Market Stats

In Tuesday's newsletter I had mentioned I thought the sell-the-news expectation may be getting a little too crowded and that I don't like being part of the crowd (except in a momentum move). With the crowd looking for a reversal after the FOMC announcement I thought it was ripe for a big short-covering squeeze. When the market didn't sell off after the FOMC announcement on Wednesday, followed by buying in the futures Wednesday night/early Thursday morning, we were looking at a monster squeeze and that's what we got.

Now the question is whether or not enough shorts were squeezed out of the market to make it vulnerable to the downside now. The answer of course will be determined by the amount of new money coming into the market vs. short covering. The rally finished at the high of the day and in the past this has typically been the result of short covering right into the close. The risk therefore is that today was a one-day wonder rally that will not see any follow through. That's of course the bearish perspective. The bullish perspective is that we just kicked off the next leg of this great bull rally and SPX 1250 here we come.

The DOW blasted past its April high near 11258 (gapped right over it) while SPX inched higher into the close by about 2 points. The NDX of course has been above its April high since gapping above it on October 15th. The RUT is the laggard in comparison, still under its April high by about 12.50 points (1.7%). So we've got a mixed bag between the indexes in regards to the April highs but clearly the market looks bullish at the moment. Prior to today we had bullish sentiment (as measured by trade-futures.com with the Daily Sentiment index readings) exceeding previous market highs so I can only imagine what the readings will look like now.

But interestingly, the DSI bullish sentiment has been dropping back over the past week or so. It seems even the bulls recognize we've run too far too fast. While today's rally could spark a lot more bullish sentiment, it also remains possible more bulls will be feeling very nervous up here, especially if the bulk of the buying was more short covering than anything else and we fail to see follow through. At past highs we've seen sentiment tail off even as the market made a new high. The chart below shows the highs in sentiment and then higher market highs with lower sentiment. It's another form of bearish divergence and it's showing up again.

SPX vs. Daily Sentiment index, chart courtesy elliottwave.com

As noted on the above chart, in April the DSI peaked on April 14th while the market peaked April 26th, a Fibonacci 8 trading days later. So far we've got a peak in DSI on October 18th and today's new high is a Fibonacci 13 days later. Does that mean today's high will be THE high? I have no earthly idea and I'm sure not recommending that you go ahead and short it right here. My tactic, as I've been saying for weeks now, is to follow this higher since I don't like the risk playing the upside (although in hindsight there clearly was very little risk) and I'm trailing up my key levels that indicate when a top has been made and when it's safe for bears to get back in the water.

One bullish sentiment that hasn't pulled back yet is from the AAII (American Association of Individual Investors). The bullish minus bearish sentiment had a reading of 29.60 as of last week and as the chart below shows, this puts it higher than all of the highs since 2007. Each time it has reached 26-29 it has marked an important high, even if it was good for just a stronger pullback. But more bullish sentiment at a retest of the April high for SPX is probably not something the bulls want to see. Sentiment can easily go higher but when it gets this high it usually makes good sense to start watching for reversal patterns rather than continuation patterns.

AAII Bulls minus Bears Sentiment, chart courtesy elliottwave.com

Following the Fed's desire to crush the U.S. dollar, um, I mean, insert more money into the banking system, the rest of the world's bankers are not very happy with US. And I don't blame them. Geithner, et al, said at the G-20 meeting a couple of weeks ago that the U.S. supports a strong dollar. Once again he's proven that if his lips are moving he's lying. Our government and the Federal Reserve continue to take the U.S. down a lonely path and it's "damn international opinion, full speed backwards".

Last night, following the Fed's decision, Bloomberg Asia analysts discussed the idea that they thought the U.S. was running a giant Ponzi scheme, which echoes Bill Gross' (PIMCO) statement made last week. You can see how the Fed, and the U.S. in turn, is losing credibility and quickly. A country with the world's reserve currency needs to be more responsible to the world community and our government and Fed are clearly showing a complete lack of responsibility to the rest of the world (imho). If this is what Obama meant by "change" and making an effort towards reconciliation towards other countries, he has a funny way of showing it (end of political commentary).

