Market Stats

Yesterday the market broke out to the upside but you always need to be a little suspicious when it happens at the end of the month. Hedge funds will often hit the market with buy programs to set themselves up to liquidate inventory at the first of the month. The buying triggers a desire by mutual fund managers to continue buying the dips, using new-month money coming into the funds. The hedgies then sell into that buying. So follow through in the first day or two of the new month is important to their strategy and if the buying doesn't show up then the hedgies are forced to chase the market lower and dump inventory on the way down rather than on the way up. The lack of any appreciable bounce today is evidence of that happening.

Bonds also rallied and that has it looking like a major rotation program hit the market today as money was rotated out of stocks and into bonds in an allocation move. This happening on the 1st of the month seems like a very plausible move.

I've mentioned in the past that you should look for reversals following a strong move that closes at/near the high or low of the day. This usually happens when there's a mini capitulation into the close and then there's no follow through the next morning. Those who felt they were missing the train on the long side yesterday, and the shorts throwing in the towel at the end of the day, left a dearth of traders looking to get long this morning. We could have the opposite setup heading into tomorrow morning since today saw a strong decline that closed at/near the lows. This sets us up for an immediate bounce tomorrow morning (look out below if we don't get a bounce).

Equity futures were down slightly before the first economic report hit at 8:30 AM but then tanked from there. With the market gapping down, the bull trap set yesterday was sprung. Many who bought the close were immediately under water and probably many were waiting for a bounce to get out of their positions. That bounce never came and if they didn't stop themselves out they were dragged deeper under water as the day wore on. There were only tiny little bounces, evidence of steady distribution of stock (from the hedgies) and controlled selling. The steady decline is one of the things that has me thinking allocation from stocks to bonds, or simply into cash as fund managers move to the sidelines for the summer.

The first report out this morning was the employment data from the ADP. Adding to the plethora of recent reports that point to a significant slowing in the economy, this morning's ADP Employment Change report was a sucker punch to the bull's solar plexus. Following yesterday's strong rally, closing at the high, this morning's downside reaction in pre-market futures led to a gap down open that never recovered. It's the way of this market to get both sides chasing big moves.

In April the ADP report showed 177K jobs added (revised lower from 179K) and the expectations coming into today was for another 170K-190K job added. The actual number of 38K was a miss by a mile and it makes one wonder how the economists could have been so far off on their estimate. Most of the jobs lost were in the manufacturing sector while the service sector added 48K. The loss in manufacturing has been telegraphed to us from the recent regional manufacturing surveys, which have declined significantly in the last few months. The ADP report now has many worried about Friday's payroll numbers.

The next report, out at 10:00 AM, also supports the recent manufacturing surveys. The Institute for Supply Management (ISM) reported U.S. manufacturing activity fell to 53.5 in May, a significant drop from 60.4 in April, making it the largest one-month decline since 1984. It is the 3rd straight month of declines and the lowest it's been since September 2009. This comes after peaking at 61.4 in February, which was a 7-year high. It also came in weaker than what most economists had expected (57.1), showing once again that most economists know how to project based on previous trends but they do not know how to forecast and universally miss important turns. The employment index also fell, from 62.7 in April to 58.2 in May, supporting ADP's dismal report.

A reading over 50 for the ISM indicates expansion but it's the rate of expansion that has been slowing. Just as we were getting a lot of "less bad" reports in 2009 we're now getting "less good". The market is always eager to accept the "less bad" and rally on that news but is reluctant to accept "less good" news (as witnessed with yesterday's rally even on bad news). Hope still rules over fear but when fear takes front and center that's when the stock market typically reacts harshly. Today's reversal of the past week's decline is witness to that.

