The sellers hit the market a little more this morning but the bulls bought the dip and drove the indexes back to the flat line this afternoon, helped by Fed minutes showing an inclination towards further monetary easing.

Market Stats

The techs got most of the love today, thanks mostly to AAPL, GOOG, AMZN, PCLN and a couple of other big-cap tech stocks. It's becoming a narrower-breadth market, as I'll get into a little bit, so while the market can continue higher in the face of indicators and sentiment that tell us to expect a reversal, it's important to recognize what the trend is and it's still up. As traders, we try to anticipate when the leaks (waning market breadth) in the dike will turn into a sudden break of the dike (downside disconnect) so that we can get our personal belongings (stock holdings) to safety (cash) before the break. And for those of us who like to play the short side, catching the wave following the break can be an exciting ride.

One market breadth indicator is the advance-decline line, which measures the number of advancers minus decliners. It is a good indicator to show the strength of a move. When you see new price lows for NYSE that are accompanied by less negative a-d values you know the momentum is waning -- fewer stocks are being sold off with the index. It's the same in a rally but reversed. A rally to new highs that is showing a lower a-d line with each new high provides a warning that the rally is happening on the backs of fewer and fewer stocks in the index.

As the chart below shows, the NYSE has been making new highs since July 3rd but the a-d peaks have been lower, which creates a bearish divergence against price. The divergence is especially dramatic at the recent high on August 16th and there wasn't even a lower high for yesterday's new price high (because of the intraday reversal). Even today's numbers show the weakness -- as you can see in the table above, the decliners outnumbered advancers by a factor of 1.5 while indexes closed near the flat line, thanks to only a few strong stocks today (AAPL's bounce for example). Price can continue higher in the face of this but it's a clear warning to bulls -- trade carefully on the long side if you must.

NYSE vs. Advance-Decline line, Daily chart

It was relatively quiet in the market today and even the VIX showed little concern, closing up only +0.09. There were no market-moving economic reports and even the existing home sales number, at 4.47M, was neutral, coming in a little better than June but not quite as good as expected. The market waited for most of the day to get the FOMC minutes released at 14:00, which mentioned more Fed members favor additional quantitative easing if the economy is in need of it. This is of course more jawboning since saying they won't do anything more, even if the economy is turning south, would be the last thing I'd expect to hear. Therefore there was nothing new in the minutes and the initial reaction was a little ho-hum. But the DOW was able to erase about 60 points of the day's loss before selling off 20 points into the close, finishing down about 30 points.

The important part of the minutes stated, "A number of [members] indicated that additional accommodation could help foster a more rapid improvement in labor market conditions in an environment in which price pressures were likely to be subdued. Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery." Since very few see a "substantial and sustainable strengthening" in the economy over the next few months we've got most believing the Fed will announce some kind of easing program. In a little bit I'll show the setup in Treasuries and how it supports the idea that the Fed will announce something that will be bullish for bonds but not necessarily for stocks.

Since I discussed the NYSE above, I'll start with a review of its weekly chart. There is an A-B-C rally from March 2009 up to the May 2011 high, a pullback to the October 2011 low, followed by another a-b-c rally up to the lower high in March, a pullback to June 4th and now another smaller a-b-c rally into yesterday's high. So we have a fractal pattern in the bounces and as shown on its chart, we have two H&S tops that also display a fractal pattern. The larger H&S top has the left shoulder in April 2010 and a higher right shoulder in March 2012. For the right shoulder there is a smaller H&S top with the left shoulder in October 2011 and a higher right shoulder into yesterday's high. Each leg up into the head of the H&S tops is of the same a-b-c form. In addition to these patterns pointing the index south in a big way, yesterday's high tagged its downtrend line from 2007-2011 so a failure here could start a big decline into the end of the year.

NYSE Composite index, NYA, Weekly chart

Moving over to the SPX, I'll start tonight's review with a longer-term view of the SPX weekly chart, showing the rally off the March 2009 low. I've updated the wave count to accommodate this week's new high above April's, confirming what had been speculation last week. The rally off the June low is obviously now part of the larger bounce pattern off the March 2009 low instead of just a correction of the April-June decline. This interpretation means there's additional upside potential to the top of the rising wedge pattern from the October 2011 low and that the rally from June can be considered the 5th wave of the rising wedge for the move up from June 2010. This 5th wave might have finished on Tuesday or it could chop a little higher into September (the top of the wedge is near 1450) before the completion of the rally.

