Dark clouds over Spain and the threat of more storms has caused the next round of liquidation of stocks and accumulation of bonds. Money also is leaving the euro and flooding into the dollar. How long this will continue is the big question.

Market Stats

The euro got hammered today as money left it and ran to the relative safety of the dollar. The euro is deeply oversold and the dollar is deeply overbought, each begging for some relief. But we know oversold/bought conditions can last far longer than we think is possible.

Money is also leaving the stock market and heading for the relative safety of bonds. U.S. Treasuries are the beneficiaries of allocation programs as well as money flooding into the U.S. from Europe. The 10-year yield is at multi-decade lows and could be heading lower still (1.62% today). There is currently a lot of fear in the market but surprisingly little is being registered by the VIX, which did close higher today, up nearly +15% to 24, but that's low when measured against highs over the past several years. In other words there's lots of room to run for both the VIX and the stock market.

With the bad news out of Spain, with its banking crisis, the equity futures were already pointing to a bad start for the day and that was not helped by the Pending Home Sales report, the only important economic report this morning. It came in at -5.5% vs. the March increase of +3.8%, which was revised higher to +4.1%. The market was expecting a small increase of +0.6%. So it was just another number to remind everyone that everything is slowing down.

The euro got pounded today because many are starting to talk about Spain leaving the euro. Spain is a very different country from Greece, with a relatively strong manufacturing base (but obviously not strong enough at the moment and hence so many unemployed who can't buy stuff and it has created a vicious cycle). They do not have the same kind of ties to the EU as France, Germany and some of the other smaller countries. The ECB doesn't have the money to bail out Spain and that could spark an earlier departure as well. And if Spain leaves it could derail the euro in a hurry.

The fear of the euro being abandoned sooner rather than later will create even more fear by those who hold the euro. Bank runs to clear out holdings in anticipation of exchanging them for some kind of devalued currency (back to the peseta for Spain, drachma for Greece) will collapse the banking system. There is no FDIC-like government organization to protect their savings and like the bank runs following the stock market crash in 1929 in the U.S., banks went into bankruptcy and many people lost their life savings.

Bank runs also become a vicious cycle of mistrust and the only way our current financial system works is through trust. If I give my bank my money I have faith that I will get it back. If a bank lends me money to buy a house they have faith that I will dutifully pay it back, either through monthly payments or when I sell the house. Businesses get letters of credit from banks overseas before they ship their products. If the trust is lost, which it was in 2008, the credit system locks up tighter than a drum. There is very little cash in the system and an worldwide credit freeze would be difficult for the central banks to overcome.

So taking money out of the banks is one way many Europeans are hedging their bets and that is making it even more difficult right now for Spanish banks to survive. Credit downgrades have been coming fast and furious and Spanish bonds yields are climbing toward the tip-over point. All of this is of course very worrying to stock market participants and worry is not a bullish thing. Worry causes selling and that's what we got today. How it fits into the larger picture is what we'll review.

As I did last week, I'm going to start off with a high-level view of the NDX and drill down to see what we should be watching for as we try to figure out the next move for the market. The NDX is one of the last holdouts for a possible new high before it too succumbs to more selling pressure. I'm not saying it will achieve a new high but only that it still maintains that potential better than the other indexes. This would not be unprecedented since it made a new high in 2007, unconfirmed by the other indexes. So while the longer-term picture is bearish I can't yet rule out the possibility for a new high in July before it too finishes its bear market rally.

Starting off with the monthly chart, it's easy to see the sharp decline off the 2000 high (the chart is scrunched and the years at the bottom run into each other so it's hard to read each year). The impulsive (5-wave) decline has been followed by a 3-wave bounce correction from 2002 to 2012 (labeled w-x-y, which is a little more complex version of the regular a-b-c). A 5-wave move followed by a 3-wave correction will be followed by another 5-wave move, down in this case. That will create a larger A-B-C pullback from the 2000 high, which is a correction to the longer-term rally from last century.

Nasdaq-100, NDX, Monthly chart

Notice the 3 attempts to push back up to the broken uptrend line from 1990 through the 2002 low. This year's high has created a reversal setup known as "3 drives to a high (or low)". You can see the bearish divergence after the first attempt in 2010. The impulsive move up into the 2000 high will be followed by a large 3-wave pullback (into 2016-2018) which will then be followed by another impulsive move up in the next secular bull market (into the 2030s). It's the basic EW (Elliott Wave) pattern. We'll have some pain (unless you like to make money on the short side) for the next few years but then a once-in-a-generation buying opportunity.

