Market Stats

Cisco Systems (CSCO) disappointed the market Wednesday evening and today with its lackluster report describing a less than spectacular outlook for 2011. Oops, wrong thing to say--back of the woodshed for you. It was beat severely about the head and shoulders and gave up 3.97 (-16.2%), its worst day in 16 years (1994). Through the entire bear market CSCO has not had a worse day. That's saying something and that something is that we're still in a bear market. The only thing amazing to me is that the rest of the market did not suffer a worse fate and I think a low-volume day helped those who wanted to support the market. We already know that's a stated intent by the Fed and we know they have lots of money to do it.

But we also know there are a lot of traders (the majority) who will continue to look at dips as golden buying opportunities. After all, how many big gaps to the downside have we seen completely reversed the very same day? Bullish traders were hoping for a repeat performance today and while the bounce was solid off the gap down, I think it could be telling that it failed to close the gap, never mind head higher. There are also a lot of traders, probably the majority, who believe the market will not drop much because the Fed is intent on holding it up.

The Fed has done some painstaking work over the past couple of months (actually couple of years) to build a foundation under the financial markets. For the stock market that would be the Bernanke put--the foundation upon which the rally has been built--and no matter what bad things happen, our fearless leader will not let the market sink. And now further QE is here to save the day.

The market is so convinced that a stock market rally can now be expected for at least another 6 months that I worry about how many people will get sucked in at what I perceive to be a possible major top in the market. There are still many analysts saying now is a good time to buy because valuations are still relatively cheap. I like Richard Russell's comment about this: "... some analysts claim that stocks are a bargain. What planet are they on? Based on the original writing of Charles H. Dow, values trump all other considerations, including even the price action. The public is loading up on stocks at a time when stocks are providing almost no dividend yield. Dow believed that when dividend yields were below 3.5% the market was on dangerous grounds." 'Nuf said.

The only guarantee in the market is that the majority will be disappointed. That's why we pay attention to sentiment indicators and use them in a contrarian way. The current bullish sentiment can always go higher but it's already in nose-bleed territory and to bet on it going higher is to bet against the odds. It's not the way I prefer to play and therefore you may call me all the names you want (perma bear and pessimist are the usual ones, and some unprintable ones) and it won't hurt my feelings. I simply call it as I see it, right or wrong (which is never known until in hindsight). Always confident in my opinion and often wrong (as Bill Fleckenstein would often say). I'll simply point out what I see and hopefully you can use it as part of your own analysis and make your own financial decisions.

The Fed of course wants the stock market to rally--they no longer even attempt to hide that fact (as Greenspan did). They want the bond market to continue to rally so that it keeps yields down. By being a massive buyer of Treasuries they hope to keep bond prices high. They say their policy decisions are not meant to cause the value of the dollar to go down but that it is instead a consequence of their policies. I'm not sure if he's telling the truth or just assumes we're all naive. Foreign leaders sure don't believe it and they're attacking Bernanke and Obama with a vengeance (deservedly so when you consider we've attacked China for years about currency manipulation and now Germany and others for exporting too much stuff to us).

Foreign Leader Reactions to Fed's QE2

So far the Fed is listening only to itself (when the Fed lives in a vacuum can it hear itself talk?) but the growing chorus of dissent may soon have an effect. There are a couple of Fed governors who are already uncomfortable with QE. In fact it might not be long before QE is killed. Why? Because starting in 2011, there will be three new voting Federal Reserve Bank presidents who vocally oppose any more easing initiatives. Charles Plosser of the Philly Fed and Richard Fisher of the Dallas Fed oppose QE and Narayana Kocherlakota of the Minneapolis Fed is skeptical it will work. They replace the three "doves" in the form of Rosengren from Boston, Pianalto from Cleveland and Bullard from St. Louis. "Mutiny at the Fed" coming to a book store near you.

When we review the market's action over the past week since the QE2 announcement, there are already some cracks appearing in the Fed's foundation. We're getting some indications that the Fed's policies may not have the intended effect. It's still very early and it remains possible for the stock market to push a little higher but I'm now thinking the stock market has topped out. Commodities, including the metals, are showing some potentially important bearish key reversal patterns after Tuesday's red candles and the subsequent corrective bounce. The dollar looks to be rallying off support. The bond market is selling off instead of rallying. Real estate, the big nut that Bernanke is trying to crack, could be in trouble. The DJ REIT index (DJR) gave us a huge sell signal out of a rising wedge pattern from July with Tuesday's nearly -4% decline. Everything at the moment is going against the Fed. Hmm, another one of those infamous conundrums.

