people for their reactions to a decision before the decision is made. Instead of doing the right thing, following a moral compass, they do the politically expedient thing. The Fed is now playing the political game of telling the market what it wants to hear instead of following a moral compass and telling the market what it needs to hear. It's a huge difference.

Bernanke is a very intelligent man and is the acknowledged expert when it comes to figuring out what happened during the 1930s depression. I think the piece he's missing is that the problem is not just numbers. If the economy suffers a slow down and GDP drops 2% I do this... or if the inflation rate drops to 1% I do that... What Bernanke and most economists don't seem to understand is the enormous influence of social mood. It's why I've been saying for years that the Fed is pushing on a string and that they can lead the horse to water but they can't force it to drink.

Shoving helicopter loads of cash into the money system will not accomplish the normal expansion of the money supply if that money is not lent out (the fractional reserve banking system is dependent on leveraging the money in order to create the growth). If we collectively (people and businesses) are too worried about taking on more debt we will simply not borrow more, no matter how cheap the interest rates are. It's why ZRP (Zero interest Rate Policy) has done nothing to help the housing market, business expansion or consumer spending.

We've been in a very different kind of recession than what we've experienced over the past 50-60 years (it's actually a depression but it won't be recognized as such until a couple more years, after the Great Recession II). This one is not the result of the normal business cycles but is instead due to a severe credit contraction following a blowout credit expansion. These credit-induced recessions are relatively rare and do not respond to the same stimuli from the Fed as normal business-cycle recessions. Hence Bernanke's conundrum (and Greenspan's before him). It's why QE2, 3, 4, etc. will not work either. We have to simply go through the credit contraction (deflation) in order to get to the other side of it.

But Bernanke and politicians will try everything they can, using the traditional arsenal of weapons that don't work in this environment, which typically involves throwing more money at the problem (which is what people like Krugman call for). And now we've got Bernanke wondering what to do so he's asking the bond dealers and investors for guidance. That's a bit like asking a junkie how many drugs he would like. The last thing our economy needs is more debt and that's exactly what Bernanke is proposing.

An article in the NYT came out today, Fed Poised to Act, discussing the fact that the Fed is getting ready to do some more QE but the consensus of many economists seems to be that it might not help. Even the Fed has already acknowledged the same in a statement in August, saying "central bankers alone cannot solve the world's economic problems." James K. Galbraith, an economist at the Lyndon B. Johnson School of Public Affairs at the University of Texas, Austin, said "Quantitative easing will accomplish nothing beyond flooding the banks with cash which they will use, if at all, for speculating rather than lending." I think there are more than a few of us who would agree with that statement. Most of us also acknowledge that the eye-popping bonuses to the banks' proprietary traders and bank managers, thanks in large measure to this flood of money coming to them, has resulted in additional strife between Wall Street and Main Street.

Most people will also acknowledge that even if another round of QE will not have a significant positive impact on the economy, Bernanke has no choice but to try. He doesn't want to stand accused later of not trying everything he could possibly think of to stop the deflationary spiral. The acknowledged expert in depressions will learn over time, in my opinion, that it's a cycle that must run its course and cannot be stopped by monetary policy. The failure of Bernanke to stop this train will be part of our collective loss in faith in government, the Fed and other institutions designed to manage the public. And then we'll start the healing process for the next cycle.

The latest estimates for the next round of QE still range between $500B and $1T. From my reading I think the consensus is for $100B per month and that amounts to $1.2T in the next year. If there's any hint that it will be less than that the stock market could take a hit (and the dollar rally). But the bottom line is that there's no clear idea on how quickly it would be implemented or what securities would be purchased. The primary dealers would of course love to see several trillion coming their way (they borrow at 0% and make whatever the rate happens to be for the securities they purchase) so asking them how much the Fed should offer is again like asking a drug user how much he wants. Most others are very concerned that too much money coming into the system will spark too much inflation. That's a reason Bill Gross at PIMCO came out last week with his prediction for the end of the bond bull market.

In fact the 10-year yield (TNX) has been on the rise since October 8th and broke a downtrend line from April (and as yields rise, bond prices fall). This is causing a dilemma for investors who have been running out of stocks and into bonds. If the bond market is topping, is now a good time to get out of the bond market? That's a tough question to answer right now and last week I showed two long-term monthly charts of TNX. I'm not convinced we've seen the lows for yields yet and it will take a 10-year rate above 4% to confirm, in my mind, that we have indeed seen the bottom for yields/top for bond prices.

