Market Stats

For traders who actively traded the market in the heady days leading up to the top in early 2000 it was a common tactic to buy in front of earnings and anticipated stock splits (which were often announced at the same time as earnings). Without digging through my notes I believe the idea was to buy about 7-8 trading days before the earnings/split announcement and then sell the day before (the idea being profit taking would often start the day before the announcement as more and more traders started gaming the system. At any rate, it was a profitable strategy and it's looking like some of those traders are back.

The big dog for earnings is Intel (INTC) and they will be announcing after the close on Thursday. It will be interesting to see if we see some profit taking start during the day tomorrow. INTC has been credited/blamed for a lot of big moves in the market and as we rally into the announcement I can't help but wonder if we're seeing another setup for a sell-the-news event. Oftentimes we'll see the futures spike higher after INTC announces but then completely reverse and sell off the following day, often with a gap down.

But that's tomorrow/Friday. Today started with another gap up, this one credited to the "good" news about Portugal's success in selling its debt, albeit at a higher rate than previous sales. I wouldn't be a bit surprised to learn that the ECB was in there doing a lot of buying to ensure Portugal did not face a failed auction. All hell would break lose if and when that happens. So there was a lot of relief in the banks, which hold a lot of European sovereign debt. The first failed auction (if it happens) will crush bank stocks.

With the rally in the financials the market started off with a positive attitude and held its early-morning gains throughout the day. That was the good news if you were long coming into this morning. The bad news for traders wanting to get long is that once again the overnight futures action, and the gap up once the cash markets opened, was about all there was to the rally. The rest of the day was spent essentially consolidating sideways. There were no good trading opportunities for either side, except for small scalping plays.

I read an interesting statistic earlier in the week by David Rosenberg, discussing the past year's rally. He stated, "One has to really wonder about a stock market (talking about the S&P 500 here) in which 134 points of the 143 points that were racked up in 2010 occurred in the first trading day of each month (see 'The Trader' on page M3 of Barron's). That is truly remarkable -- 94% of the entire year boiled down to 12 sessions. And what do you know? 2011 started with a 1.1% pop and has sputtered since.

"It is truly the nuttiest thing -- the best days last year were the first day of each month (save for June and July) and then after that there were practically no crumbs to nibble on: These are the point changes for the first trading day of each month in 2010, which totals 134 points (as we mentioned above): December +26 points; November +1 point; October + 5 points; September +31 points; August +24 points; July -3 points; June -19 points; May +16 points; April + 9 points; March +11 points; February +15 points; and January +18 points.

"Now look at 2011 -- +14 points to kick off the month and year, to close at 1,271.87, and here we are today, after a supposedly ripping ISM and ADP set of numbers, and as of January 7, the S&P 500 is sitting at 1,271.50. Hope you didn't decide to get in on the second day."

We had a nice rally today but who knows how the rest of the month will go. In addition to this observation, when you add in the fact that probably 75%-80% of those gains occurred in the overnight futures market before the cash market even opened, you really have an untradeable market. I suspect in a move down we'll see the same thing in reverse.

Once the day started with the gap-up move there was little to spark additional buying interest. The good thing is that sellers didn't immediately pounce on the move up and sell into it, a pattern we've seen recently. There weren't any economic reports to jar the market one way or the other as there were no surprises. The Beige Book report didn't come out until 2:00 PM and it had a slightly negative impact but nothing much. Its information will be used in the next FOMC meeting scheduled for January 25-26 so traders were trying to figure out what the report might mean in the Fed's decisions around QE. The report talked about modest growth with a gradually improving economy with low wage or inflation pressures. Net net it would appear there's little to dissuade the Fed to back off on their QE program, even though there are a couple more hawks on the FOMC board this year.

As I'll get into with the charts, I'm expecting a continuation of the rally tomorrow but it might not be much. I wouldn't be at all surprised to see a quick move up and then consolidate for a good portion of the day as the market goes on hold in front of INTC's report. What happens after the announcement is anyone's guess but the price pattern is suggesting caution after a new high.

While points were added to the board today it continues to be a weaker and weaker rally, which simply means you would be wise to follow it up with trailing stops as a way to protect profits and/or enter a short play. Let the market prove it has finished by breaking some key support levels. One way to gauge the strength of the rally, other than the oscillators (stochastics, RSI, MACD, etc.) showing waning momentum, is to look at how many stocks are participating in the rally of the indexes. A chart I've shown before, comparing the advance-decline line to the NYSE, demonstrates vividly how the market breadth is deteriorating. The NYSE is making new highs on the backs of fewer and fewer stocks. This is how tops are formed (we just don't know exactly where or when).