DJ REIT index, DJR, Daily chart

DJR finished its rising wedge from July with a throw-over above the top of it last Friday, a classic finish. Tuesday's sharp decline confirmed the sell signal out of this pattern. So far it's only been able to retest the broken uptrend line and as long as that line continues to hold as resistance we should see the decline continue. There are a couple of real estate related ETFs, including SRS, an inverse ETF. Keep in mind that a rising wedge tends to be completely retraced in a much faster time than it took to build it. So back below the July low before the end of the year is the potential move in front of us. For the initial part of the decline there will be many hopeful traders buying the dips. It's what will fuel the expected strong decline.

Hope is a wonderful thing but not in the financial markets. The stock market rally since August has been nothing but a hope-filled rally, hope that the Fed really can save the day. I remain skeptical. But we need to let price lead the way and so far, in looking at the daily charts, the bulls could be forgiven for holding onto hope. NDX put a dent in that hope today, as I'll review later, but for the most part the indexes could still produce new highs. A continuation lower on Friday would be a confirmed break of a very important uptrend line.

Starting off with the SPX weekly chart, the dead stop last week near the 62% retracement of the 2007-2009 decline continues to hold. The clear danger here is for a double top against the April high. But so far the weekly chart is not showing us anything bearish. The strong uptrend from August is clearly intact and therefore there remains a good possibility we'll see just a pullback and then press higher into the end of the year (dashed line means it's the less probable path in my opinion but possible). If we start seeing some strong impulsive price action to the downside it would be a warning that a significant high is in place. Below 1129 is needed by the bears to confirm a lasting top is in place.

S&P 500, SPX, Weekly chart

The daily chart also shows the bulls to be in good shape still. The uptrend line from August through the November 1st low held SPX up today so before we start even a small pullback to correct the leg up from August it remains possible we'll see another push higher to tag the 1231 area that I thought we'd reach last week. A drop below 1196 would tell us we're into at least a correction of the rally from August, if not something more bearish.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1220
- bearish below 1196

There are a few projections to the 1232-1234 area that continue to beckon SPX like the siren song. Bears are lashing themselves to the mast so as not to be lured in but the bulls seem to be mesmerized. The depth of the pullback so far is what has me leaning to the downside from here, hence the bold red path to the downside vs. the light dashed red line to a new high. But if we do get the new high I continue to think it would be an outstanding short play setup there. If we instead get a breakdown on Friday and SPX drops through 1195 it would be confirmation that the leg up from August has finished. The multiple gaps below would then become downside targets.

S&P 500, SPX, 120-min chart

Bullishly the DOW is holding in a parallel up-channel for price action since October 4th. Of course it's also still in the larger up-channel from July. It remains possible for another leg up to the top of the smaller up-channel where it intersects a line parallel to the uptrend line from July that is attached to the June high, near 11550. Currently I think it's more probable for the decline to continue, rather than get a new high, and therefore that's what I'm showing on the chart. But the DOW needs to get below 11219 to confirm we've seen the high and that hasn't happened yet.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,260
- bearish below 11,219

This morning NDX broke below its uptrend line from October 4th, which should be telling us that that rally leg has finished. I'll continue to show the possibility, with the light red dashed line, for another leg up to test the October 2007 high but I consider that the less probable path at this point. The alignment of Fibs near the high fits well for a high of significance. The 138% extension of the April-July decline is a typical reversal level. I like the 127% extension even better but when that extension doesn't hold I often see the 138% hold. Also, for the move up from July, the 2nd leg up (from August) is double the 1st leg up, near 2185, so there's symmetry there. The top will be confirmed in place with a decline below 2132.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2200
- bearish below 2132

Moving in a little closer, the NDX 120-min chart below shows more symmetry in the move up from the October 4th low with two equal legs up near 2196. From this shorter-term perspective, this morning's break below 2155 says there's a good chance we've seen the high. The break of the uptrend line from October 4th is telling us the same thing. This afternoon NDX rallied back up to the broken uptrend line for a little smooch. If it drops back down tomorrow then it will be a bearish kiss goodbye, which is what I'm showing. If the bad news bulls instead show up and drive NDX back above the broken uptrend line then it would clearly be bullish for another run higher, in which case the October 2007 high near 2240 becomes the target.