I continue to caution investors about the stock market -- I believe we've got another leg (or two or three) down in the secular bear market that we're in. Certainly historical patterns, including most recently Japan's market since 1990, suggest we will continue lower. Therefore it's a trader's market and the run back up from August is probably the 2nd best opportunity this year to take profits on the run up from March 2009. I've been suggesting investing in U.S. Treasuries as a way to be in cash and to protect yourself. That's still my recommendation but be aware of the possibility that bond prices may have peaked.

What's especially important, as far as bond investments go, is to stay away from high-yield bonds (junk bonds). Many fund managers, including money-market managers, have gone into high-yield bonds in an attempt to pump up their returns. The pursuit of returns of at least 8% (still in the charter of many pension funds) requires the managers to hunt down these riskier bonds. These are probably riskier than the stock market. At this time the consensus is that it's a slam-dunk investment to be in junk bonds and when the majority feel this way you know it's ready for a major correction.

One way to track the price of high-yield corporate bonds is by following HYG, the iShares ETF. In the rally off the August low it briefly exceeded the highs made in January and April, near 90.30. It made its own little triple top last week on October 26, 28 and 29, effectively mimicking the triple top against the January and April highs. Price then collapsed yesterday and in so doing it dropped back below the January/April highs and broke its uptrend line from May. It has left a false breakout above 90.30 although today's rally has brought it back up to just above the April high. But it stopped at its broken uptrend line and therefore what it does from here will be important. If it leaves a bearish kiss goodbye at the trend line and drops back below Monday's low at 89.95 it could be the canary in the coal mine for the rest of the stock market.

High-Yield Corporate Bond ETF, HYG, Daily chart

The reason I say HYG could be a canary in the coal mine is because this fund is a measure of investors' willingness to assume more risk, be it in higher-risk bonds or in the stock market. Selling in the riskier junk-bond market should coincide with selling in the stock market, and vice versa. So keep an eye on this to help you decide how to be invested, or not, in the stock market.

SPX continues to struggle near its 200-week moving average, now located at 1193.38 (today's close was 1193.57). Even if it will eventually break above this important resistance it would probably fare better with a pullback first so as to relieve some of its overbought indicators. Certainly I'd be uncomfortable going long here and that means at a minimum you should have stops on long positions pulled up tight.

S&P 500, SPX, Weekly chart

The daily chart below shows SPX also struggling with the 88.6% retracement of the April-July decline. This is a level commonly associated with a double-top pattern. It's also trying to push back up to its broken uptrend line from August through the October 19th low. By Friday that trend line will be closer to 1208 which is what I'm currently projecting, although the rally could fail at any time, hence the dashed line showing a decline from here (or maybe one more stab higher to tag 1200).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1195
- bearish below 1177

The 60-min chart below shows just one idea (I can't put them all on the chart) for how the market could hold up into Friday. This suggests the market will rally a little further tomorrow, pull back after the FOMC and then push higher Thursday. A selloff (on the jobs report?) would follow on Friday. Or we could have a wild gyration around tomorrow's FOMC, put in a final high around 1200-1202 and then sell off. Or we could spike down on the news and rally to the moon. You get the idea -- it's anyone's guess in this kind of market. Price action has been nothing but 3-wave chop which is usually a very good indication of an ending pattern. Where that end will be is anyone's guess but as noted on the chart, the Fib convergence zone between 1194 and 1208 gives us a relatively wide range but a zone that I expect to see a market high. It takes a break below Monday's low near 1177 to confirm we've seen the high.

S&P 500, SPX, 60-min chart

Sticking with the same pattern and expectations for the DOW as I'm showing for SPX, we could see a quick high test the April high and then sell off (dashed line), or we could get a little more upside action into Friday and top out around the top of its parallel up-channel, near 11315 by Friday. It takes a drop below 11062 to confirm we've seen the high so let that happen before you get aggressively short. Back below 11K would be a bummer for the bulls so that's another level to wait for before getting aggressively short (meaning short the bounces after that).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,185
- bearish below 11,062

Again, the same picture as the DOW and SPX is pointing NDX to about 2175 to hit the top of its rising wedge pattern by Friday. Watch for the possibility of a test of the top of the wedge, especially with a throw-over above it and then drop back inside, after the FOMC announcement and then a selloff -- that would be bearish. A break below 2117 would confirm we've seen the high. Today NDX came within less than two points of 2157.17, which is the 127% Fib extension of the April-July decline, a level that commonly sees a reversal.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2117