Of course the government has been running one of the biggest Ponzi schemes ever created--the Social Security system. If the U.S. ever tries to push China in the future to let their currency rise and to stop manipulating it, China will have every right to jam those words down our throats and demand that we practice what we preach. We have clearly lost the moral high ground (many would argue we lost it years ago).

Europe's central bank, the ECB, has been talking about removing some of the stimulus as they're worried too much will cause an inflation problem that could get away from them. Of course they've got their own internal problems with very different economies to deal with. Strong exporting countries like Germany are leading the effort to deflate the value of the euro in order to make their exports cheaper to the outside world. Now the Fed has taken a big step towards a continuing to deflate the dollar in an effort to do the same for the U.S. It's a race to the bottom and exactly the same thing that happened in the 1930s. That didn't work out too well for the world back then and I seriously doubt it will work out any better this time. From the man who supposedly understands the Great Depression Bernanke sure is repeating a lot of the same mistakes.

Europe and the U.S. economies are performing roughly the same. But the Fed and ECB have disagreed on how best to proceed. The Bank of England and ECB have parted company with the Fed as they don't believe more QE is the answer. They announced today that they would hold rates the same and that they would not be expanding their own bond purchasing program. Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam, said, "That reflects a deep-seated difference in central bank philosophies. The ECB is happy with moderate growth and moderate inflation; the Fed finds it totally unacceptable."

I think one of the missing pieces here is that the Fed wants the stock market to rally in hopes it will spark positive consumer sentiment, which in turn will spark some buying interest and get the economy moving. It's a dangerous game he's playing and one that I think will fail miserably. But he clearly feels he's running out of options and does not want to go down in history as someone who didn't try everything at his disposal to fight deflation. I expect he'll soon throw a kitchen sink into the middle of the stock market trading floor.

But for the time being Bernanke's plan is working like a charm--the DOW is up about 15% from August and more than 18% from July. Not a bad return if you bought those lows. For the year the DOW is up about 7.5% which is still a very good return, especially on top of the 2009 return. The DOW is now challenging the level seen in September 2008, just before the crash, so back to break even on that time frame.

Back to the September 2008 level. Think about that for a minute. This was just before the Lehman Brothers collapse and bankruptcy. From there the market crashed lower into October/November 2008 based on fears of a poor housing market, overleveraged banks and a slew of bad investments called mortgage-backed securities and the alphabet-soup of derivatives based on those securities. Have we seen any improvement in these areas? I'd say no and in fact they've gotten worse. We now know the banks may soon be forced to take back many of these MBS products that they fraudulently sold as AAA investments. Housing looks ready for another leg down as mortgage resets continue to spike higher (and the foreclosure rate with it). If not for FASB (Financial Accounting Standards Board) rulings, such as allowing the banks to carry mortgage assets at full value instead of market value, the banks' balance sheets would be toast. So have we simply returned to the scene of the crime, ready for another whipping?

I'm going to look at the DOW's weekly chart tonight because it has jumped above its April high and reached a potentially important level. Back in July-September 2008 price was consolidating in a sideways triangle from which the DOW then broke down. The apex of these continuation patterns is often support/resistance when retested. This is the first time the DOW has made it up to this level and therefore a retest and kiss goodbye is a distinct possibility. Any reversal from here that drops below the week's low (Monday's low at 11062) would be a sell signal. So bullish above and bearish below (call it 11K).

Dow Industrials, INDU, Weekly chart

The daily chart shows a little more upside potential, to about 11500, if it's headed for the trend line along the highs since September 21st. It might even do a little throw-over above the line if we're into a blow-off finish. If the market is going to work its way higher this month it will still (typically) need a little pullback before making a final(?) high later this month, shown with the dashed line. In this case the upside target would be near 11725 which is where the 2nd leg up in the a-b-c bounce off the July low would achieve 162% of the 1st leg up. It takes a drop below 11097 to tell us the top is already in place.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,260
- bearish below 11,097