The bulls need to defend the uptrend line from October 2011, currently way down near 1320. At the moment SPX has stalled at the top of its parallel down-channel for price action since the October 2002 low and October 2007 high (dark blue line on the chart). The double top with April is showing bearish divergence, adding to the bearish picture, here and now, but on a weekly basis you can see a move to 1450 would not be difficult to accomplish.

S&P 500, SPX, Weekly chart

Yesterday's intraday reversal left a bearish shooting star for the candlestick but closed at support at the top of its parallel down-channel. Today it broke below the trend line but the afternoon reversal brought it back up to it, near 1413. So it's clearly trying to hold the line. At today's low it tested its uptrend line from July 24th and held, which is now near 1411. That's why a drop below today's low at 1406.78 would confirm the break of its uptrend line and the next test would be its 20-dma heading up to 1400. Back above 1426 would have me looking for at least 1437 if not 1450.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1426
- bearish below 1397

The Fed minutes released at 14:00 show the Fed stands ready to do what it takes to push the market higher, I mean help improve the economy. This gave a bounce to the market and SPX retraced almost 50% of its decline into today's midday low. A 62% retracement would take it up to 1419. A higher bounce into tomorrow morning could have it retesting its April high near 1422 and potentially the bottom of its little up-channel from August 14th, near 1424. There remains the potential for one more rally leg up to the 1440 area if the market starts believing more firmly that the Fed (and ECB) will spill a few trillion more dollars/euros into the monetary system. There's also an important Gann Square of Nine number at 1437, which is six squares away from the 666 low in March 2009 the same relationship between the October 2002 low at 768 and the October 2007 high at 1576. So as long as today's low at 1406.78 holds we're still in an uptrend and there are a few reasons why 1437-1440 could happen before the bull is finished.

But the bearish setup is for a bounce correction to a lower high and then a stronger decline. If the bounce off today's low is followed by a break lower it would also be a confirmed break of its uptrend line from July 24th and leave little question in my mind at that point that the top is in place. Hopefully we'll have our answer very soon, potentially tomorrow (Thursday).

S&P 500, SPX, 60-min chart

Yesterday the DOW broke its uptrend line from July 24th but RSI has not done the same yet. There remains upside potential to the price projections coinciding near 13386, which could coincide with a back test of its broken uptrend line next week. But a drop below 13094 would be more immediately bearish.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 13,386
- bearish below 13,094

It's a little hard to see on the NDX chart below but yesterday's decline was to its uptrend line from July 24th and this morning's decline was a break of the line. The afternoon bounce brought it back up to the trend line, a setup for a bearish kiss goodbye if tomorrow sells off. A continuation higher would target 2841 where the c-wave of an A-B-C bounce off the June 4th low would equal 162% of the a-wave.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2803
- bearish below 2704

Following up on last week's update on the semiconductor index (SOX), which showed a break of its uptrend line from July 23rd, it rallied Thursday to a new high and tested the broken uptrend line and tested its broken uptrend line from October-December 2011 again. The decline from there looks corrective and therefore I can't rule out another rally attempt (red dashed line), potentially up to the 412 projection. It takes a drop below 397 to put the bears more firmly in control of this index.

Semiconductor index, SOX, Daily chart

As I've mentioned in the past, a good sentiment stock is AAPL and so far we've got a bearish setup from a contrarian perspective as most analysts have turned bullish on the stock. When it rallied above April's high on Monday several analysts were tripping over themselves with some very bullish calls, including one for $1,111 to make it a trillion-dollar company. But a chart that Larry Williams posted, showing the percentage of bullish vs. bearish AAPL analysts, shows that the bullish sentiment has now hit the area of previous tops for AAPL so yesterday's key reversal is potentially important. But as we've seen multiple times in the past, key reversals have often been reversed again and today's high bounce could lead to another push higher. Larry Williams wrote "As I see it, Key Reversals are most often false and of precious little value." So we've got a setup for a reversal but it means it must reverse today's bounce and immediately head lower Thursday morning. For now I'd say short below 675 and long above it (although I'd be very careful about the long side right now).

AAPL Advisory Sentiment Index, chart courtesy Larry Williams

AAPL is of course the largest driver in the NDX. As goes AAPL (and the SOX) so goes NDX, which in turn either turns on or off the risk-on mentality of traders. In a yahoo headline this morning, Jeff Macke talked about AAPL's reversal signaling a mood shift underway (Mood Change). The more traders hear this kind of stuff the more nervous they'll become, especially if today's big bounce is reversed and the dip buyers get punched out of their positions.