This latest ISM report mirrors what we've been seeing from the regional reports from Philadelphia, New York and Chicago, all of which showed a sharp slowdown in growth last month. And the U.S. is not alone in its slowdown. Once again we're seeing the global economies attached at the hip. While the U.S. and Europe are slowing more significantly, especially Europe, China's latest PMI showed the slowest pace of expansion in nine months. The Euro area has fallen to a 7-month low. Russia's manufacturing growth is "near stagnation" according to HSBC Holdings, citing data from Markit. Japan's earthquake-related damage has probably already tipped them back into a recession. The U.K.'s factory gauge is at its lowest level since September 2009. Australia has slowed the most since 1991, thanks in part to their disastrous floods which have hurt exports. But their drop in exports can also be attributed to the slowdown in world economies, including China's.

Much of the supposed growth in the U.S. is questionable anyway. While we've seen GDP growth that looks respectable, much of that growth is dependent on other government numbers that are, well, let's just say they're suspect. Even the inflation adjustment to GDP, if properly accounted for, would very likely show negative GDP instead of positive. For this reason the regional surveys and employment (non)growth are probably far more important signals than any government report right now. In a nutshell, if a report comes from the government it is not to be trusted. I know that sounds like conspiracy theory but the facts back up my opinion. The government is all about self preservation (politicians lying so they can keep their jobs). There's a reason we all smirk when we hear "I'm from the government and I'm here to help."

While high oil prices get much of the blame for the economic weakness, not to mention weather-related (or earthquake/tsunami) damage, there is also the problem with massive debt. The U.S. government is not in a position to flood the economy with more spending, which is largely responsible for any hint of GDP growth over the past two years (and it can easily be argued that government spending is actually detrimental to economic health, except for perhaps some of the spending such as on infrastructure). This is true for most global economies right now. European countries have massive sovereign debts to deal with and that's probably going to result in some form of debt destruction, a part of the global deflationary cycle we're still in.

Yesterday's excuse du jour for the rally was the agreement to fund Greece rather than require them to restructure at least a portion of their debt. "Total restructuring" is out but we don't know yet about "soft restructuring" or "partial reprofiling" or some other term that will be invented in place of "default". Heaven forbid we should tell everyone what they already know will happen. They might scare the sheeple if we let them know that Greece (and Portugal, Italy, Ireland and Spain) will need to "restructure" their loans. Greece's debt received another downgrade from Moody's today, from B1 to Caa1, saying their debt stands a 50% chance of failure. It's as if they wanted to tell the European bankers that they can run but they cannot hide.

The ECB (European Central Bank), which is of course on the hook for loans to Greece and other countries flirting with default, is in worse shape than Lehman Brothers just before they collapsed and the only way for them to get out from under their debt load is to pawn, um, I mean, sell their assets to the private market. Yea, good luck with that. The massive sovereign debt will have to be paid down or it will go into default, which is all part of the debt destruction cycle we're in. My bet is on the latter.

Yesterday the market ignored all this information from Europe (it had an end-of-month agenda) and rallied strong. In last night's update on the Market Monitor I had mentioned that it was imperative that the bulls kept yesterday's rally alive today, which they clearly did not. Indexes closed at resistance and a move back down, especially if it was to be a gap down (which it was) would leave bearish candlestick patterns and a kiss goodbye at resistance. We've got a whippy market right now and anything goes, especially when we throw in the unknown such as government intervention, but tonight's chart patterns leave a bearish taste in one's mouth.

In hindsight, which always makes trading easier (wink), it was clear that we should have moved strongly into bearish positions before yesterday's close. What could have clued us to do that? The new moon of course. While it's always fun to watch the moon phases and the stock market reaction (if any), today's new moon certainly coincided with a major stock market reversal. My MPTS (Moon Phase Trading System) set up a very profitable trade for today. The next potential reversal is June 15th, a full moon and total lunar eclipse. I'll discuss this at the end of tonight's newsletter as just something we'll watch as we get closer to mid month. In the meantime, the reversal off the high at the new moon appears to be a common event. If the common pattern holds we'll see a decline into the full moon on June 15th and then a reversal.