NYSE vs. Advance-Decline Line chart

The dates are hard to read because I squished the charts but it starts from May 2009 and you can see the long-term slow bleed in the strength of the rally over that time. The April 2010 high, about in the middle of the charts, shows a significant negative divergence on the a-d line. The strong rally from November is showing an even worse negative divergence, something that warns me when price breaks down it could go very quickly. This chart comparison screams at me "caveat emptor".

Many people credit the stock market rally with an improving economy. Keep in mind that an improving economy does not guarantee a continuation of the rally. All market tops are made on great and improving economic reports and all bottoms are made on the worst reports. It's also noteworthy that many measures of the economy are showing a slowing of improvement. The bulls will of course concentrate on the fact that the numbers are still improving. The bears will concentrate on the fact that the numbers are slowing down. The bottom line though is that it's not business that is the problem, it's debt. And the massive debts incurred are still on the books of all the banks. People are still working down their debt loads.

Because we are all globally linked to one another it's important to keep an eye on the global economic health as well. Watching China has become a favorite pastime for many. They do not have enough domestic demand to soak up their capacity and therefore they are very dependent on other countries to support their business model. An eye on the Shanghai Composite index ($SSEC on stockcharts.com) will help us figure out how traders are feeling about China's business, which will be a good indication for global businesses.

One additional measure of the economy can be measured using the Baltic Dry Index (BDI). There's been a bit of a glut in available ships after a building boom the past few years and that has depressed shipping prices but I think it can still be used as a guide. When combined with the SSEC we can see if one's message is supported by the other. Currently I can't say I get a bullish message from them. The below chart compares the BDI and SSEC with the S&P 500 index.

Baltic Dry Index (BDI), Shanghai Composite index (SSEC) and S&P 500 index (SPX), Daily chart

The BDI is the bottom line and importantly, I think, is the recent break of the July low. This index is telling us business is slower than it was last summer. SSEC, the middle line has put in a series of lower highs since August 2009. Following its sharp drop from the November 2010 high it has been consolidating sideways, which fits as a bearish continuation pattern. I expect to see this index break lower. And then there's SPX flying happily higher without a worry in the world. These indexes typically track very well together and SPX stands starkly all alone up there. And I doubt SPX will drag the other two back up so when the correction comes it could be fast. Again, that's not a guarantee but when we trade we like to put the odds in our favor. Right now the odds are increasing (imho) that the traders who are whistling past the graveyard are going to soon be spooked by the goblins.

Todd Harrison on Minyanville, posted an interesting statistic that he got from Jason Goepfert: "...the SPY has gained 0.5% to start the new year when it's near a three month high five times -- '97, '00, '02, '05, and '10 -- and four of those times, or 80%, it's given back the December gains." Hmm...

So now when I look at a chart like the one below, which shows a huge increase in bullish speculation, especially since the July low, I have to wonder how much frothier and overbought the market can get. And it makes statistics like Goepfert's that much more interesting. The chart below shows the measure of total call purchases plus put sales (each bullish) divided by the total put purchases plus call sales (each bearish). The current reading is the most bullish ever recorded, including the high just prior to the May flash crash.

Options Speculation Index, chart courtesy agorafinancial.com and data from SentimentTrader.com

As with all sentiment indicators, it can remain very high for long periods of time so it's not a license to go out and short the market here and now. It's simply another warning that things are getting a bit too frothy to be complacent about the upside. Complacency, more than overbought or overpriced, is what gets the market into trouble and the VIX is telling us complacency is abundant at the moment. All the pieces are in place for a market correction so stay aware of what's happening in the market here.

The charts will hopefully give us the clues we need to make our trading decisions, either to stay long, get out or get short. Starting with the SPX weekly chart tonight, it's looking like SPX could head for the August 2008 highs, which is in the 1298-1300 area. At the same location is the top of a rising wedge pattern for price action since the July low. On a weekly basis the bulls remain in control until price breaks below 1173, the November 29th low (although a break of the uptrend line from August would be a bearish heads up.

S&P 500, SPX, Weekly chart

The top of the rising wedge pattern is shown more clearly on the daily chart below. Slightly lower than the 1298-1300 target is 1292 which is where the 5th wave of the rally from July would equal the 1st wave. And only marginally higher than that, near 1294, is the top of a small parallel up-channel from December 8th (the lines are also parallel to the uptrend line from August). It takes a break below 1261, last Friday's low, to indicate the top is in so it remains bullish until then.

S&P 500, SPX, Daily chart

Key Levels for SPX:
bullish above 1277 to 1292-1300
bearish below 1261

The 60-min chart below zooms into the move up towards the top of the channel and top of the rising wedge pattern. I've drawn out what a typical move from here would look like as a way to complete a 5-wave move up from last Friday and I've projected the move up to about 1293-1294 by tomorrow's close, which just so happens to be in front of the INTC earnings report. The risk for bulls, if it plays out this way, is that a rally into the end of the day Thursday to complete the wave count could set the market up for a disappointing reaction to INTC's earnings.