Nasdaq-100, NDX, 120-min chart

The small caps have remained bullish--leading the way higher and holding up under bearish pressure. That keeps alive the potential for a push up to resistance at the April high near 746 for the RUT. But that would also be a very good setup for the bears to take a big bite out of the small caps. A decline from here below 714 would tell us the top is already in place.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 714

Since the Fed made QE2 official last week the bond market has been selling off, just the opposite of what the Fed is hoping to achieve. Some are speculating that foreigners, who are none too pleased with Bernanke or Obama for significantly increasing the quantity of U.S. dollars, will retaliate with a decrease in their purchases of Treasuries. If the rest of the world turns its collective back against the U.S. by not buying Treasuries it will remove the bid under Treasury prices that the Fed is hoping to achieve. That in turn would cause our rates to go up and keep money attracted to our bonds instead of allowing dollars to flood other countries in pursuit of higher rates It's that law of unintended consequences again and shows how the global market is the great equalizer and will counter the Fed's actions.

As you can see on the chart below, the past week's rally in the 10-year yield broke above the October 27th high at 2.72%. This confirms the low on November 4th should be the end of the pullback correction to the leg up from October 8th (with almost a test of the broken downtrend line from April). TNX closed back below 2.72 yesterday but the rally in yields should continue. The bond market was closed today, except for futures which sold off again today so yields could gap up on Friday. With the break of an inverse H&S neckline the upside projection is now to about 3.12%, which ties in closely to the previous low and high in May and July, resp., and would be a tag of its 200-dma.

10-year Yield, TNX, Daily chart

A rate of 3.1% would be close to a +20% increase above the 2.6% rate just prior to the Fed's announcement. That would be the bond market telling the Fed they're on the wrong course and a reminder to the Fed that it's the bond market that governs price, not the Fed. And that would of course have a significant effect on traders who believe in the stock market rally because they trust the Fed is in control. They're not. Social mood is in control of the market and that's of course what the Fed has really been trying to manipulate with its discussion of trying to support the stock market, um I mean the bond market.

Banks received a big shot in the arm last week, thanks to the QE program. I know there's an argument about whether or not the banks benefit from the Fed's efforts to stimulate the economy. I'm on the side of yes, the banks do greatly benefit from the money. The Fed wants to buy Treasuries. What is the Fed? It's a consortium of private banks, the big money centers I love to bash. These banks borrow virtually all the money they want at zero percent interest, buy Treasuries with the money and instantly earn the credit spread. And for this genius approach to investing, the banks' traders and managers earn millions in bonuses, thanks to the taxpayers. These banks had either no losing trading days or only a couple in the past year. That's simply unheard of and speaks volumes for what they're doing, and with whose money they're doing it. It's the reason I say the QE program is really just another bank bailout program with money that the Fed is not constitutionally allowed to use. Congress has simply abdicated its responsibility.

And speaking of trading desks, some of the money that these banks are borrowing is given to their proprietary trading desks for trading in the stock and commodity markets. Again, no losing trading days here either, and we're talking tens of millions of dollars per day. Free money to leverage up and make more money. The Fed has already made it clear it wants to see the stock market higher and it's using these banks to help do that. So are the banks beneficiaries of the Fed's QE program? I argue that they clearly are. I know my opinion, which is all it is, is different from many others including Jim and other writers on the OIN staff. But it's my day to write and I'm giving you my opinion (wink). Seriously though, opinions are just that. Like noses (I'm keeping it clean), we all have one. Through your own reading and research, be sure to form your own, especially when it comes to the market and how you trade.

And the banks may not be finished enjoying the fruits of the Fed's labor (money). The pattern for the banks looks constructive for another leg up to finish a 5-wave move up from mid October (which would clearly support another leg up for the broader market as well). If Wednesday's low holds, the 5th wave would equal the 1st wave at 143.94 for the BIX so that would be the upside target for the top of its 3-wave bounce off the August low. If it declines further from here instead it will look more bearish. It would not be confirmed bearish until a break below the October 25th high at 129.98.

Banking index, BIX, Daily chart

The Transports are threatening to break down. The TRAN has broken its uptrend line from August and bounced back up to it today. Any further drop tomorrow would leave another bearish kiss goodbye. I'm showing a new low and then bounce back up next week but the risk is for a drop to build up more speed to the downside right away. If the bulls can rally the market on Friday and into next week I see upside potential to 5065.

Transportation Index, TRAN, Daily chart

The bounce off last week's low for the dollar (right after the Fed's QE2 announcement) has remained in a tight parallel up-channel when viewed on a 60-min chart so the rally seems real (vs. just another correction to the decline). The real test for the dollar bulls, of which there are very few, will be the downtrend line from June, near 79.35. I would bet there are more than a few who have been trailing their stop down on their dollar shorts. Just before the downtrend line is the 50-dma, currently near 79.01. I would expect a pullback from that resistance if reached and that should coincide with a bounce for equities and the metals. But if the 50-dma and downtrend line are broken look for a fast rally as the dollar carry trade gets unwound. That is one crowded trade.