S&P 500, SPX, Daily chart with MPTS

The Russell 2000 small cap index (RUT) seems to be leading the way, up and down, so we'll start with it tonight and review its charts from the weekly on down. As I'll show in the shorter-term charts, the setup for the RUT was particularly bearish at yesterday's close and the bears capitalized on it today. The weekly chart below shows price bounced off last week's low at an internal parallel uptrend line within the parallel up-channel from March 2009. It bounced up to the broken uptrend line from August but is currently showing a big red candle at that line of resistance. If the market manages to rally into a mid-June turn window we could see it at least test the May 2nd high before finishing its rally. The risk for longs is that the rally is already over.

Russell-2000, RUT, Weekly chart

The daily chart below shows yesterday's rally finished marginally above its broken uptrend line from August-March (thanks to a final spurt higher into the close). Today's decline is larger than we've seen since August 2010 and the psychological damage alone is going to be hard to turn around, especially this time of year. The drop back below the downtrend line from May 2nd is another notch in the bear's gun. For an idea I'm considering for a wave count there is a downside target near 795 before expecting a bounce/consolidation. The more bearish risk is as steeper decline from here that breaks the March low before getting any kind of sizable bounce. It takes a rally back above 848 to negate the bearish price pattern.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 848
- bearish below 816

The wave count idea that I mentioned for the daily chart is shown more closely in the chart below. It's been a choppy move down, filled with 3-wave moves. The setup into yesterday's close was for an upside target at 846.65, which was achieved just before the close. That projection is for an expanded flat a-b-c correction off the May 17th low where the b-wave dropped to a minor new low (on May 24th) and the c-wave (the rally to yesterday's high) was 162% of the a-wave, a very common projection for this kind of pattern. Another a-b-c move down that equals the first one (May 2-17) is where I got the 795 downside target on the daily chart. So it will be a level to watch if reached. In the meantime, look for a relief bounce as a shorting opportunity. If it bounces back above 843 back away from the short side.

Russell-2000, RUT, 120-min chart

Similar to the RUT, yesterday's bounce for SPX took it up to its previously broken uptrend line from August-March, closing slightly above it but at the top of its parallel down-channel from May 2nd. The down-channel looks like a bull flag and could still be so respect that possibility if you're short the market. But today's decline looks very sharp and strong to be part of a bull flag pattern so I'd look at a bounce back up to resistance, such as its 50-dma near 1331, as a shorting opportunity. If it falls out of bed here and drops below the bottom of the flag it will be very bearish -- a failed pattern (bull flag) tends to fail hard. A similar downside projection for SPX as explained for the RUT (to 795) is near the April 18th low at 1294.70.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1345
- bearish below 1331

The head-fake break above the downtrend line from May 2nd is very clear on the chart below. The strong break back below the line is clearly bearish. I'm showing a bounce up to the downtrend line and broken uptrend line from August-March (which is a different position than shown on the daily chart above because I'm using the arithmetic price scale below) tomorrow but that's obviously just a guess. But that trendline cross in combination with the 50-dma near 1331 will be formidable resistance if tested (i.e., a good shorting opportunity).

S&P 500, SPX, 120-min chart

The DOW had also rallied to the top of its flag pattern yesterday and failed miserably. It almost dropped to the bottom of the flag today. If it continues to hold then the bullish potential remains but if the DOW breaks below the flag, near 12230 tomorrow, get short and hang on. If it manages to bounce back up to its 50-dma near 12456 watch for a weakening of the bounce to try shorting it.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,575
- bearish below 12,450

NDX has been in a much sloppier price pattern and has been more difficult for me to get a bead on (as far as price levels to watch). For now it looks bearish below 2346 (50-dma and broken uptrend line from March) and bullish above 2375.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2375
- bearish below 2346

The larger indexes are in full agreement with the other major indexes here. DWC had bounced up to the top of its flag pattern and its broken uptrend line from August-March. Today's sharp decline leaves a bearish kiss at those lines of resistance. The sharp decline back below the 50-dma is going to scare away fund managers, especially as we enter the 2nd worst month of the year.

Total Market Index, DWC, Daily chart

The NYSE has been playing with two uptrend lines -- one from March 2009 through the July 2010 low and the other from August-March. You can see below how price has reacted to both trend lines since May 12th. Today's clear failure at both lines will make it difficult to attract more buyers.

NYSE Composite index, NYA, Daily chart

For all the talk in recent months about the demise of the Treasury bonds it would seem it's falling on deaf ears. Bill Gross was out again today telling everyone that bonds are a bad buy, making me wonder if his short position is starting to hurt. It would appear that there was some rotation today from stocks into bonds, making it look like a major allocation program was in play. Happening on the 1st of the month makes a lot of sense and could be the primary reason for yesterday's rally followed by today's selloff (rally the stock market to get better selling prices to then rotate out of stocks into bonds).

With the rally in the bonds there was of course a corresponding drop in yields. TNX broke support in the 3.04%-3.07% area (50-dma and 50% retracement of the October-February rally) and it would appear TNX is now heading for the 62% retracement at 2.87%. It should be due a bounce soon (or more, especially if Bill Gross is correct) but if the stock market continues to decline we could see money continue to flood into the perceived safety of Treasuries.

10-year Yield, TNX, Weekly chart

Wouldn't it be ironic if TNX drops back down to 2.5% after QE2 stops? The Bernank told us he wanted to start the QE program as a way of keeping yields low to help businesses, consumers and home buyers borrow money (as a way to use the fractional reserve banking system to expand the money supply). After $600B (actually a lot more) he has nothing but higher stock and commodity markets to show for it (which is very likely what he really wanted). And just like the housing market completely reversing its gains following the government-inspired buyer credit program, so too will the stock market completely reverse the Fed-inspired gains. It's been all hype, hope and fluff. What a colossal waste of money it's been.

Not even the Bernank's pet banks have been helped by all the money printing that's been going on. The banks are so far under water with their mark-to-model assets that there's little hope for any kind of quick recovery for them. The banks will either have to recognize the losses, which would cause major bank failures if it happens, or they will be forced to carry the dead-fish inventory for years to come, holding them back from making "real" loans. The Fed's monetary programs and interventions, for decades, have been one big monetary experiment that's gone bad. The chemical stew they've mixed up has been set over the Bunsen burner to see what color flame they get. Instead I see the chemistry lab blowing up.

The banks got crushed today, with the indexes down roughly -4%. The pattern of the decline from February has been rather choppy but as shown on the BKX chart below it's been somewhat orderly inside parallel down-channels. Assuming this sector will continue to decline (follow the money if it does) I'm showing a couple of possible choppy paths it could take while staying inside the channels, finishing near 44-45 before setting up a larger bounce out of the down-channels. A break out of its larger down-channel and 50-dma near 51 is what it takes to turn the pattern bullish. Remain bearish the banks as long as BKX remains below 49.75.

KBW Bank index, BKX, Daily chart

Today's candle for the Transports looks more bearish than the DOW's -- it retraced all of the price action since May 17th in one fell swoop. From the top of its down-channel from May 2nd to the bottom of the channel. There's still the potential it will break out of the bull flag pattern but don't be long if it break down below the bottom of it instead. It's close to testing what should be strong support at its August-March uptrend line and bottom of its down-channel, which cross near 5260 tomorrow. If it bounces up to its 50-dma and then drops lower it's going to be a shorting signal.

Transportation Index, TRAN, Daily chart

The dollar's leg down from May 23rd looks like it might have finished today and that in turn should complete an a-b-c pullback from the May 16th high. If true then get ready for a strong rally in the dollar. The pullback achieved what it needed to from a sentiment perspective as most traders turned bearish the dollar again, believing it's heading for new lows. The short covering should propel it quickly above the May high. But if the bears have a little more work to do then look for support near 73.40 before starting the next rally leg.

U.S. Dollar contract, DX, Daily chart

Gold's 3-wave bounce off its May 5th low may have completed today, along with the dollar completing its low. If it heads a little higher it will improve the odds for a new high into mid June (green dashed line on its chart below). But the pattern counts well as complete at this point and if the bears take back over we should see gold drop sharply toward 1400 in June. A drop below 1510 would likely mean the new leg down has begun.