S&P 500, SPX, 60-min chart

The DOW closed 5 points above its January 2000 high. It tagged the top of its parallel up-channel from December 8th and looked relatively weak this afternoon so it's possible it's putting in a high right here. But like SPX I think it would look best with at least one more new high, even a test of today's high, to finish its rally pattern off last Friday's low. The top of the larger up-channel is close to 11900 and therefore the upside potential for now. But the shorter-term pattern is what has me thinking it could top out sooner than that, maybe 11800.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
bullish above 11,750 to 11800-11900
bearish below 11,570

The techs have been relatively stronger since the first of the year and NDX is pressing up towards the top of its parallel up-channel from November. It's also been riding up underneath a broken uptrend line from August (light gray line on the chart below). Upside potential to the top of its channel is near 2320 and there's a Fib price projection near 2330 where the c-wave of an A-B-C bounce off the March 2009 low would achieve 62% of the a-wave. So I have 2330 as the level where NDX would be even more bullish whereas a drop below 2254, last Friday's low, would be bearish. It's bullish until the bulls can't hold it up any longer or the bears take over and drop the indexes through key levels.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
bullish above 2330
bearish below 2254

The RUT continues to struggle with the 800 area although it was able to close above it today. The short-term pattern suggests today's high might have been its last but if the broader market is able to push higher I suspect the RUT should be able to as well. Upside potential is to the top of its rising wedge pattern from July-August, currently near 810. So it would be more bullish above that level (that holds above) whereas a break below 777, last Friday's low, would be bearish. Keep in mind that if the rising wedge pattern is the correct interpretation, and it fits in the larger wave pattern, we should be looking for a complete retracement of it (so back to the August low) in a faster time than it took for the rally (oftentimes Much faster where a 5-month rally could be retraced in a month or two).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
bullish above 810
bearish below 777

Bonds have been consolidating sideways since mid December. The theory that stocks have been benefitting from a rotation out of bonds doesn't hold any water when you see that bonds haven't moved in the past month. The 10-year yield, TNX, looks like it has formed a bullish descending or sideways triangle following its rally from October, making it more likely a bullish continuation pattern. I have it labeled as a 4th wave correction which calls for another leg up to a target at 3.66% if it breaks above 3.57% and then a pullback to correct the rally from October before proceeding higher again. That's the bullish pattern (for yields, bearish for bond prices).

10-year Yield, TNX, Daily chart

A longer-term rally in yields would of course not help the Fed's cause since they've been trying to support bond prices as a way to keep yields down. It's an effort to help the housing market and it's also a way to keep borrowing costs low for governments (local, state and national). Needless to say, the green path for yields will not help overly indebted governments and would put additional pressure on the housing market (as well as corporate borrowing in general).

But it's not clear yet is whether the bond bulls or bond bears will prevail here. The red wave count calls for a drop back down below the October low as it continues its multi-year decline towards 1%. A break below the mid-December low near 3.25% would be a sell signal (buy signal on bonds) and a failed bullish pattern (the triangle) often fails hard.

The news that Portugal was able to sell its debt (albeit at a higher interest rate) sent waves of relief through the banking community, including U.S. banks. The BIX has now bounced hard to correct the initial decline from last week's high, which was right in the 152.96-153.65 Fibonacci zone that I showed last week (the high on January 6th was 153.56). As of today's high (152.13), BIX has retraced 78.6% (152.10) of the decline. If it can press higher it could retest its high and the broken uptrend line from mid December, which fit as the bottom of a rising wedge. As long as it doesn't make a new high the bounce fits as just a correction but a new high opens up the door to 160-165 to test the April highs.

Banking index, BIX, Daily chart

The price pattern for the TRAN's "rally" from December is very choppy and it supports the idea that it's in an ending pattern for its rising wedge pattern from July. It remains bullish as long as it remains inside its rising wedge but the bearish divergence and choppy price action tells me it's close to finishing. A break below 5100 is needed to confirm we've seen the high and then the risk is for a relatively fast retracement of the wedge-- back down to the August low near 4000 (24% decline). That's not a prediction but it is the risk.

Transportation Index, TRAN, Daily chart

With the "good" (OK, less bad) news about Portugal finding willing buyers for its debt, the euro got a nice bounce and the U.S. dollar tanked. So far the dollar's pullback from Monday's high fits as a correction of the leg up from December 31st and the rally should resume even stronger once the pullback completes. The bullish pattern would be negated with a drop below the December 31st low near 78.77.

U.S. Dollar contract, DX, Daily chart

The dollar's strong pullback has given commodities a boost and the commodities index, CRB, looks like it wants to try for the upside target zone that I've been showing recently--at 337.06-340.84. This is the 50% retracement of the 2008-2009 decline and two equal legs up from February 2009, respectively. The wave count looks best with the new high and the Fibs fit well for a high of importance here.

Commodity index, CRB, Weekly chart

While the broader commodity index is registering a new high, gold is not. The bounce off last Friday's low looks like a correction of the decline from January 3rd. It's currently testing the broken uptrend line from mid November, which I am calling the bottom of its rising wedge pattern that concluded its rally from 2008. A break below 1352 and its uptrend line from October 2008, currently near 1336, should be followed by accelerated selling.

Gold continuous contract, GC, Daily chart

Oil seems to be following the commodities index as it presses back up towards its high at 92.58 on January 3rd (today's high was 92.39). Its price pattern is not at all clear and I could argue equally strongly for a push higher to about 95 as I could for a decline from here that strongly breaks below the key level to the downside at 87. We could see choppy price action in between.

Oil continuous contract, CL, Daily chart

Tomorrow morning's economic reports include PPI numbers and it could move the market if there's a big bump up in inflation. That would spook traders into thinking the Fed might feel they'll have to back off on their QE program. At this point no surprises are expected.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, it would look best if the market presses a little higher on Thursday as that would do a good job completing some short-term price patterns to the upside and get the indexes tagging some potentially important target levels/resistance. But don't get complacent about new highs tomorrow in front of the INTC earnings report after the close. Whether we get a sell-the-news reaction or not, that's the way the charts are setting up. And the significance is that the setup is for a possible major high, especially if we see multiple rising wedges start breaking to the downside.

The market has been bullish and remains bullish. So the warning above is simply that. We've seen time and again where the market rallies up to resistance, looks like it could tip over and then instead blasts higher (usually with the help of short covering following an overnight rally in the futures). This formula could work for a lot longer and I know many of you think it's foolish to even think about fighting the Fed. It's not the Fed I'm fighting. It's bullish sentiment among the traders who Think it's the Fed. The Fed can't hold this market up by themselves and while some money trickles into the stock market through the primary dealers, it's the expectations of a Fed-induced rally that keeps people buying and throwing caution to the wind (as represented in the multiple sentiment reports we read and a few that I've shown). It's complacency that kills bull markets and complacency reigns supreme right now.

Therefore stick with the bulls while it's working but stay aware that the risk is increasing (I believe) for a downside disconnect where we open down and sell hard for the rest of the day. If you don't have stops in place, which can be triggered even if the market gaps below your stop, you could find a nasty surprise at the end of the day. Use conditional orders to protect your positions. While this top has been incredibly difficult to find, I've been through enough of them to realize this one in particular could be the most dangerous for bulls. There's just too much bullish sentiment and complacency and trust in the Fed.

I'll throw out one more interesting statistic. A friend of mine, Ed, is writing a book on George Lindsay and had this to share with me:

"As part of my research for my book on George Lindsay, I was reading his newsletter from 5/21/71 last night. It appears (to me) to apply to our current situation.

Quoting Lindsay, "If we count, not just from an ordinary bear market low, but from a really epochal bottom, there has always been a sharp break eight years later -- a break so deep and rapid we can say that both an important high and an important low came within two or three months of each other. The crash of 1929 came eight years after the 1921 low. Eight years after the all-time low of 1932, the market really plummeted in May-June 1940, when Germany invaded France. The low of 1942 marked the end of a five year bear market, and stocks plunged in June-July 1950, when the Korean War broke out. The break of 1957 came eight years after the major low of 1949. When we count eight years from the low of 1962, we come to the spring of 1970, and again the market took a nosedive."

"Note that the break can occur at any stage of the market cycle: in 1929, it came at the top, in 1940 during a bear market, in 1950 during a bull market and in 1970 at the bottom. It makes no difference."

As Ed has stated to me, "Our last epochal bottom was late 2002 or early 2003 which makes the eight year count end....excuse me, I need to call my broker."

I had posted the above on the Market Monitor earlier in the week and Joe sent me an email with a monthly chart of the S&P 500, showing a big H&S topping pattern, starting with the left shoulder at the 2000 high. He was just wondering about the possibility when he read the above from George Lindsay. Look at the monthly chart of the DOW or SPX and you'll see it. I'm not predicting, I'm just sayin'...

So stay sharp and enjoy the ride higher if you're long. Just don't get complacent and be quick to sell and ask questions later. Bears need to wait their turn still but I suspect it won't be long and you'll need to be quick.

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

Key Levels for SPX:
bullish above 1277 to 1292-1300
bearish below 1261

Key Levels for DOW:
bullish above 11,750 to 11800-11900
bearish below 11,570

Key Levels for NDX:
bullish above 2330
bearish below 2254

Key Levels for RUT:
bullish above 810
bearish below 777

Keene H. Little, CMT