Market Stats

No surprise, today's trading volume was anemic and price action was likewise. If your enjoy watching grass grow you would have enjoyed today's market (in)action. I would expect tomorrow to be a day that will require toothpicks propped under eyelids. But the bulls are keeping the market up and ready for next week which is when the Santa Claus rally is supposed to arrive.

It's of course hard to get a true sense of market direction during these pre-holiday periods but the bottom line is the market remains bullish as it chugs marginally higher each day. The bears have gone into hibernation for the holidays and we'll have to see if they're brave enough to stick their noses out of their caves in January.

Economic reports didn't even move the market. The 8:30 reports cause a minor blip in the futures and then started the day at the flat line. It didn't get any more exciting after that. So with little to talk about for the day I'll just jump right into tonight's charts and see if there are any clues as to how much further we can expect the bulls to rally this market. One index making a very bullish statement is the banking index and I'll review its chart later.

With a very bullish market the one index that has shown the most bullishness is the small cap index (RUT). As Jim has mentioned many times, this index is a good proxy for market bullishness, especially as we run into the most bullish time of year for small caps. It has clearly outperformed the other indexes since the market lows in July. For reference, since those lows the DOW is up about +20%, SPX +24%, NDX +31% and the RUT is up a whopping +33%. Those numbers would be impressive over a 4-year time frame never mind 4 months. At any rate, I want to review a top down approach to the RUT tonight so I'll start off with its weekly chart.

Scrunching the weekly chart to show price action since the October 2007 high shows the bullish move above the downtrend line from 2007 through the April 2010 high in early November and then 5 straight up weeks from there. There is upside potential to at least the 800 area where it could run into trouble from previous price-level resistance in 2007 and 2008. The Fib projection at 789 that's shown on the chart is the 127% extension of the April-July decline. I like to watch this Fib extension because it's very common to see reversals occur at this Fib. It's a common Fib for the head of a H&S pattern (161.8% being the other common Fib extension). On a weekly closing basis it will be important to see how the RUT does against this 789 level.

Russell-2000, RUT, Weekly chart

I'm projecting a move down from the 790-800 resistance area but obviously that's just a guess right now. The bulls have done nothing wrong and price action remains very strong. Momentum and market breadth have been weakening for some time but clearly that can't be used for market timing. The trend is your friend until the bend at the end and so far there's been no bend. On a weekly basis it takes a drop below the uptrend line from March 2009, currently near the 200-week MA at 657, to tell us the bears mean business.

Zooming in closer to the rally from July, which is the c-wave of an A-B-C bounce off the March 2009 low, the daily chart below shows a 5-wave count for the rally, with the 5th wave as the move up from November. I've added a bullish green count so I can start tracking what might be happening if it rallies above 800 (meaning we'll get a much larger c-wave). But right now we've got some Fib correlation in the 786-794 area to watch (today's high was 793.28). These Fib projections are based off the wave structure for the rally from November. The fact that the different projections correlate in a tight range tells me there's market symmetry to the move up and that makes it more likely that this zone will be resistance.

Russell-2000, RUT, Daily chart

Make note that the 789 level on the weekly chart is also in the middle of the 786-794 Fib zone on the daily chart, adding one more reason why this Fibonacci zone is likely to be important. Whether it leads to a pullback, and how large it will be if it does, will only be known in hindsight. It's merely a warning right now for a possible reversal. The wave count, as labeled, says the pullback could be more significant than just a correction to the rally from November. Today finished as a star doji in the middle of this resistance zone so a down day on Thursday, especially with a break below the uptrend line from November 30th, near 787, would be the first indication of a "bend at the end". A break below the December 16th low near 767 would tell us that at least a larger pullback has begun. Stick with the bulls until proven wrong but stay aware of a possible reversal from here.