The leg up from 2009 is viewed more closely on the weekly chart below. Price has formed a rising wedge pattern between the uptrend line from 1990-2002 at the top and the uptrend line from 2009-2011 at the bottom. The bottom of the wedge is currently near its 50-week MA at 2412. The wave count for the move up from October is looking for another rally leg to complete the 5th wave. An upside projection is currently 2800-2885, which is obviously a wide target zone at the moment but if we get the rally I'll be able to start narrowing it once (if) the rally gets underway. A break below the October high near 2412 (coincidentally the same as the 50-week MA and uptrend line at the moment) would negate the bullish pattern and turn it bearish.

Nasdaq-100, NDX, Weekly chart

The small pullback on the weekly chart above is zoomed in on with the daily chart below. If NDX rallies from here and breaks out of its down-channel, confirmed with a break above 2600, it would greatly improve its chances for a higher rally into July. A 3-wave move down from April is all we currently have so a rally from here could leave it that way. But if NDX drops lower this week and into next, perhaps down to its 200-dma and uptrend line from 2009, near 2440, it will create a 5-wave move down from April and that would declare the trend as being to the downside. I would look for a bounce correction to the decline as a shorting opportunity later in June.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2600
- bearish below 2500

Now zooming in closer to the little bounce off the May 18th low, it's very choppy (corrective), which is bearish. It's pointing to the 5th wave down mentioned above. Today NDX broke its uptrend line from May 18th and then bounced back up to it this afternoon. Dropping away from here will leave a failed back test and kiss goodbye, which of course is a good trading setup to get short. The bulls need to step in here and negate the setup Thursday morning. How it will resolve to the upside from here (from a wave count perspective) but I'll worry about that later. The wave counts on a shorter-term basis are all corrective 3-wave moves and that makes it much more difficult to get a bead on direction.

Nasdaq-100, NDX, 60-min chart

When we look at our "sentiment" stock, AAPL, I see potentially bullish things. Today it rallied and closed above its inverse H&S neckline near 576. As long as it's not a head-fake break, a continuation higher would target new highs for the stock, especially since the pullback from April is only a 3-wave correction to its rally. If AAPL rallies I don't think the broader market will ignore it.

Apple Inc., AAPL, Daily chart

For SPX and the DOW I'm using the May high as THE high for the market but it could clearly be the b-wave high of an a-b-c pullback from April. If the bulls grab hold of this market and rally it from here, getting it above the April lows, then we'd have the potential for new highs with NDX. Today's pullback found support at the cross of the broken 2007-2011 downtrend line and the bottom of the up-channel from October so it's possible we'll see a resumption of the rally tomorrow. The problem is the bounce off the May 18th low -- if it looks like a correction, smells like a correction and bounces like a correction, it probably is a correction. And that says we'll get another leg down. I'm showing a leg down to test the October high near 1293 again but the risk is for a much strong decline, one that takes SPX down to the 1225 area before setting up a bigger bounce correction. So with all of this chop I'm waiting to see if the bulls can break price above 1348 or if the bears drop it below 1283. In between, beware the chops and whipsaws.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1348
- bearish below 1283

A picture of this choppy bounce is shown on its 60-min chart below. If it drops a little lower tomorrow I'll be watching for possible support at its uptrend line from May 18th, near 1305, and then a bounce to get short. But again, with all the choppy price action I can't yet rule out the possibility for a rally to a new high for the bounce, if not a much higher rally (especially if it gets much above 1354 where it would close its May 14th gap down).

S&P 500, SPX, 60-min chart

It's the same picture for the DOW and there's really no change from last week. The bottom of the up-channel from October continues to act as resistance which is clearly not bullish. I've been expecting a bounce at least up to its broken neckline, near 12700, but so far there hasn't been enough strength for that. If more selling breaks the DOW below its October high at 12284 and its 200-dma, currently at 12246, there's a good chance it will achieve its M-top price objective near 12K.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,700
- bearish below 11,280

Unlike the DOW, the RUT has been able to back test its neckline, which now coincides with its 20-dma near 778. Trend lines along its lower lows and lower highs since March show a potential descending wedge for it decline, the bottom of which crosses a price projection for the 5th wave of its decline near 714 later in June (where the 5th wave would equal the 1st wave. That would also be very close to the H&S price objective at 716. So that makes for a good downside target if that's where the market takes it. Obviously a break above its neckline would be potentially bullish but it takes a break above 807 to become convincingly bullish.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 802
- bearish below 748 and more bearish below 714

I was asked a good question earlier today: "How low can bond yields go and your commentary on what are the ramifications of such low yields?"