One could argue that the price shelf of support back in August/September 2008 was near 1235 and once that level was broken in September the flood gates opened and flushed the market away. Therefore a return to that level could be the "thank-you-God" opportunity for many. This is the level that caught longs by surprise, they held during the entire decline, swear at themselves for not using a stop and then promise their god that if and when price gets back to that level they'll get out of their position and promise never to trade without stops again (until next time, wink). So, will we see these players get out at or near 1235? Interestingly, the 162% projection for the 2nd leg of its a-b-c bounce off the July low is near 1231. As for today, SPX ran up to its trend line along the highs since September 21st and is therefore vulnerable to a reversal from right here, or at least a pullback before proceeding higher later this month.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1202
- bearish below 1183

The 60-min chart below shows how exact SPX tagged its upper trend line. More than a few traders are watching that line. As noted on the chart, the uptrend line from October 4th and the trend line along the highs since September 21st creates a parallel up-channel, which are typically very good for trading. Therefore it's a setup for at least a pullback and if the pullback is a choppy sideways/down kind of consolidation/pullback then we'll have a good idea that another leg up would be coming, shown with the dashed line. That would create a 5-wave move up from November 1st and could complete the rally (emphasis on "could"). Otherwise a stronger and steeper (impulsive) decline would be a heads up that the market is breaking down. A break below 1183 is needed to confirm the high was made.

S&P 500, SPX, 60-min chart

For NDX I've been watching the 127% extension of the April-July decline as a potential upside target (common reversal Fib extension). This morning's gap up cleared that hurdle and the next Fib extension that I often see as a reversal level is the 138.2% extension. That's at 2196.70 which was missed by about 3 points today. It's also near the top of a parallel up-channel for price action since the October 4th low. Today left a big gap to close but if we get a price consolidation near the high we could see price press higher to its October 2007 high near 2239 (shown with the dashed line). Also near that level is a price projection for two equal legs up from August, near 2242, to finish off a double zigzag wave count (a-b-c-x-a-b-c) for the corrective bounce off the July low. Bears need to see NDX back below 2132, Wednesday's low, in order to get confirmation that the top is in place and you're free to start shorting rallies. Bears need to stay very defensive in the meantime.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2132

The RUT has been playing serious catch-up the past 3 days, especially Tuesday and today. It's the last one to get above its April high and clearly trying to get there fast before the others leave it in their dust, which might be back down. But for now it clearly looks bullish with upside potential to its April high near 746 and possibly 760 if we see just a pullback and then press higher into mid to late November. A break below 705 and its uptrend line from August would tell us it already made its high, otherwise continue to respect for the potential for more rally.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 705

Since the Fed is intent on keeping downward pressure on bond yields, especially the 10-year (since that rate has the most influence on loan rates, including mortgages), it will be important to keep an eye on the TNX (10-year yield) over the next few weeks. The bond market will tell us whether or not the Fed will be successful and based on what the bond market tells us we'll have a better sense of what the stock market could do next. TNX broke its downtrend line from April on October 22nd but appears headed back down to it for a possible retest. The bullish implications of a test would of course thwart the Fed's efforts to keep rates down. If the Fed is failing then the stock market would eventually take notice. A drop back below 2.33%, the October 8th low, would say the Fed is being successful with their QE program.

10-year Yield, TNX, Daily chart

In Tuesday's wrap I has looked at HYG the High-Yield Corporate ETF, and suggested it was setting up for a move down after bouncing back up to its broken uptrend line from May. Not so fast is what the market said yesterday and today. Especially after today's strong rally it spiked well above resistance near 91. Plus a reader emailed me (thanks Don) to let me know that HYG kicks out a 60-cent dividend on the 1st of every month and that's how much it had dropped on Monday (you can see how important it is to know such things if you're trading ETFs).

Since this is an important sector to watch (an indication of willingness to take on higher risk) I wanted to see why it stopped where it did today. The weekly chart below shows it rallied up to the level where it broke down (seriously broke down) in September 2008. So another symbol back to the scene of the crime. Now we'll see how many decide to take profits and get out while the getting is good.