Gold continuous contract, GC, Daily chart

Silver has been more bearish than gold since the highs and today it was again more bearish. While gold popped higher for the day silver instead sold off. I expect to see more of this as silver outperforms to the downside (part of the risk-off trade). If the dollar drops further and the stock market heads back up we could see silver press a little higher to 41 (50% retracement) otherwise the top of its bounce may already be in. Look for a drop to 25, possibly lower, for the next move down.

Silver continuous contract, SI, Daily chart

The bounce pattern for oil since its May 6th low looks very similar to silver's. It has been struggling beneath its broken uptrend line from February 2009 through the August low. If the bulls can get a little more work done here we could see the 104.99 target achieved (for two equal legs up for its bounce). Regardless how you feel about the fundamentals for oil remember that fundamentals follow price, not the other way around. The chart pattern is bearish and I would not want to be long oil here. Back above 105 I'd think about it, but not here. If it starts back down it should get a bounce off its 200-dma near 91 but better support for another bounce is down near 85.

Oil continuous contract, CL, Daily chart

Tomorrow's reports should not spook the market more than it already is, unless the reports come in really bad. If anything I think the market is ready for at least a relief bounce so any positive surprises will get some short covering going. It will be Friday's payrolls report that will have the market on pins and needles.

Economic reports, summary and Key Trading Levels

There was a lot of technical damage done today and the big bearish engulfing candlesticks points to a strong reversal. We could see another reversal as part of a very whippy move higher into mid June (as part of a topping pattern) so it's not a time for bears to get complacent. This market has been spanking both sides for sitting in a trade too long and there's nothing that says that's going to stop. But at the moment it's looking like the bears mean business and intend to take full advantage of fund managers wanting to liquidate some inventory.

The first reaction in looking at most of the daily charts is that we're in large bull flag patterns. These need to be respected by the bears since price has not violated them. Many traders are going to be buying the dip based on the bullish pattern. But look out below if price breaks down from these flag patterns so don't be buying any more dips if that happens.

Before today's collapse I thought there was a decent chance for a new high into mid June based on some cycle studies. Some longer-term cycles are already starting to put some downward pressure on the market so we could see an early reversal but a couple of studies point to June 13-15 as a particularly interesting time. So again, for the bears, remain a little cautious until this plays out. If we get the new high I think it will be a monster short play setup but we'll have to see what happens between now and then. Currently it's not looking like we'll get a new high and it's possible we'll get a reversal off a low instead.

In addition to the cycle studies we'll have a full moon on June 15th. At the same time we'll have a total lunar eclipse. A guy by the name of Steven Puetz, who made many stock market predictions in the past, had discussed the full moon/total lunar eclipse event as the setup for a potential market crash. He emphasized that this alone doesn't predict a market crash but he made note of past crashes happening around the same event. He postulated that it might cause a "rapid transformation of investor psychology from manic greed to paranoia."

Puetz looked at 8 previous crashes starting from the Tulip Mania in 1637 through the Nikkei crash in 1990 and found they were lumped together near full moons that are also lunar eclipses. For this year that will be on June 15th and December 10th. He noted that once the panic starts it generally lasts from two to four weeks. The tendency has been for the markets to peak a few days ahead of the full moon, move flat to slightly lower, waiting for the full moon to pass. Then on the day of the full moon or slightly after, the brunt of the crash hits the marketplace.

So we'll watch over the next two weeks how this sets up but I thought it interesting enough to pass on. For the short term I don't know if it means we should look for another rally to set it up or if instead it might mean a stock market reversal from a low. Or perhaps gold will rally into the turn window. We can only speculate from here but I'll update this picture next week.

In the meantime, volatility has picked up so be careful -- both sides are getting whipsawed right now. Good luck and I'll be back with you next Wednesday.

Key Levels for SPX:
- bullish above 1345
- bearish below 1331

Key Levels for DOW:
- bullish above 12,575
- bearish below 12,450

Key Levels for NDX:
- bullish above 2375
- bearish below 2346

Key Levels for RUT:
- bullish above 848
- bearish below 816

Keene H. Little, CMT