I see a setup for reversals as TYX tests last October's low and TNX makes a minor break but showing bullish divergence against its September low (on the weekly chart) and against its May 16th low (on the daily chart). Bonds are where scared money is currently running to but that market is getting very overcrowded. Commercial traders (smart money) are holding a large net short position (selling in bonds will result in higher bond yields). Either the commercials are only hedging other positions (entirely possible), completely wrong about the bond market, or we're soon going to see a bond rally. I would not be chasing bond prices higher here.

As to what the ramifications are, it's clear that money is running into the safety of bonds out of fear about the stock market. Stock market crashes have scared many participants out of stocks and into bonds over the past several years. This is well documented. Money from Europe is heading for the U.S. and going into Treasuries. It's what's driving the euro lower and the dollar higher. We're seeing signs of slowing in momentum but no signs of reversals yet. While I look for possible reversal levels in anticipation of catching a ride it's clear we don't want to get bloodied by catching falling knives.

As to the question how low can they go, I'd say zero, even negative when inflation if factored in. While that's said somewhat tongue-in-cheek, Germany recently sold 2-year bonds at 0% (safer place to park your money in Europe). I do see support at current yield levels but if they don't turn here then TNX could drop down to the bottom of a parallel down-channel from March, near 1.4% (from its current 1.62%).

For a look at the 10-year yield (TNX) I first want to show a monthly chart back to 1962 (that's all the data I have from ThinkorSwim). After the sharp decline from 1982 (when I bought my first house after getting out of the Navy), yields have been coming down inside a parallel down-channel since the late-1994 high. The bottom of that channel is currently near 1.25%. A trend line along the lows since 2003 is currently near 1.36%. So those are two downside targets based on trend lines. You can see the lows since the November 2008 low are showing bullish divergence.

10-year Yield, TNX, Monthly chart, 1962-present

The weekly chart below zooms in on the decline from 2010,which I'm counting as a 5-wave move down in a bullish descending wedge pattern (which has the bullish divergences supporting the interpretation. What's not clear at the moment is whether we can expect a move down from here to at least the trend line along the lows from 2003 (1.36%) or if we'll first get a bounce up to the top of the wedge, near 2.0%, before dropping down to the lower target, which will be near 1.0% by October. Or some combination of moves to achieve one of those downside targets. A break above 2% would be potentially bullish.

10-year Yield, TNX, Weekly chart

Over the weekend Richard Russell commented on the recent DOW Theory sell signal. In his update he stated "IMPORTANT --- Dow Theory -- The D-J industrial Average recorded a high of 13,279.32 on May 1, 2012. This Dow high was not confirmed by the Transports. The two averages then turned down and broke below their April lows. This action confirmed that a primary bear market is in progress -- it was a textbook bear signal."

Robert Colby has a DOW Theory tutorial that is very good and can be found at this link (an excerpt from his 820-page research book): DOW Theory. This includes a running history of signals since 1899, with the 68th and latest one being a sell signal on May 17th.

After breaking its uptrend line from March-April the TRAN bounced strongly back up to it last Friday and again yesterday. Today's selloff is bearish, no ifs, ands or buts. That's a bearish back test and a slap following the kiss goodbye. If the broader market rallies it can always pull the TRAN back up with it but right now the TRAN is on a sell signal, which is already on a DOW Theory sell signal.

Transportation Index, TRAN, Daily chart

As mentioned earlier, the dollar was on a tear to the upside today, on top of an already strong rally from May 1st. It's clearly overbought but there's still some upside potential when looking at the daily chart. The 2nd leg of the rally from March would achieve 162% of the 1st leg at 83.58, about 40 cents above today's high. A trend line along the highs from October and January currently crosses a price projection at 84.29. If fear of a collapse of the euro continue we could see the dollar go ballistic on us as money rushes into its relative safety (I'd like to know where money is going to hide when the U.S. has to deal with its fiscal crisis; maybe the yuan? Singaporean dollar?). As for the next month or two I do see the possibility for a reversal of the rally from May for a big A-B-C correction off the January high before heading higher again but I think the more likely scenario is a pullback to correct some portion of the rally from May 1st and then higher again (bold green path).

U.S. Dollar contract, DX, Daily chart

Looking closer at the dollar, today's rally popped a little above a small rising wedge from Tuesday as well as the top of a larger rising wedge, running from the May 16th high. If the dollar starts back down on Thursday it will leave a little throw-over finish and a possible completion to a 5-wave move up from May 1st. That would lead to at least a larger pullback into June before heading higher in July.