So let's walk through AAPL, starting with its monthly chart to get some perspective. The monthly chart below shows a 5-wave move up from its low in 1997, in arguably a bearish rising wedge pattern, although admittedly its rally from $3 to $675 could hardly be called bearish (wink). From a pure price perspective, it remains potentially bullish as long as it stays on top of the rising wedge, which is the trend line along the highs from 2000 and late 2007, currently near 565. As noted on the chart, the completion of a 5-wave move calls for a correction of that move and the bearish divergence between the 3rd and 5th waves lends credence to the wave count. Even a relatively small 38% retracement would mean AAPL will eventually pull back to 418 and look like only a minor hiccup along the way to much higher levels. A 50% retracement would drop it down to 339.

Apple Inc., AAPL, Monthly chart

The weekly chart zooms in on the leg up from January 2009, which is the 5th wave on the monthly chart. It too needs to be a 5-wave move, which I have labeled as wave (i) through (v) into the April high. That high was followed by wave-a down into May, wave-b into yesterday's high (at least that's the current setup) and now looking for wave-c down. I'm showing what would be a typical correction, although I use that term loosely – it's an oxymoron when it comes to corrective wave structures. I'm projecting for now an a-b-c pullback into October to complete a larger-degree wave-A that will find support in the 490-500 area (Fib projection and bottom of the up-channel from May 2010). It will then be set up for a big bounce into the end of the year to complete wave-B, perhaps back up to the 600 area to get the bulls all fired up again (surviving another “dip”), which will be followed by a stronger decline into early 2013 for wave-C, which in turn would complete the next larger-degree wave-(a), and so on. Obviously this is pure speculation how a correction might play out but again, the 5-wave move up from 1997 requires a multi-year price correction. I think all the juice has been squeezed out of this one.

Apple Inc., AAPL, Weekly chart

The daily chart below zooms in on the a-b-c pullback pattern from the April high. In past updates I discussed the 127% extension of the a-wave (the April-May decline) at 675.37 and mentioned it will be resistance if the rally from May is only part of a larger corrective pattern (expanded flat a-b-c correction) and not a new bull leg up. This 127% extension of a previous leg (the April-May decline) is an important Fib to watch for a reversal -- if it doesn't reverse there then you know it's more bullish (works in reverse as well). For the leg up from July I had been looking at 646.65 which is where the 5th wave of the move would equal the 1st through 3rd waves (common for an extended 5th wave). Instead it really extended and hit the 162% projection, which "coincidentally" was only 5 cents away from the other 675 extension. That 675 line was a solid wall and its high at 674.88 was certainly close enough to the target price. Now we'll see if the bears take over or get kicked to the side again.

Apple Inc., AAPL, Daily chart

The other sentiment index, the RUT, was leading to the upside as fund managers were positioning for an unquestioned rally. The risk-on trade has been alive and well over the past week. If the market has topped and those same fund managers start to worry they got sucked into a rally that starts to vaporize we'll see the RUT leading the way lower as risk-off becomes the trade of choice (blue chips and Treasuries being the recipients of funds).

The RUT's move up from July 24th counts well as a completed 5-wave move in a rising wedge for an ending diagonal c-wave (to complete an a-b-c bounce off its June 4th low). A break of its uptrend line from August 2nd, which is the bottom of its rising wedge, would be the first sell signal. The line, near 813 this morning, was broken but then recovered this afternoon. As with the others, that makes today's low important for the bulls to defend.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 827
- bearish below 791

Lastly, from a sentiment picture, Mark Hulbert wrote an article today in MarketWatch (May-June correction was a failure) about how his sentiment indicators are flashing warning signs to the bulls. This is especially true for tech stocks that are showing double the percentage of bullish short-term advisors, at 58.8%, than where it was at the May 2011 high. Lower price and double the bullish percentage -- a scary combination that will likely not play out in the bull's favor. As Hulbert says, "These sentiment comparisons show that the stock market's May-June correction failed to do what corrections are supposed to do -- wring some of the optimism and enthusiasm out of the market, thereby giving it better odds of rallying to a new high after recovering from the correction."

Treasury yields are at an important point and should help point the way from here for the stock market. If stocks sell off we'll probably see another flood of money into Treasuries as a defensive play. That would knock yields lower and that's the current setup. TNX made it up to its downtrend line from 2011 as well as its 200-dma at 1.86% with Tuesday's high of 1.86%. Today's gap down could be the start of the next leg down, especially with the afternoon rally in bonds following the FOMC minutes. Bond players are assuming the monetary easing will be bond purchasing but it would clearly be bullish for TNX (bearish bond prices) if it rallies above 1.87% (although there would be the possibility for a bearish interpretation, which I'll cover if and when TNX makes a new high). The setup here is for TNX to make it down to below 1% by November, which also may result from the Fed stating they'll be continuing their bond-buying program with something like Operation Twist II and thereby support more buying in Treasuries.