Key Levels for RUT:
- bullish above 800
- bearish below 767 and longer-term bearish below 701

The 120-min chart below zooms in closer to the 5th wave of the rally from July, which is the leg up from November 16th. This 5th wave also needs to be a 5-wave move and as labeled on the chart we're into the final 5th of the 5th wave. It achieved equality with the 1st wave at 792.92. So we've got another price projection inside the 786-794 zone, showing the importance of this area on a weekly, daily and intraday basis. Again, it does not mean a reversal will happen but if the rally is finishing, this is where it will finish. The small break today of the uptrend line from December 16th, followed by failed retest on a bounce this afternoon is the first heads up for possible trouble tomorrow.

Russell-2000, RUT, 120-min chart

The DOW continues to inch up along the top of a parallel up-channel from 2009 and is now very close to the 127% extension of the April-July decline, near 11594. Today's high was 11567. Only slightly higher, near 11613, is where the 5th wave of the rally from July would equal 62% of the 1st wave. So this makes the 11600 area (besides being the century mark) potentially strong resistance. This is only potential resistance for the same reason mentioned above. The trend is still up and that's the direction of least resistance. A move above 11615 would be bullish with upside potential to the price-level resistance near 11900 and then to 12035 where the 5th wave would equal the 1st wave. As projected with the green dashed line, a move up to that high before mid January could coincide with some cyclical turn windows. The bulls are not in trouble until the DOW breaks below 11330.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 11,615
- bearish below 11,330 and longer-term bearish below 10,900 (the November low as well as the 200-week MA)

For the RUT I mentioned the 127% extension as a common Fib for the head of a H&S pattern and that the 161.8% extension is the other common Fib. For SPX the 161.8% extension of the April-July decline is at 1260.50 and today's high was 1259.39. So it bears watching here for a possible reversal but the bulls aren't in trouble until SPX drops below 1232. In the meantime, with the uptrend in good shape, the upside potential above 1260 is to 1292.47 where the 5th wave of the rally from July would equal the 1st wave. That projection crosses the trend line along the highs from August in early January, which would match up with a cycle-date turn window.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1260
- bearish below 1232 and longer-term bearish below 1173

The 5th wave of the rally from July is shown in more detail on the 120-min chart below. It too needs to be a 5-wave move and as I've got it labeled on the chart, we should be into the final 5th wave. As with all EW patterns it can morph into something different but for now it gives me something to watch for when looking for a possible top and reversal (especially with a lot of Fibs on the charts lining up right now). The 5th wave of the rally from November 29th has now achieved 161.8% of the 1st wave at 1259.01 (the three most common Fib relationships between these two waves are 61.8%, 100% and 161.8%). Was today's reversal off the 1259-1260 area significant? We'll only know the answer to that question in hindsight. But for now that's the potential. A drop below 1244 would be a bearish heads up and then confirmation of a high would be a drop below 1232. In the meantime, the trend (up) is your friend. Just be careful about the bend at the end.

S&P 500, SPX, 120-min chart

NDX pushed marginally higher again today but seemed to struggle to stay positive (a final squirt higher before the close kept it in the green). It's nuzzling in underneath its October 2007 high at 2239.23 (today's high was 2238.92) hoping the bear won't notice and swat it away. It has also pushed marginally above the trend line across the highs from April, currently near 2232. It pushed above it yesterday so if it can continue to hold above it and break above 2240 we could see the bulls get braver and the shorts run for deeper cover.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2240
- bearish below 2165 and longer-term bearish below 2030

For the bulls I just wish we saw stronger strength in the oscillators. Up against resistance like it is, those negative divergences are downright bearish. But price has done nothing wrong yet and it takes a drop below 2200 to indicate at least a short-term high is in place. A drop below the November 24th high, near 2165, would be more serious trouble for the bulls and below 2030 would confirm we'll likely see a move at least down to its uptrend line from March 2009, currently down near 1900. Stick with the uptrend but realize it's looking very tired here. The bend could be right around the corner.