U.S. Dollar contract, DX, 60-min all-hours chart

Keeping gold's move in perspective, the monthly chart below shows a parallel up-channel from 2001 and a small parallel down-channel from its September 2011 high. Obviously the pullback hasn't amounted to much and yet the bullish sentiment on gold has completely flipped around to where the latest DSI reading that I saw shows about 10% bulls. What a fickle bunch. The sentiment data says gold bears need to be careful since that much bearish sentiment makes it ripe for a rally, especially since commercial traders have a large net long position. However, that net long position is subject to hedging and therefore is not always an accurate gauge. The downside potential for gold is the cross of the bottoms of the two channels, near 1350 in July.

Gold continuous contract, GC, Monthly chart

The move down from September 2011 has been choppy and therefore the EW corrective wave count is subject to change. But at the moment I think gold will head lower into July. I show a bounce first into early June, perhaps up to its downtrend line from February, currently near 1610, before heading lower again. It could simply continue lower from here but the choppy pullback from last week suggests a bounce first. Above 1625 would make me more bullish on gold.

Gold continuous contract, GC, Daily chart

Oil got hammered today, down -3.30 (-3.6%) to 87.46. The last time it saw this level was in October as it was rebounding from the 74.95 low in October. From a wave count perspective the leg down from May 1st can be counted as complete although it looks like it has at least a minor new low to finish. From a trendline perspective I see better support a little lower near 85.40 where it would tag its uptrend line from February 2009 through last October's low. But that might be good for just a multi-week bounce before heading lower again to its 200-week MA near 81 before we see a higher bounce in crude. I am expecting to see much lower prices after the summer and into 2013, as depicted on its weekly chart.

Oil continuous contract, CL, Weekly chart

One index that is very bearish, and certainly an indication of a global economy that is contracting, is the commodity index (CRB). Its weekly chart below shows it recently broken support near 293, which was the high in January 2010 and then lows in November 2010 and again in October and December 2011. The break of support is significant and note that the break of the January 2010 high, labeled wave A, means the bounce off the February 2009 low has been left as a 3-wave move, which is a correction to its 2008 decline. That sharp impulsive 5-wave decline, followed by a 3-wave correction, will be followed by another 5-wave move down. That means back below the 2009 low (which several foreign stock indexes have already done). This is a BIG negative warning for us to dutifully note. While it's possible an index or two MIGHT make a new high this year, that upside potential is dwarfed by the downside risk. This one chart below is why you do not want to be exposed to the stock market.

Commodity index, CRB, Weekly chart

If the bond market is too risky, as well as the commodities and real estate, where does one park one's money (especially all the money you're going to make on the short side of this market)? Cash. Literally cash. Find a safe bank (most are not safe) and park it in a bank CD or a savings account. Hide some in envelopes in the house. In a deflationary environment cash will increase in value whereas all else will decrease. It's a good thing to think about as far as "diversifying" your holdings.

Tomorrow morning will be busy with economic reports and Friday will be the busiest, and most important, day of the week. Thursday morning we'll get the ADP employment report and the Challenger Job Cuts report. GDP and the Chicago PMI will also be important numbers. The unemployment numbers (the numbers that no one trusts) will also be out before the bell. Friday's reports include the nonfarm payroll reports, earnings, income and spending levels, ISM, Construction spending and auto/truck sales. Depending on how the market is already reacting to Europe will determine what kind of reaction these reports might elicit.

Economic reports, summary and Key Trading Levels

All of the choppy price action since April/May (lots of 3-wave moves) leaves the direction of the market up for grabs and I'm not sure who can jump higher here, the bulls or the bears, to grab the ball. The key levels are a little wide at the moment and that's in an effort to keep away from the chop zone we're currently in. If we drop to a new low in the coming week it could be more of a test of the May low or it could drop hard into mid June before it will be ready for a bounce back up to current levels (and then roll over hard). Watch for bearish divergences at new/tested lows since a higher bounce would be a very good trading opportunity on the long side.

If the market starts back up from here, presumably on good news out of Europe, it could go strong or it could quickly run into resistance and roll right back over. A break of the key levels to the upside will add confidence to being long but all trades must be monitored closely since we could be close to a bigger move and I'd rather miss it than be caught on the wrong side of it following a big gap move. Live to trade another day, not necessarily today. Sitting it out for a period of time is sometimes the best way to trade.

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

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying