The exuberant rally on September 13-14, following the Fed's QE-Infinity announcement, has now been erased. It's been a slow sell-the-news reaction but clearly the market is now wondering what can power it higher.

Market Stats

Following Tuesday's decline the stock market continued a little lower today. The tech indexes were hit a little harder as AAPL continues to take a hit following the rally into expected good news from its iPhone 5 sales. Now it's looking like AAPL might find it difficult to source the parts it needs for the phones and that has investors worried about quarter-end results. Additionally there are complaints (Google maps primarily) that appears to have taken the bloom off the rose. Buy the rumor, sell the news, appears to once again be the reaction around AAPL's product announcements.

U.S. indexes started the day in the red after European indexes dropped lower on concerns about, what else, bailouts. The Spanish IBEX fell almost -4% on concerns that the Spanish government might hold back on asking for enough funds to recapitalize their banks. The austerity measures required to get the funding, and the Spanish citizens' reaction to these measures, has the government concerned. The newly elected Prime Minister Rajoy is already dealing with some of the regions calling for new elections. Once again, as with the Fed, we may find there is more money being offered than will be taken, foiling the attempts of the central banks to flood the system with more money.

Tuesday morning we heard news that lawyers for the ECB and German Bundesbank were looking into whether or not the ECB's proposal for Open Monetary Transactions (or OMTs) broke the central bank's mandate. This is adding to the concerns about Europe's debt crisis and as the German newspaper Bild reported, Bundesbank is preparing a lawsuit against the ECB, claiming that the central bank is overstepping its mandate in launching the latest round of bond purchases. The ECB plan is still just that -- a plan that has yet to be implemented and obviously the stock market's rally in anticipation of more European bailouts would be in jeopardy if the plan starts to fall apart. We all know the stock market is not rallying on fundamental economic strength.

Countries are preparing to submit aid requests to the EU, with Spain being the first test case, to initiate the bailout program. Greece is of course in perpetual begging mode now. But Greece is in really bad shape -- they have missed budget targets by a wide margin and their need for more money continues to grow. The only way for Greece to get more money is for the EU to not demand as much in austerity sacrifices as has been demanded in the past. Greek citizens are more than fed up with austerity measures and multiple strikes in the past couple of days have effectively shut down the country.

The Spanish have also been protesting and we could see additional fireworks on Thursday once Spain releases its 2013 budget (with expected austerity measures to appease the European troika). We can expect many more protests, violent ones since anger is building, as the countries needing loans deal with the requirements of the troika (for basically more austerity measures). The ECB plan might not get off the ground unless they back off on demands for austerity as part of the approval process for loans. But that's where Germany is putting its foot down -- they are refusing to be on the hook for more loans to countries that have little hope of paying it back. They feel, rightfully so in my opinion, that it's simply pouring good money after bad down a black hole.

Not helping the situation, in fact what's making it painfully clear that the financial situation is getting worse, is the fact that economies are slowing down. We're receiving reports on a weekly basis that the global economy is sliding back down the hill. The effort by global central banks to pump up the money supply was only able to do increase manufacturing supply but not the demand. People are not in a spending mood when they see inflation eating away their declining income.

Reports out of China, Europe and the U.S. point to a slowing manufacturing sector (and the Transportation index if reflecting this). Global growth is essentially collapsing after the spike to the upside following the massive liquidity injections by central banks around the world in 2009-2010. The chart below shows the year-over-year percentage change in global growth rates and the decline from 2010-2011 now exceeds the declines in 1995-1996 and 2000-2002. And yet the U.S. stock market indexes are at multi-year highs! There's quite a disconnect between hope and reality. We've got a recession coming and where's the stock market prediction of it? So much for a smart stock market that predicts things six months ahead. We're very likely already in a recession (we never really got out of the last one) but it hasn't been "officially" recognized yet.

Global Growth Slowdown, chart courtesy Morgan Stanley

When we see this kind of economic slowdown it should come as no surprise when we hear reports from UPS and FedEx that their businesses are slowing and that they expect further slowing in the coming quarters. The Shanghai Composite index has been reflecting the global slowdown and is closing in on its November 2008 low near 1769. For the first time since January 2009 it dropped below 2000 today, before closing at 2004, and is down a little more than -67% from its 2007 high. Compare that to the U.S. indexes pushing to multi-year highs recently and trying to challenge the 2007 highs. I think China is heading for a hard landing and when they hit the ground it's going to cause an earthquake through the rest of the global economies. Don't forget, one of the reasons China is slowing down is because of lack of demand for the products they're manufacturing (in addition to not getting the volume of manufacturing business during the boom years). There's also the massive overbuilding they've been doing the past several years, as a way to keep their people busy, but that clearly can't continue much longer. They created a bubble economy and unfortunately for them we know how bubbles finish.

Another transportation measure is the Baltic Dry index (BDI), something I've mentioned in these reports in the past. The BDI is down -60% this year and it's been bouncing along its lows since November 2008 with declining tops since 2009. This has created a descending triangle pattern and while it could be a bullish basing pattern I think it's more likely we'll see a breakdown. Not surprisingly, the BDI and Shanghai Composite index look similar, each reinforcing the idea that a global slowdown has not been stopped by all the central bank interventions.

Shanghai Composite index vs. Baltic Dry index, 2008-present

It should come as no surprise that U.S. manufacturing indexes have been weakening over the past few months. Thursday morning we'll get the Durable Goods orders and they're expected to decline further. If the U.S. manages to avoid a recession I'll be amazed. And when the stock market recognizes that the economy doesn't support the high stock prices (when it realizes Bernanke's plan will be another failure) I think there's a good chance we'll see our indexes head down to join the others and not the other way around.