U.S. Dollar contract, DX, Daily chart

On Tuesday gold briefly spiked above the trendline across the highs since June and then finished below Monday's low, creating a throw-over finish above its rising wedge pattern and closing back inside. That was a sell signal from that pattern. It also created a key reversal day with the bearish engulfing candlestick and this now puts gold bulls on the defensive. If they can drive gold back above Tuesday's 1424.30 high they'll be able to declare victory. But until that happens I think we're about to see a significant pullback in gold, especially if the dollar continues to rise. The short-dollar-long-everything-else trade could start to unwind very quickly.

Gold continuous contract, GC, Daily chart

Silver has an even higher spike up above its up-channel from August (silver tends to be more volatile like this) but then closed back inside the channel. It has created the same sell signal as gold. The bounce off Tuesday's low looks corrective and a test of the top of the channel near 28 would be another good shorting opportunity. The stop needs to be placed above Monday's high at 29.34 so manage your risk appropriately. If you haven't traded silver before I'd start with paper trading it to get a feel for how it moves. It's a wild pony.

Silver continuous contract, SI, Daily chart

Crude looks to be putting the finishing touches on a 5-wave move up from mid October, which in turn should complete the bounce pattern off the May low. A good upside target for now is near 90 with higher potential to about 93 (although I do not think this higher level is in play). From a form standpoint crude has met its pattern objectives and therefore the rally can be considered complete at this point. Therefore a drop below 85.48 would tell us the top is in place.

Oil continuous contract, CL, Daily chart

Economic reports, summary and Key Trading Levels

There are no significant economic reports today and the only one tomorrow morning, at 9:55 AM, will be the Michigan Sentiment report. Expectations are for the number to be 69, up from 67.7 in October.

Summarizing tonight's charts, there's a good possibility that we've seen the high for the indexes. NDX is potentially the most bearish at this point while the RUT is the most bullish. That's an odd mix and that alone should tell both sides to be cautious. The blue chips are in the middle. If the market continues rallying on Friday it would increase the probability that we'll see a new high into next week (opex which is typically bullish). But I'm seeing just enough evidence that has me leaning towards more downside right away. The short-term pattern supports the idea that we'll see a gap down Friday morning (or maybe after a disappointing Michigan Sentiment report?) and then a hard selloff. If that were to happen it would be convincing evidence that we've seen the high for the leg up from August. Then it would be time to start figuring out if it's going to be just a pullback before heading higher into year end or if instead we're going to get a strong selloff into year end.

Europe's sovereign debt woes are starting to rear their ugly heads again. Actually the problem never went away but instead just disappeared off the front page headlines. I'm thinking a bad surprise, that causes a big gap down/selloff, will come from overseas. Our market is so hyped up with bullishness right now that it wouldn't take much to prick that bubble. So be careful of that possibility if you're holding long in hopes of seeing higher highs.

As you can tell from my charts I love Fibonacci and use the retracements, projections extensions all the time. I also watch for time relationships and we have an interesting one occurring at this time. There were 1259 trading days from the low in October 2002 to the high in October 2007 and then 774 trading days to the November 5, 2010 high. That gives us a nice Fib relationship that's very close to the Golden Mean (.618), coming in at .615 (774/1259). A perfect 61.8% ratio gives us 11/11/10, today. If we're seeing a high for the market here you've got to admire the Fib timing of it.

So far I'm thinking we're setting up for a post-election/QE correction of the rally. There had been a strong consensus that there will a sell-the-news reaction but we got the opposite. Now there's a high expectation that we'll get just a correction of the rally and then a rally higher into year end. The normally bearish September-October period fooled the majority who went defensive in August expecting a bad period ahead. Now we're entering the typically bullish November-December period with the majority looking for dips to buy. Could the market once again be setting up to fool the majority?

In the last 70 years we've seen a negative November-December period only 20% of the time. This September finished the strongest of any in those 70 years. Considering how overbought the market is and how bullish the sentiment is, I'm getting the feeling we're about to see the market once again be the Disappointer-in-Chief and sell off into year end. The contrariness of the market may mean any attempt to rally from pullbacks will fail and that a buy-the-dip strategy will not work this time. Food for thought as we head for the food holiday period.

Good luck and I'll be back with you next Wednesday (Jim will be taking Thursdays and I'll be switching to Wednesday, except for Thanksgiving week when Todd and I will switch nights).

Key Levels for SPX:
- cautiously bullish above 1220
- bearish below 1196

Key Levels for DOW:
- cautiously bullish above 11,260
- bearish below 11,219

Key Levels for NDX:
- cautiously bullish above 2200
- bearish below 2132

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 714

Keene H. Little, CMT