Looking at the bigger market index, the NSYE, it too is facing potential Fib resistance in the 7905-8016 area (today's high was near 7935). Besides the 127% and 161.8% Fib extensions (for the head of a H&S pattern) there is a 113% extension that's common in a double-top (or double-bottom) pattern. The three most common price levels in a double top are the 88.6% and 100% retracements of the previous decline and the 113% extension. The 113% extension of the April-July decline for the NYSE is at 7924. The 5th wave of the rally from July is equal to 62% of the 1st wave at 7905 (it would achieve equality at 8226 and a move to that level is depicted with the dashed red line). The big daddy of the retracements is the 62% retracement of the 2007-2009 decline, at 8016.70. So there's clearly some upside potential for the current rally, especially if it does not turn back down tomorrow. The bulls are not in trouble until the NYSE breaks below 7780.

NYSE Composite index, NYA, Daily chart

The banking indexes had presented a very nice reversal setup last week and even started to follow through with a decline into last Thursday's low. Well, it got blown out of the water with a strong rally the past two days. That's why they're called setups and not guarantees. With the setup we had I'll take the short every time. Stops are for when they don't work and this one did not. Now it's time to see where the banks could be heading next.

BKX has now blasted through the 50-51 price-level resistance band and firmly broken above its downtrend line from September 2008. A real test would be a pullback to that trend line and then a new high from there so watch for that possibility over the next week or two. In the meantime, the Fib to watch is the 62% retracement of the April-July decline at 52.66 (which by the way, note how much weaker the banks are as compared to the broader market). Today's high was at 52.54. If the rally continues into the end of the year and into January, I see upside potential to price-level resistance near 56 and then the April high near 59. A drop back below last Thursday's low at 49.23 would be bearish and it would leave a head-fake break of the downtrend line. So it's bullish until that happens.

Banking index, BIX, Daily chart

Jim mentioned Meredith Whitney in the newsletter last night. Whether you agree with her or not, or wonder what her true motives are, she was right about her call on the banks in 2007 and is now making some waves with her predictions about the municipal bond funds. She was interviewed on "60 Minutes" if you care to find it online, and she was in an article on moneynews.com today, which you can read here: Muni Defaults, Social Unrest. When we look at MUB, the muni bond ETF, it's not pretty:

S&P National Municipal Bond ETF, MUB, Daily chart

MUB may be getting ready for a bounce back up to retrace at least a portion of the decline from September but I think we can all agree the breakdown is significant and likely a signal that the end of its rally from October 2008 has completed. As sharp as the drop looks on the daily chart, it's currently sitting near the 38% retracement of the 2008-2010 rally. Bulls will certainly view this as a buying opportunity but the sharpness of the decline should be worrisome. Throw in Meredith Whitney's evaluation and it could get a lot scarier. Take a good hard look at your portfolio and see what your exposure is to muni funds. A lot of people like them because of the tax-free status.

One of the biggest problems the states and municipalities are having right now are their pension funds. There are many areas to cut spending in an attempt to stay within their budgets following the deep cuts in revenue but the pension plans are in so much trouble as it is that it's virtually impossible to cut spending in this area.

California is a good example of a state in a lot of financial trouble, but is by no means alone. A Stanford study determined that California's pension plan is underfunded by about $500B. Before Schwarzenegger leaves office the recommendation is that he inject $360B in the pension fund right now in order to give California an 80% chance of meeting 80% of its obligations over the next 16 years. And this still includes a somewhat rosy expectation of investment returns (8%) over that period of time, something that might not happen if the economy remains weak in an extended bear market.

But California has about a $20B budget gap without even considering additional funding for their public employee's pension plan. That makes it virtually impossible to accomplish and yet it's an obligation placed on the state. As we've seen with a number of companies, the airlines and GM in recent years, the way out of this pickle is to declare bankruptcy, wipe the slate clean and start all over again. Wiping the slate clean means wiping bond holders clean as well (just ask GM's bond holders how well they fared).