The small caps saw some strong buying interest today -- the RUT was up +2% while the blue chips struggled and rallied less than 1%. Even the techs rallied less than half what the RUT managed. That could certainly be viewed as bullish for the market. But it's been lagging a little during the past week so it might have been more or less catching up rather than leading to the upside. Trend lines converge near 719 by Friday so as long as it doesn't rally strongly from here we could see it chop its way a little higher into Friday. A quick tag of its trend line across the highs since October 13th, near 717 tomorrow afternoon, followed by a break below 693 would tell us the top is in place. Wait for the breakdown.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 693

With the stock market holding near its highs, if not pressing higher, the VIX is not showing the same level of complacency as it did at its low on October 13th. This supports my contention that the choppy price action since then has been a period of distribution rather than accumulation, which may include some put buying/call selling as fund managers prepare for a pullback. The rallies are quickly sold into by big money distributing stock to the masses, which is how tops are formed. And then in a decline, when the masses can't stand the pain anymore and disgorge their stock at the lows, big money is ready and able to do the buying. Rinse and repeat. With the VIX breaking its downtrend line from July it looks ready to take off to the upside. What might trigger such a "rally" in the VIX? Hmm, so many choices...

Volatility index, VIX, Daily chart

Keep an eye on a couple of the generals for some market clues. I see two stocks in the tech sector, each having a broader economic impact -- IBM and INTC -- that hit potentially important levels today.

Following the sharp gap down on October 19th, IBM has not only clawed its way back but has been able to make new highs for the move up from August. Someone really likes this stock. It has managed to test its broken uptrend line from August and today it came within 4 cents of tagging a potentially important Fib level -- the same 127% extension I mentioned earlier for NDX, but this one is for just the drop on October 19th, which is likely the orthodox high and now it's being retested. Today's candle is a shooting star (or more bearish gravestone doji) at that Fib level. So it's a bearish setup for a top to its rally but confirmation will not come until it breaks below 138.53. But be aware that this stock could foretell us something if its starts back down from here.

International Business Machines, IBM, Daily chart

Yesterday INTC closed its August 10th gap at 20.65, with 2 cents to spare. This morning it did it again, with 5 cents to spare, and promptly sold off, creating a key reversal day with the gap up, new high and then closing lower. In addition to closing its gap it also tagged its 200-dma at 20.66. The bearish engulfing candle looks, well, bearish. You can see by the daily candles that rallies are being sold into. Any follow through to the downside tomorrow will confirm the reversal. If IBM and INTC are selling off while the tech indexes try to push higher, don't trust the rally in the indexes. A rally needs its generals.

Intel Corp, INTC, Daily chart

The banks continue to be MIA during the rally attempt. The sideways coil in BKX is breaking down and any continuation below 44.66, Monday's low, would be confirmation of the breakdown. Follow the money if the banks start selling off harder.

KBW Bank index, BKX, Daily chart

And remember, as with all the charts, while I'm showing an ending pattern with a top very close, or already in as in the case with the banks, it's just a guess based on typical ending patterns with waning momentum. This market has had some unusual influence and there's no telling where an irrationally exuberant market could take us. This is why it's important to see breaks below the key levels to confirm we've seen the highs. Until that happens we have to continue to respect the upside. I may not agree with the reasons for the rally, and I do believe that the buyers are going to end up very disappointed if they don't protect their positions (which of course includes going to cash), but the bottom line is we deal with price wherever it goes, regardless of the reason.

The TRAN continues to hold above its uptrend line from August and is pushing back up towards the top of its rising wedge pattern from the October 13th high, which will be near 4880 by Friday. A break below 4715 would tell us the high has been made.

Transportation Index, TRAN, Daily chart

With everyone expecting the Fed to announce another major QE program it has an overcrowded pair-trade getting even more overcrowded. That pair trade is of course short-the-dollar-long-everything-else. The dollar has been getting beat lower in anticipation of further devaluation because of the amount of new money expected to come into the system. So traders have been shorting the dollar and using the proceeds to buy other assets. Commodities and the stock market have been beneficiaries of this trade. The big question of course, especially with such a large percentage of bearish sentiment towards the dollar, is what happens when this pair trade starts to unwind. There will be a rush to cover the dollar short trade, which will cause a spike in the dollar, and the money to buy back the dollar will come from selling other assets, namely commodities and equities.