For some time I've been thinking we'll see TNX below 1% before it puts in a final bottom. This is supported by a long-term wave count calling for one more leg down to complete an a-b-c decline from March 2012. The bounce correction off its June 1st low fits as the b-wave, which stopped at its downtrend line from April 2011 and its 200-dma, should be followed by another leg down to complete wave-c and the projection is down to 0.906% if we're to see two equal legs down from March 2011.

10-year Yield, TNX, Weekly chart

Only slightly above the 0.906% projection are two important trend lines (one is the bottom of a descending wedge pattern and the other is the bottom of a parallel down-channel from 1994) that cross near 0.94% in mid-November. So the setup is here and I can only guess what the Fed might do but the chart pattern suggests Bernanke will announce something positive for bond prices, which in turn could hurt stocks and keep TNX and stock indexes in synch at least through this year.

One side note on the chart above, MACD has bounced back up toward the zero line from its June low, relieving some of the oversold condition. More often than not I've seen MACD act as a very good buy/sell indicator around the zero line and a bounce back to it and rollover would create a sell signal. This of course can be done on any time frame and is a good tool to use.

The banks had a bullish day yesterday but then gave it all back and BIX had a flaming shooting star at resistance (its downtrend line from 2010). The banks got a bigger bounce this morning but again gave it back and BIX closed firmly below its downtrend line. As you can on its chart, this downtrend line was tested in May and multiple times in July and August. The market thinks this line is important and a failure after multiple attempts like will almost always lead to a reversal (down in this case). A break below 157 would be the first solid indication the bears are starting to really growl but obviously it would be more bullish if it can get above 160 and stay above.

S&P Banks index, BIX, Daily chart

The dollar has now dropped to the bottom of a bullish descending wedge pattern for its pullback from July 24th, and close to its June 19th low at 81.39. That could set up the start of another rally leg, assuming the pullback is just a correction of the larger rally, but ideally the descending wedge needs one more up-down sequence to finish it. That could coincide with a test of its uptrend line from August 2011 at the end of the month.

U.S. Dollar contract, DX, Daily chart

Gold broke out of its sideways triangle pattern that I've been tracking for a while so that's clearly not the correct pattern. But it banged its head on the downtrend line from September 2011 and it's possible its bounce off the May low has now finished. Otherwise a climb up to the top of a parallel up-channel from May, currently near 1680, could be the coming move. The bottom line is that the bounce off the May low remains corrective and therefore will be completely retraced. The hard part here is identifying where it will top out. Below 1586 would be bearish and above 1680 would be bullish.

Gold continuous contract, GC, Daily chart

Oil is working its way higher to the price projection at 99.51 where an a-b-c move up from August 2nd would achieve two equal legs and complete a double zigzag wave bounce for the bounce off the June 28th low. Currently its rally has been stopped by the 62% retracement of its March-June decline, at 97.84 (yesterday's high was 97.85). Oil should be close to topping out, if it hasn't already done so, and start the next major leg down.

Oil continuous contract, CL, Daily chart

There are not expected to be any market-moving economic reports Thursday morning so the market will be at the whim of overseas news and/or rumors. Maybe there will be some "leaks" about the ECB supporting the monetary easing as the Fed minutes indicated.

Economic reports, summary and Key Trading Levels

Tuesday's highs and lows for the various stock indexes, bonds and commodity indexes are in synch for a significant reversal of trends we've been in for the past couple of months. Price is king and that's what we have to abide by so we'll know soon if the reversals off Tuesday's highs and lows will stick. For the stock market we have a very good setup for the bears but they'll need to step back in on Thursday and not let the bounce off today's low get much further, especially for AAPL, which is close to testing Tuesday's high. If the high is now in place we'll see a bounce to a lower high for the indexes followed by a break of today's lows. That would be the green light for the bears to start storming the market.

As bearish as I am about the stock market, based on a multitude of factors, one thing that has my attention and will keep me cautious and constantly checking for bullish indications in a pullback, is the pattern for the Democratic Presidential election cycle as shown with the chart below. This pattern calls for a fairly strong rally into October before it succumbs to selling pressure. I don't see this possibility this year but if most traders believe it and continue buying it, especially if the Fed feeds it, I certainly don't want to fight it. So bears need to keep this in mind as we start looking to short the market.

Democratic Presidential Election Cycle, chart courtesy mcoscillator.com

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