California is of course not alone in this. Most states are underfunded (just like our national social security and especially Medicare plans). The estimate for just the states' pension plans is that they're about $2T underfunded. This is simply a monumental problem and states may soon find that they only have enough in their budgets to pay out retirement benefits, which of course is unacceptable to the public. Hence the risk of bankruptcy as one method to rewrite the pension plan payouts. The public is not in the mood to have their taxes increased so that public employees can continue to get higher pay and a more comfortable retirement than the private sector.

The problem with the municipal bonds is that Wall Street banks and hedge funds have worked their magic on them just as they did with the subprime loans. Between synthetic rate swap deals, repackaged loans and derivatives of derivatives, the investments have not just done poorly but in fact have lost a lot of money, leaving the municipalities on the hook for huge debt burdens. This combined with the woefully underfunded pension plans has left many states hanging on for dear life.

As is usually the case, the banks who structure these loan packages for the banks derive significant fees for their work. Bonuses are based on these fees and therefore people working for these banks have a huge incentive to get "creative" in trying to help the states get the funding they need. And of course most of the bonds' ratings are AAA even though most everyone knows the states are in miserable financial shape to pay them. Only California and Illinois are currently rated lower than AA. So the problems are similar to the subprime debacle and it's the elephant in the living room that everyone is ignoring. One of these days the elephant is going to want to be heard and that's basically what Meredith Whitney is warning about.

On to the next index, on Monday I had mentioned the TRAN as one of the indexes giving me a bullish feeling about the market's chances of continuing higher. I thought the sideways consolidation over to its uptrend line from August would lead to another leg up to the top of its rising wedge pattern, perhaps up near 5200 or slightly higher. That potential still exists but I'm surprised it did not make more headway the past two days. Fib resistance lies in the 5125-5148 area (the high over the past 2+ weeks of trading was on December 13th at 5114.69) so it needs to break through there to at least make it up to 5200.

I've changed the wave count for the TRAN to be aligned with the broader market indexes and the lower Fib is where the 5th wave of the move up from July would equal 62% of the 1st wave. The upper Fib is the 88.6% retracement of the 2007-2009 decline (the first Fib in the trio of double-top levels to watch). If it can punch through this Fib resistance zone there is further upside potential to 5375 where the 5th wave would achieve equality with the 1st wave. If the bears return and drive the TRAN below the November 24th high near 4917 it would indicate we're into a larger pullback at a minimum.

Transportation Index, TRAN, Daily chart

Stepping out a bit for the dollar and commodity charts, the weekly charts helps us keep the moves in perspective. The dollar's pattern since the low in 2008 could be a bearish consolidation pattern as it traces out a sideways triangle. As in all triangles, an a-b-c-d-e wave count would be complete with one more trip to the top of the triangle near 88. So even the longer-term bearish view of the dollar calls for a decent rally over the next few months. This should continue to put some downward pressure on stocks and commodities (although both have gallantly fought off a rising dollar since the low in November. I've drawn in just one idea, in red, for how a 3-wave move might progress up to the top of the triangle.

U.S. Dollar contract, DX, Weekly chart

The bullish wave count for the dollar counts the 2008 low as a very important low and since then we've seen the dollar trace out a 1st wave up (green wave 1), a 2nd wave pullback into 2009, and then another smaller 1st and 2nd wave. This wave count puts us at the start of a 3rd of a 3rd wave to the upside which if correct will be a very powerful rally. While there may be early clues as to this happening (for example, a very strong move higher to 88), it takes a break above 88.71 to tell us the dollar is off to the races to the upside. If the dollar tucks tail and turns back down and breaks below 75.63 we'll know the dollar is heading for new lows.

When it comes to the metals, much of their move next year will be dependent on what the dollar does. Gold has many proponents who talk about it being the real currency and that the fiat currencies that the world uses are doomed for failure. Studies show that most fiat currencies last only 40 years and the U.S. came off the gold standard in 1971, 40 years ago. But we can only speculate as to what gold will do so I'll stick with the charts for clues.