The current trends could quickly reverse as traders scurry to unwind their trades. We can't know when the unwinding will begin, or what might spark it, but it's not farfetched to think it could happen around the FOMC's QE announcement, especially if the announcement is for something less than the currency market expects. The stock market could be just the tail that gets wagged by the currency dog so if the dollar starts rallying and trades start unwinding, it's not going to matter how the stock market participants feel about the economy, the Fed or anything else. Selling in the stock and commodity market will be driven by the currency market.

And of course it's just the opposite if the dollar sinks lower on fears of devaluation as a result of too much QE. A sinking dollar will embolden traders to pile on short and that money will go into more buying of commodities and equities. But again, if that happens in a hurry it should be the final move and then get ready for a very fast reversal.

In fact, with the dollar chopping up and down since the high on October 19th, which coincides with the choppy price action in the stock market, it looks like it could give us one final move lower to finish the decline from June. I show a brief pop up and then final low this week in order to finish a small 4th and 5th wave for the leg down from August but that's just a best guess for now. A finish around 76 would be a good setup for the rally to begin (and the unwinding to begin). This up-and-down-and-then-rally kind of move could easily occur around and after the FOMC announcement.

U.S. Dollar contract, DX, Daily chart

Gold has a clean 5-wave move down from the October high to October 22nd and then a clean 3-wave bounce to yesterday's high. It's a clean setup for the next leg down to begin. Now all we need to see is for price to agree. But beware if you're long gold since the next move could be a strong decline down to its uptrend line from October 2008, currently near the June high near 1262.

Gold continuous contract, GC, Daily chart

Another important indicator of economic health, as well as dollar strength/weakness, comes from copper, which looks vulnerable to a breakdown. Looking at its weekly chart, last week was the 4th week in a row that it tagged its broken uptrend line from the beginning of 2009 and could be close to leaving a bearish kiss goodbye at that trend line. A break of last week's low at 370.35 would be confirmation that the top is in.

Copper continuous contract, HG, Weekly chart

Tomorrow will be a busy day for economic reports, some of which could be market moving before we even get to the Fed in the afternoon. Of course we have no idea what the market will consider good or bad news since each will be considered in the context of how it might affect the Fed's decision. Just be aware that we could see some volatility in the morning and then of course you can bet on it in the afternoon.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, I see further upside potential but not a lot. The choppy price action as the market struggles to make it higher is classic topping action. If the market blows out the top of the rising wedges that we see across the board it will be very bullish and probably the beginning of a final blow-off move. But a blow off could tack on another 1000 points to the DOW. You don't want to short a move out the top of rising wedges.

But betting on that kind of upside move is simply betting against the odds. It would be like picking the horse with lousy odds of winning -- you'll probably lose your money but you could win big. The higher-odds play is a reversal of the rally and it's "simply" a matter of finding the top. I keep raising the key levels to the downside because it's a way to trail this market higher. I don't like the risk:reward ratio to enter a new long trade but I also know it's risky picking a top in this market, especially with some underlying influences that we don't completely understand. For example, who's doing all the buying in the futures during the overnight session, which then causes the cash market to gap up which then immediately gets sold into? How long can that continue? Your guess is as good as mine. I've shown my guess on tonight's charts and now we'll let price show us the way. Start playing the short side after the key levels are broken. In the meantime keep your powder dry.

It seems everyone expects a sell-the-news reaction to the Fed's announcement. I have been expecting the same but now I'm not so sure. I hate playing with the crowds and the crowded expectation is for a selloff. If everyone is expecting it, and placing bets that way, the market could be ripe for a flare-up as "someone" gooses the market with some big buy programs and then watches the fireworks go off as the shorts scramble to cover. Will that happen? Who knows but I'd sure be careful about the possibility.

The Fed is in the business of buying securities so who knows how much of that money has been set aside to "help" the market higher this week. But once that short-covering has ended (assuming that's how it will play out), and assuming we're not talking a huge rally out the top of the rising wedge patterns, that's when I'd start nibbling on the short side. If any flare-up results in a throw-over above the rising wedge patterns, followed by price collapsing back inside, start looking for shorting opportunities.

Good luck and I'll be back with you on Thursday for some post-FOMC analysis and to see how the end of the week will be setting up for us.

Key Levels for SPX:
- cautiously bullish above 1195
- bearish below 1177

Key Levels for DOW:
- cautiously bullish above 11,185
- bearish below 11,062

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2117

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 693

Keene H. Little, CMT