Market Stats

Yesterday saw a nice recovery off the low and in last night's Market Monitor update I mentioned how bullish the daily candlestick looked (bullish hammer at support). An up day today confirms the bullish reversal pattern so the market is now the bull's to lose. But as I'll review in tonight's charts, the bulls need to do a little more work to prove they've taken over the reins.

Following yesterday's strong reversal back up, and close near the high, today opened near the flat line (after a bullish overnight session gave back the gains) and started rallying right away. It never looked back (only small sideways consolidations) and pressed higher into the afternoon and into the FOMC minutes released at 2:00 PM.

There were no significant economic reports this morning and the major indexes looked to be more influenced by opex than anything else. I like to watch IBM and GS for direction in the market because I often find that when they're in synch, especially with the broader averages, it supports the day's move. When they diverge with each other or with the broader averages it's a time for caution. Today both IBM and GS stayed in the red while the broader averages had a nice rally. That's either a negative for the market or it's simply the influence of opex. We should know more in the next pullback/decline.

The market was already up strong when the FOMC April minutes were released at 2:00 PM and it revealed there's some division amongst the Federal Reserve members about when to ease up on their monetary stimulus policies. There was a little wobble in the market at 2:00 and then a big buy program hit at 2:05 PM, spiking the market up on volume (aided by short covering). Someone wanted a positive reaction to the minutes but unfortunately that created a little capitulation high for the day. But not to let a good rally go to waste, after a pullback to 3:00 PM the buyers stepped back in to test the day's high (but on less volume and showing bearish divergence so we could get a pullback right away Thursday morning).

With Federal Reserve officials divided as to when they should start tightening their monetary policies, bulls and bears are going to interpret this differently. Some are concerned that an early rate hike would dampen the nascent recovery that we're seeing while others are more concerned about inflationary pressures. QE3 is a big question mark as some of the Fed officials said they would only agree to it if there was a significant change in the economic outlook (worsening).

So would QE3 be a good sign or a bad sign for the market? It would of course mean more dollars that will continue to flood into the stock market and commodities but that would create more of an inflation problem. Higher inflation would result in less spending by consumers on things other than food and gas, which would not be business friendly. It would also create a further disconnect between Main Street and Wall Street and create an even more hostile environment for social mood. A slowing economy, the reason to implement QE3, would not be a good thing in the end but it would likely be short-term positive for the stock market.

The FOMC minutes also revealed that Fed officials are worried about how to exit from the very low rates, which have been between 0% and 0.25% for quite a while now and it's questionable how much it has helped businesses (it's certainly hurt savers and income dependent people such as retirees). With a balance sheet approaching $2.8 trillion in assets Fed officials want to start looking at sales of assets rather than continued accumulation.

When we look at a chart of the assets on the Fed Reserve's books (remember, this is a consortium of private banks -- they're Federal in name only), it's incredible how much it has ballooned in 2-1/2 years. The chart below shows the incredible growth since August 2007 when the balance sheet was about $870B. Since then it's now approaching $2800B, more than tripling in size (kind of like government debt). What's especially noteworthy is the makeup of their balance sheet. The orange part of the chart shows the mortgage-backed securities (MBS) and the red part is the growth in Notes and bonds.

Federal Reserve Balance Sheet, chart courtesy greshams-law.com

The value of the MBS and Notes and bonds are nominal, in other words they're book value and not market value. This could be very significant if the market takes another tumble and those assets have to be marked down in value before they can be sold. That would be part of the debt destruction that's part of the credit contraction that's part of the deflationary cycle. In other words, the Federal Reserve banks are at risk with these assets on their balance sheet. If they sense a market collapse they could dump those securities in a hurry as part of their last-ditch effort to save themselves. That's not a prediction but a risk to the financial system.

Today's rally has the charts looking bullish but before I get to them, I think it's worth noting something about this year's rally. FT.com had an article last week that compared this year's rally thus far to previous years. They noted that the S&P 500 had its best first quarter (January-March) since 1998. But the disturbing thing about it is the fact that it happened on the backs of only two strong sectors -- energy and industrials. They were the only two sectors that outperformed the broader index and of course the strong energy sector is what's causing pain at the pump.

The last time this happened during the first quarter was in 2000, just as the tech bubble was getting ready to pop. The narrow breadth back then is being mirrored now and it's never healthy when only a couple of sectors are carrying the broader market on their backs.

There are some other interesting factoids I came across, thanks to Jeff Cooper on Minyanville. As he noted last week, the typical cyclical bull market rally lasts about two years. We're now at 2 years and 2 months. Cooper loves to look at big market cycles and made note of the following:

120 years ago there was a high in May and a low in the fall.
100 years ago there was a high in June and a low in the fall.
60 years ago there was a high in May and a low in the fall.
20 years ago there was a high in June and a low in the fall.
10 years ago there was a high in May and a low in the fall (9/11).

These were the years ending in '1' and here we are in May heading into June. As I'll review on the charts, we either made a high on May 2nd or we have one more new high and a turn date on June 13th fits. How the market pulls back from here will help determine what the next few weeks will look like.

So far this week is sporting a bullish hammer candlestick at support (the uptrend line from August) and the wave count for the move up from last July and from March supports the idea that we'll get one more new high before completing the rally from March 2009. Two equal legs up from July is at 1389.81 and a 78.6% retracement of the 2007-2009 decline is at 1381.50. The alignment of those price levels makes for a good upside target (and just shy of 1400 which many pundits are expecting to see). So the bulls still control the trend but they'll fumble the ball if we see a decline below yesterday's low near 1318.

S&P 500, SPX, Weekly chart

The multiple 3-wave moves since the February high says we're in an ending pattern, shown as a rising wedge pattern on the daily chart below, which calls for one more new high. As mentioned earlier, there is a cycle date that points to June 13th as a turn date. That coincides closely with the cross of the trend line across the highs from February-May and the 1390 price projection. I'm depicting a 3-wave move up (in green) to achieve that target on that date. A rally above 1350 would move this scenario to the higher-probability move while a drop below 1318 would negate that bullish scenario and call for a very strong selloff instead.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1350
- bearish below 1318

I highlighted the RSI break of its uptrend line from March because this often provides a good heads up that the rally has finished. A retest of its broken uptrend line followed by a turn back down would leave a bearish kiss goodbye so it's something to watch for.

I'm looking at the SPX 60-min chart below with the log price scale because it brings the uptrend lines from March 2009 (green) and March 2011 (blue) into play. Those trend lines were broken in the Monday's decline and today's rally got back above the longer-term uptrend line (I've noticed swings above and below this line several times since last July) but closed on the uptrend line from this past March. The bears would love to see a decline from here, leaving a bearish kiss goodbye on the back test. Obviously the bulls want to see price back above that trend line and the downtrend line from May 2nd, currently near 1348. That's why a break above 1350 would be a bullish move (just stay aware that the rally could be a very choppy one inside the larger rising wedge pattern).

S&P 500, SPX, 60-min chart

The DOW almost made it back up to its broken uptrend line from March, currently near 12600. It was able to climb marginally back above the broken February-April neckline which provided support earlier this month. So currently it's a battle between its 50-dma below and the broken uptrend line above. I've depicted the DOW marching higher beneath its broken uptrend line, something it's done many times in the past. The DOW is weaker than SPX, which can be seen on RSI as well. While SPX is close to testing its broken uptrend line on RSI, the DOW has barely been able to lift back up towards it. A turn back down in RSI to a new low would confirm a likely failure of price at its broken uptrend line from March.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,700
- bearish below 12,378

NDX is also playing tag with its broken uptrend lines from March 2009, where it closed today, and from March 2011, which was recovered today. As with the others, the bulls do not want to see a failed retest here. Back above 2380 is needed to get the bulls more firmly in control of the tape.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2380
- bearish below 2320

Different index, same story -- the RUT has bounced back up to its broken uptrend line from March (and slightly back above its broken 50-dma at 830.52) but not quite back up to its broken uptrend line from August, near 838 on Thursday. We've got some mixed messages on the RUT's daily chart so we'll need additional price action to help clarify it. Bullish is the candlestick pattern -- a morning star reversal pattern with the big red candle on Monday, gap down and finish with a doji yesterday, and then gap up and big white candle today. But it came without any "warning" from the oscillators -- there was no bullish divergence hinting of a coming reversal. It's not required but remains suspect for now. And the close at the broken uptrend line from March is bearish so far. If we get a pullback tomorrow and then another rally it will start to look more bullish. If the pullback turns into something steeper and breaks yesterday's low near 815 it will be time to jump aboard the southbound train and enjoy the bullet-train ride to much lower lows.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 850
- bearish below 815

Bond yields got a bounce today and the 10-year yield, TNX, bounced back up to the top of its parallel down-channel for its decline from early April. Ideally the pattern calls for one more new low before putting in a tradable bottom (top for bonds) but any further rally in TNX would indicate a low has been found. The longer-term bearish case for yields calls for a bounce to correct a portion of the April-May decline and then a continuation lower this year. The bullish pattern calls for the resumption of the rally that started last October. The kind of bounce we see will begin to yield some clues about the longer-term pattern.