Sticking with the weekly views here, gold has been pressing up to the top of a parallel up-channel from 2005, so a longer-term uptrend to be sure. As I showed on Monday, it appears to be in a rising wedge pattern since November as it wedges itself into a corner here and it looks like an ending pattern. The wave count supports the ending pattern and the count says it will be a significant high, ending the rally from 1999, which calls for a correction of that rally (from about 253). Needless to say, that calls for a big correction. Gold bulls will scoff at the idea but from a chart perspective it's what we should be looking for. A break below 1315 would tell us the top is in but until there's even a break below last week's low at 1361.60 I'm looking for "one more high".

Gold continuous contract, GC, Weekly chart

Before I get to oil I thought it would be worth mentioning a prediction that was mentioned this morning on the Market Monitor. Jane had posted some 2011 predictions by Steen Jakobsen who created Saxo Bank's "10 Outrageous Predictions". Jakobsen creates this list each year because he "...felt most outlooks were of little or no value as they merely extend present-year trends into the next. Instead, I wanted to present 10 ideas that could force the investor/reader to adjust their positions -- the premise being it is better to be proactive than reactive. You can find his predictions posted on Minyanville at Jakobsen's Predictions. If nothing else his predictions will make you think.

His 8th prediction was that crude oil will drop to $20 a barrel "due to slow growth and a substantial drop in China growth". This seems like an outrageous prediction to be sure so I wanted to see if there was anything on the charts that could possibly back up his prediction. If the dollar blasts higher I can certainly see that possibility I like to review each chart on its own merit and then look for correlation. But first, this is what I posted earlier today on the Market Monitor:

Steen Jakobsen's 2011 predictions, his 8th one--predicting oil down to $20--is probably raising more than a few eyebrows. It does seem unrealistic. But is it? Let's play what if. What if the economy drops into a funk again next year (in keeping with the longer-term secular bear market theme, which is yet to be proven of course) and what if we have a bad case of deflation instead of inflation (through debt destruction and a reduction in the monetary supply, in spite of the Fed's efforts). That scenario would likely increase the value of the dollar and depress the prices of all commodities.

I'm only playing what if so go along with me here. When oil was at $147 in July 2008 did anyone think it would drop down to $33 in about 6 months? I was looking for a big drop but even I was surprised by the magnitude of the drop in such a short period of time. That was a little more than a 77% decline. So what if the first leg down was wave A and the bounce since January 2009 has been wave B (which has now retraced 50% of wave A) and we still have wave C down to finish a large A-B-C pullback from the 2008 high before oil rallies to the moon into 2012 and beyond (when hyper inflation starts kicking in and the Fed can't pull money out of the system fast enough).

Another drop that equals the first, the same -77%, would drop oil down to $20.50. Using Fibs, a 62% projection for wave C would have oil dropping to $20.30. You don't suppose Jakobsen was using the same tools do you? Suddenly his prediction is not that farfetched. Of course we're only playing what if right now.

Oil continuous contract, CL, Weekly chart

If we dial in closer to the daily chart, to look at the wave-B bounce, it should have a corrective wave structure and that's what I've been showing for the past year. An A-B-C bounce off the January 2009 low puts us in the c-wave and the 5th wave of it is what we've been in since the November low. It's possible to count the rally complete now or after it progresses a little higher to the $95 area. A drop back below 86.80 would tell us the rally has probably finished but in the meantime there is still more bullish potential so let it play out if you're interested in the short side.

Oil continuous contract, CL, Weekly chart

I was looking through many commodities this week and noticed a very similar pattern and each is pointing to a potential high soon. When I looked at the commodity index, the CRB, it wasn't surprising to see it could be close to complete an a-b-c bounce off its February 2009 low. Two equal legs up would be 340.84 and a 50% retracement of the 2008 decline would be at 337.06 so there's tight correlation there for a possible high. It's currently just shy of the top of its parallel up-channel from 2009 and therefore I'm watching closely for evidence of a turn back down (below 312 would be the first sign of a reversal). But notice how similar the pattern is the oil chart shown above.

Commodity index, CRB, Weekly chart

Tomorrow is an even busier day for economic reports and could move the market (especially with the lighter-than-normal volume). The core PCE is watched closely by the Fed so any number that is off the mark will spur all kinds of guessing how the Fed will react. Of course any number higher than expected could create even more inflation fears. The Durable Goods Orders and Michigan Sentiment could also move the market. All but the sentiment number and new home sales will be out before the market opens so watch how futures react.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, we're in a bullish period and the charts show a well established uptrend. Fighting that uptrend has been a fruitless exercise and the uptrend could continue into at least early January when we will hit some cycle turn windows coming together around January 11th. But if we drop first and then bounce into that window it would be a good setup for trying the short side. In the meantime stick with the trend and wait for the bend at the end, which will be when the key levels to the downside start breaking.

Those key levels for the most part are relatively close so you won't have to give up much if you're long. If you're looking to play the short side, use put options and buy at least 3 months out so as to reduce time decay. Puts will be cheaper at the same price level when prices are heading up vs. heading down so a strategy is to pick a level you feel the market is going to reverse and buy puts just before it gets there, with a stop just above resistance.

If you're looking to keep playing the upside I'd also use options and buy calls right now instead of selling puts. Selling puts could get you in trouble if the market suddenly disconnects to the downside. Besides, premiums are so cheap right now that it's not worth the risk selling premium.

I thought the following was a good summary made by John Gray on the Market Monitor this morning:

"In the interest of disclosure, I am not making any huge directional bets in this market right now. My preferred method of trading is "market neutral" using Iron Condors and credit strangles. As I shall discuss later, even that has been very challenging in this extremely bullish environment over the last four months.

I have no quarrel with the bulls. They have a lot of things going for them:

1. Seasonality (October through April are the most bullish months of the year).
2. Improving economic conditions.
3. Improving corporate profits, and finally
4. An accommodative Fed that has made no secret of the fact they plan to do "whatever it takes" to continue to flood the system with liquidity. Of course, if you are a bull you already know this, and have embraced it.

However, I would be remiss if I didn't point out warning signs that I see along the way. This does not mean that I'm a bear, but, (I prefer to think), a pragmatist. I have traded bull and bear markets over the past 15 years and I hope I've learned some things that might be useful to our readers.

With regard to the present bull run (from September 1st), I don't have any problem with the fact that it occurred, I only am troubled by how far it has come in such a short period of time. For example, since the end of August the DOW is up 16%; SPX is up 20%; NDX is up 27%; RUT is up 32%. Those would be wonderful gains for a year, but they have occurred in less than four months. History (and the charts) tells me that this is not sustainable. I am not suggesting that the bull market is about to come to an end. I am merely pointing out the fact that it is not "normal".

In the last prolonged bull market (2003-2007) there were five corrections of between 5%-10%. In this bull market (since March, 2009) there has only been one (May through July). The one thing I can say without fear of contradiction is that there is a correction in your future. Whether it will be a "normal", garden-variety type of correction, or a major trend-changing top is obviously unknown.

So, as traders, what do you do? Follow the Boy Scout motto - "Be Prepared". If you are a bull, and you're long the market you need to objectively analyze your options. If you are not comfortable buying protective puts (insurance), then you need to place realistic stops in order to preserve a portion of your gains. There is absolutely no excuse for letting profits turn into losses."

I could not have said it better so with that, good luck and I'll be back with you next Wednesday. I wish everyone a very Merry Christmas (whether you celebrate it or not) and blessings to you and your families.

Key Levels for SPX:
- bullish above 1260
- bearish below 1232 and longer-term bearish below 1173

Key Levels for DOW:
- bullish above 11,615
- bearish below 11,330 and longer-term bearish below 10,900 (the November low as well as the 200-week MA)

Key Levels for NDX:
- bullish above 2240
- bearish below 2165 and longer-term bearish below 2030

Key Levels for RUT:
- bullish above 800
- bearish below 767 and longer-term bearish below 701

Keene H. Little, CMT

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