High-Yield Corporate Bond ETF, HYG, Weekly chart

The real beneficiaries of the Fed's QE program will be the banks (of course). They can borrow from the Fed for virtually free and then use the money to buy the Treasuries and get an immediate no-brainer return on the interest rate spread. And for this their managers get paid huge bonuses for being so brilliant. So the banks have enjoyed a rally the past two days with the broader market, they continue to significantly lag in the rally off the August lows. The BIX, the S&P bank index, has done marginally better than the BKX, the KBW bank index, and today exceeded the September highs near 132.50 (BKX has not been able to do the same yet).

Not much higher for BIX is the price projection at 135.22 where the bounce off the October low would have two equal legs up. The multitude of 3-wave moves in this index tells us that level could be tough. Slightly higher is would close its gap from August 10th, at 135.86. And then at 137.17 is where the bounce off the July low would have two equal legs up. So there's a little more upside potential but the risk is for the banks to start selling off hard (dark red line). The other possibility, shown with the dashed line, is for the market to continue higher into the end of the month (Thanksgiving day finish?) and then start a serious selloff. The bottom line is that between price projections, trend lines and the 200-dma, all in a range of 135-140, it's going to be very difficult to climb through all that, especially with an overbought market.

Banking index, BIX, Daily chart

The TRAN almost made it up to its trend line along the highs since early September, currently near 4970. As with the other indexes and sectors, this could be ending the rally from August or we could get a pullback and then another new high later this month. A break below 4800 is needed to confirm the top is in.

Transportation Index, TRAN, Daily chart

Thanks to the Fed the dollar took another hit today and dropped to a new low for its decline from June. It's now poking below the uptrend line from 2008 through the November 2009 low, currently near 76.27, with today's close at 76.02. Since the June 8th closing high the dollar is down -14%. Since the June 8th closing high of 1062 on SPX it's up +15%. That means foreign holders of U.S. stock have gained a whopping +1%, thanks to the depreciation in the dollar. Gold is up a little less than +12% over the same period so foreign holders of gold have lost money even after what looks like a strong rally in gold. The bottom line is foreign holders of U.S. securities, be they bonds, stocks or commodity ETFs, will soon tire of the Fed's refusal to accommodate anyone other than their own interests and start selling U.S. assets. With such an overbought market--in bonds, stocks and commodities--it wouldn't take much foreign selling to get the ball rolling down hill.

At this point it looks like the dollar could drop down to a trend line along the lows since August, currently near 75. I'm not sure if yesterday's low on the chart is a bad tick (happened right after the FOMC announcement) but at 75.235 it could be where the dollar is headed. Sometimes these "bad" ticks have a way of predicting where price is heading. In any case, I expect to see the new low met with bullish divergence and set up a strong rally leg, which will catch about 97% of the traders leaning the wrong way (that's the bearish sentiment on the dollar right now).

U.S. Dollar contract, DX, Daily chart

With the dollar dropping we've seen a concurrent rally in the euro as investors sell the dollar and buy the euro, which makes it more difficult for the Europeans to compete with their international trading partners. The weaker dollar/rising euro, as well as the lower Treasury rates, is also forcing investors to seek commodities as investments, which is forcing commodity prices higher and will add to inflation pressures. Today we saw a big spike across the commodities, including the metals (precious as well as copper), soft commodities (grains, sugar, coffee, etc.) and oil. Certainly I would expect the decline in the dollar and rise in commodity prices to be at least a little disconcerting to the Fed. If not then they really do have their head in the sand (I'm trying to keep it clean, smile).

The commodity related equity index, CRX, took a big jump up today and smacked its head at the top of a parallel up-channel from August. If the dollar finds its footing and leaves just a throw-under below its uptrend line from 2008 and starts rallying from here we could see CRX tuck tail and dive lower from here. Otherwise it remains bullish as long it stays inside its up-channel.

Commodity-related Equity index, CRX, Daily chart

Another weekly chart of a commodity, one that I showed on Tuesday, is copper. This is a reflection of both commodity prices in general (especially with a weak dollar) and global economic conditions/expectations. It has been pushing up underneath its broken uptrend line from early 2009 and today it pushed right back up to it again. Unless it can climb back above this trend line, it's a bearish setup, especially with the bearish divergence at the new highs. But it needs to break below last week's low (370.35) to confirm it.

Copper continuous contract, HG, Weekly chart

Gold made a new high today and in so doing it ruined a perfectly good EW setup for an impulsive decline. I hate it when that happens. But the impulsive leg down from the October high should still mean the trend has changed to the downside. Today's new high, which could press a little higher, is part of a more complex corrective pattern that will unfold to the downside. It means the downward projection will be more difficult to determine. But especially with the bearish divergence at the new high, I'd be looking for a selloff rather than a continuation of the rally.

Gold continuous contract, GC, Daily chart

Oil came very close to testing the May high at 87.15 (today's high was 86.83). The new high above early October's is showing bearish divergence so far and therefore the risk for bulls is a double-top failure of the rally (dashed line). But we could see just a pullback and then another press higher into later this month (like the stock market) in which case a 113% Fib extension of the May decline, at 90.13, could be the upside target. This is the first Fib extension to watch for a possible double-top pattern if it makes it through the previous high. Not shown on the chart is the 50% retracement of the 2008 decline which is at 90.23.

Oil continuous contract, CL, Daily chart

Today's economic reports were pretty much ignored. The big gap up had everyone feeling bullish no matter what the reports said. In previous weeks the market rallied on the "less bad" news about unemployment claims. Today's number showed an unexpected jump back up -- +20K to 457K vs. expectations for 442K. Ach, don't bother me with deteriorating fundamentals, I've got a rally to attend!

The other reports, Productivity and Labor Costs showed some improvement but the positive productivity number (+1.9%) was merely a reversal of the previous month's -1.8%. If you look at the chart of productivity and labor costs since 1994 you can see the trend for the past few quarters is not good. Labor costs have bumped up this year but still in negative territory (part of deflation). Productivity has taken a sharp turn back down once the government stimulus money ran out.

Productivity and Labor Costs, chart courtesy briefing.com

Friday's reports include the very important nonfarm payrolls number, unemployment rate (which no one believes), earnings, work week, home sales and consumer credit. It's a full docket and could be market moving, especially before the bell.

Economic reports, summary and Key Trading Levels

If today's rally was mostly short covering, which I have no doubt considering the number of people piled up on the sell-the-news side of the fence, and considering the market closed at its high, there's a good possibility we'll see a reversal of at least some of today's rally. This makes the pre-market economic reports potentially explosive. However, if there's any hint of trouble for the rally we might see "someone" step in to help it before the market opens. That's pure speculation on my part of course. Just be careful of any early volatility one way or the other.

When the market has had a strong up day, closing near or at its highs, the following day has tended to be weak. I've mentioned this many times before -- it's like little capitulation days and then there's nothing to follow through the next day. The shorts had to get out and usually end-of-day short covering by the last to throw in the towel leaves no one to buy the next day. So that's the setup heading into Friday.

The Fed and their minions would love nothing better than to see the week close out near today's highs. That way they avoid the embarrassment of a failure of the market to support the Fed. So how active some will be to support the market tomorrow can't be known but consider the possibility if you're thinking of playing the short side.

It being a Friday, there's also a good chance we'll see the market simply digest this week's price action. I think both sides are going to be a little leery about what's next. The bulls know this market has gone too far too fast even if they're enjoying the ride. Fear of losing profits may become too strong for some. Bears know they've been steam-rolled multiple times by a market that constantly gives off sell signals and setups and yet refuses to sell off. They're going to be on the sidelines licking their wounds and letting the market prove it's done before they enter the fray. The combination could result in a very quiet market tomorrow.

So I see either a selloff because there are simply no more buyers and the early economic reports start the snowball or we'll see a consolidation/choppy pullback in preparation for pushing higher next week. Don't be anxious to short this market -- keep following it higher with the key levels. It's an irrational and exuberant market right now, one that's very dangerous for both sides but especially the bears.

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

Key Levels for SPX:
- cautiously bullish above 1202
- bearish below 1183

Key Levels for DOW:
- cautiously bullish above 11,260
- bearish below 11,097

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2132

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 705

Keene H. Little, CMT