10-year Yield, TNX, Daily chart

Note that 3.039% would be a 50% retracement of the October-February rally and that we've had a 3-wave pullback since February. That's a bullish setup (bearish for bonds) and something to be considered by those who are invested in bonds, such as in your retirement accounts, or if you're looking rates to bottom for now before you finance/refinance your mortgage. If deflation is going to become more of a problem in the next couple of years, which is the direction I'm leaning, then TNX will only get a bounce and then continue its decline below 2% (after consolidating between 2.5% and 3.3% for another year). We won't have the answer until the bounce gets underway and we can see how impulsive/corrective it is.

Supporting the idea that TNX is ready for a larger bounce now is what I see on TLT, the 20+ year Treasury ETF. You can see that its pattern is the inverse of the one above. Yesterday's high was 96.60 and its rally off the February low achieved two equal legs up at 96.45, hit the top of a parallel up-channel from February, tagged the 200-dma at 96.27 (and 50-week MA at 96.59) and achieved a 38% retracement of the October-February decline at 96.26. That makes the 96.26-96.59 a very tough resistance area and sure enough today's big red candle shows traders taking profits at resistance. So while we could get one more minor new high (while TNX gets one more minor new low), the setup here is for a reversal here and now.

20+ Year Treasury ETF, TLT, Daily chart

The banks had rallied strong yesterday, which followed a long-legged doji on Monday. BKX also created a reversal pattern at support (200-dma) and today had a little bit of follow through although for much of the day it was weaker than the broader averages. Upside potential is to the top of its down-channel from February and 50-dma, both at 51.45. But the little hanging man candlestick today warns of another reversal back down and with RSI still below 50 and MACD below zero there is the potential for this week's bounce to be just a correction in the longer-term decline.

KBW Bank index, BKX, Daily chart

The banks are in a precarious position. The Fed has been trying to plump them back up in hopes they'll be in a better position (better capitalized) to absorb losses that are still on their books. It's a big unknown what the real value of their assets and liabilities are but it's safe to guess the value of the assets on their books, at their own estimated value rather than market value, are not reflecting reality.

Banking chiefs are smart people and financial types -- they're bankers and they know the true value of their books. They know about all the bad debt they have and that they're conveniently being allowed by FASB (Financial Accounting Standards Board) rule changes and Fed rule changes to keep their asset values marked up and to keep some of their problems off the books. They know that a jobless recovery, which is all we've had so far, is not a real recovery. They therefore know people's ability to pay off their debts and bad mortgages has not improved. They know the problem is getting worse.

These bankers are being told by the Fed that things are improving and that they can reduce their reserves (for "bad stuff"). The bankers don't talk about all this "bad stuff" in public so that they can show improved earnings and entice more investors to buy their stock, all sanctioned by FASB and the Fed. But these bankers are not ignorant of what's happening in the real economy and they can tell from their own information that the economy is not doing well. Borrowing by consumers and businesses is not robust, no matter how low the interest rates get.

When the real story eventually comes out, and it will, our government leaders, Fed heads, and bankers will all feign shock and dismay and wonder how it all got so bad (again). Investors will be caught holding the bag (again), the bankers will demand another bailout to "save the financial system" (notice that if-my-lips-are-moving-I'm-lying-Geithner is already out pounding the table about a financial calamity if Congress doesn't raise the debt ceiling), and the end result will be a mass exodus from stocks and probably into bonds. The Fed will have achieved their goal of getting bonds to rally so that interest rates decline. He's certainly doing it in a roundabout way.

While it's hard to say when the shift out of equities and back into Treasuries and lower-risk assets will begin, it's likely going to occur around the same time the Fed begins its exit from quantitative easing. Once it happens, and it could occur about the same time bankers also wake up and smell the coffee (that they're on their own to survive and will need to start properly accounting for the detritus on their books) we'll likely see traders also waking up to reality. Once they decide (not if) equities are not safe they’ll start leaving in droves and a lowering tide will once again expose all the rocks (the same ones that were covered up with Bernanke's flood of money).

Getting back to the rest of the charts, the Transports is the one index I've using to point to a new high coming and I'm sticking with that until proven otherwise. I think like the broader averages, a break below Tuesday low near 5310 would likely mean there's not going to be another new high. But the 3-wave pullback from the May 2nd high supports the idea for a new high and a price projection near 5672 is the upside target for now. I don't particularly like the wave count because the pattern is so ugly but that's true across the board. I'm watching trend lines to help gauge support/resistance and trend changes.

Transportation Index, TRAN, Daily chart

The U.S. dollar has been strong since its low on May 4th and today's little pullback found support at its broken 50-dma, which it last broke below in January. I'm showing the possibility for a little deeper pullback to its broken downtrend line, near 74, but so far the pullbacks have been very small (an indication of short covering powering this higher). If it runs higher from here I suspect we'll see resistance near 77 where it will hit its downtrend line from June 2010 and the 50% retracement of the December-May decline.

U.S. Dollar contract, DX, Daily chart

Gold's pullback found support at its uptrend line from January, bounced, pulled back to the uptrend line again (broke it intraday on Monday) and remains above it for now. Two equal legs up from the low on May 5th would have it bouncing up to 1535.40. Much higher than that would mean a new high, otherwise the high is already in and another break below the uptrend line and 1462 should lead to a move down to just below 1400 where it will find support at its uptrend line from October 2008 and 200-dma.

Gold continuous contract, GC, Daily chart

Silver has a similar pattern as gold's except that the selloff was more pronounced (as was its rally before collapsing back down). It's struggling to find support at its uptrend line from July 2009 and there are two patterns I'm watching in order to determine when it might roll back over. A smaller upside correction from the low on May 12th could see a failure around 37. Higher bounce potential exists to its broken trend line along the highs from 2006-2008 and 50-dma, both near 39 (and where the bounce on May 11th stopped, and then up to about 43. The pattern of the bounce should provide some clues for when to look for the reversal and I'll be providing those updates on the live Market Monitor. Downside potential is to its 200-dma near 29 and then another uptrend line from October 2008 near 25. I think there's a reasonable chance we'll see silver back down to 20 in a couple of months at the most.

Silver continuous contract, SI, Daily chart

Oil's pattern looks the same as gold and silver. In fact many of the commodities look the same, including the commodities index (CRB). Oil is struggling to get back above its broken uptrend line from February 2009 so the risk for bulls is an immediate decline from here. I'm showing a higher bounce back up to the 50-dma at 105.49. Two equal legs up for an a-b-c bounce off its May 6th low would target 104.99. But a break back below 95 would say the bounce is over and look for a move down to 90, 85 and then lower.

Oil continuous contract, CL, Daily chart

Tomorrow's economic reports include the weekly unemployment numbers pre-market and then existing home sales, Philly Fed survey and Leading Indicators at 10:00 AM. Those three reports could move the market so be careful if you're in a position at that time. The Philly Fed is expected to show a slowdown, which at this point should not be a surprise. But the market would not like to see a worse than expected slowdown. Same with the LEI.

Economic reports, summary and Key Trading Levels

After-hours news includes LinkedIn, whose symbol will be LNKD, has raised its IPO price to $45 (the 2nd time it has raised the price from $32 to $35 initially, thanks to strong demand) on the eve of going public. This has Nasdaq 100 futures (NQ) higher in after hours and is reminiscent of the tech bubble when internet companies were fetching high valuations. The IPO price of $45 values LinkedIn at about $4.2B. Another sign of a market top? Groupon and Facebook are expected to be next (they better hurry before it's too late).

The daily chart shows a strong reversal pattern so I think we have to lean with the bulls here. But I want to see a corrective pullback and then press higher before I get comfortable with the idea of getting long. The fact that my market direction indicator -- the IBM/GS pair -- did not support the rally has me wondering if the rally in the indexes was more opex related than real buying interest. The indexes stopped at potentially important resistance levels (previously broken uptrend lines) and that sets up a potential bearish kiss goodbye. Obviously a continuation of the rally on Thursday would be bullish.

Strong one-day wonder rallies are also the hallmark of bear market rallies so if the market has turned the corner then today's rally might have been just an opex-inspired short-covering rally. This brings me back to why I want to see either a continuation of the rally from here or a corrective pullback and then a push above today's highs.

If we start a stronger and impulsive decline with corrective bounces then it's likely we'll instead see a break below yesterday's lows. That would be the green light for the bears to climb aboard the train before it leaves the station. The decline from there should be strong and fast. So let price lead the way and we should have our answer soon, hopefully tomorrow.

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

Key Levels for SPX:
- bullish above 1350
- bearish below 1318

Key Levels for DOW:
- bullish above 12,700
- bearish below 12,378

Key Levels for NDX:
- bullish above 2380
- bearish below 2320

Key Levels for RUT:
- bullish above 800
- bearish below 778

Keene H. Little, CMT