The next two charts show the divergence between SPX vs. the BDI and SPX vs. the TRAN. It's clear that either the transportation indexes are way undervalued or else SPX is overvalued. I suspect it's the latter.

SPX vs. Baltic Dry index, 2008-present

While the TRAN has held up much better than the BDI (or Shanghai index), you can see the worry that investors have had in the transportation stocks this year. Meanwhile SPX continues whistling past the graveyard believing the Fed can stop the night of the living dead.

SPX vs. TRAN, 2008-present

Tuesday's selloff was partly blamed on Charles Plosser, the president of the Philadelphia Fed Bank. He's known as one of the leading hawks on the Federal Reserve and he criticized the Fed's latest QE-Infinity program, saying that it wasn't necessary, that it wouldn't work and that it's risky. As he said, "We are unlikely to see much benefit to growth or employment from further asset purchases." Many already know this and he didn't say anything new but the bearish reaction to his statement was a change in character for the market. It shows a level of nervousness we haven't seen for a while. It doesn't mean the rally is finished but it's another warning added to many that I've been pointing out recently.

Charles Plosser is being joined by a chorus of highly-regarded economists who feel the Fed has gone too far with a program that has not succeeded. Einstein provided us with a definition of insanity -- doing the same thing over and over again and expecting different results. Granted there are just as many highly-regarded economists who applaud Bernanke's latest move. But most will agree that the Fed's monetary policies need the help of Congress to get spending under control and essentially get our fiscal house in order.

Joining Plosser is Richard Fisher, the Dallas Fed President. He is in agreement that the Fed is in unchartered waters in taking on so much debt. With a balance sheet showing a mind-numbing $1.5T in debt the Fed has committed to taking on an additional $85B per month through the rest of this year ($40B in mortgage-backed securities and continuing Operation Twist's $45B) and then nearly a half a trillion dollars each year for the next several years (no end date). Fisher rightfully says the Fed can't bring unemployment down if Congress doesn't address the problems with their fiscal profligacy and policies that don't support business growth.

This week Fisher gave a speech to the Harvard Club of New York in which he addressed these issues. He addressed the Fed's dual mandate (without referencing the third mandate that the Fed now feels it has -- to move the stock market higher) to lower unemployment while keeping inflation under control (less than 2% although that's apparently being raised). He made a comment about Bernanke's recent testimony to Congress in which Chuck Schumer (NY Senator) told Bernanke "You are the only game in town." I remember thinking what a stupid thing to say -- admitting that they've given up on their job of fixing the problem created by them.

Apparently Fisher believes similarly, saying "I thought the chairman showed admirable restraint in his response. I would have immediately answered, 'No, senator, you and your colleagues are the only game in town. For you and your colleagues, Democrat and Republican alike, have encumbered our nation with debt, sold our children down the river and sorely failed our nation. Sober up. Get your act together. Illegitimum non carborundum; get on with it. Sacrifice your political ambition for the good of our country -- for the good of our children and grandchildren. For unless you do so, all the monetary policy accommodation the Federal Reserve can muster will be for naught.'"

Bravo to Mr. Fisher for saying this. Now if only our weak-kneed politically motivated Bernanke would say the same.

The market might finally be reaching the point where it begins to recognize the Fed doesn't have the ability to do anything more. While they can come out in the future and say they're going to up their purchases of debt by buying auto loans, student loans, etc., I think at the point it simply wouldn't matter. People will recognize the Fed can't stop the market. So many have believed for so long in "Don't fight the Fed" that it might be possible the market is actually now more vulnerable to a significant decline from disappointment that the Fed has lost the game.

The universal thought this month was that Bernanke would boost the market higher and then end-of-month/quarter window dressing would boost it even higher this week. The way prices were consolidating since mid-month it certainly looked like we were going to get another rally leg. As with many previous major tops, the failure of these bullish consolidation patterns leads to fast selloffs as traders get caught leaning the wrong side. There is risk for an even stronger decline into Friday although, as I'll show, I see the potential for the market to chop its way a little lower and then give us a higher bounce next week. I also can't yet rule out a rally into mid-October to a new high. Based on a few things I think the odds have shifted toward a more significant decline in October but we'll have to see how price develops in the next few days.

SPX dropped below 1440 today, tried to bounce back up to it and then dropped back down in the afternoon. It had stalled beneath 1440 from September 7th to the 13th while waiting for word from the Fed. The market exploded higher following the announcement on the 13th, peaked on the 14th and now it's back below 1440 and the pre-QE announcement. What's interesting about this level is that the May 2008 high was at 1440. This was the high before the market served a can of whoop-ass to the bulls and the collapse into November 2008.

SPX is now also back below the trend line along the highs from May 2011, which I'm interpreting as the top of a rising wedge pattern. The throw-over above it, on a news-related move, followed by a collapse back below the line creates a sell signal. This is usually a very good trade setup (for a short) and I would now look to short bounces. A drop below 1400 would be another confirmation level for the bears.

S&P 500, SPX, Weekly chart

So far it's looking like the 127% extension of the April-June decline, at 1464.71, held on a closing basis each attempt last week to climb above it. This is a very good Fib level to use in your trading, no matter the time frame. Today SPX broke its 20-dma at 1437.69 as well as its uptrend line from July 24th, near 1436. I don't give much credence to a one-day break as a quick recovery on Thursday could leave a false break. What I want to see over the next few days is how it handles this support zone and as depicted on the chart, I see the potential for choppy and potentially whippy price action into next week. It takes a move back above 1464 to put the bulls back in control otherwise I think they're now on defense.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1464
- bearish below 1410

I think there's a chance for a bounce on Thursday, back up to the 1440-1442 area, before heading a little lower to stronger support near 1427. If the bears are now in control we should then see another bounce/consolidation into early next week before dropping lower again to support near 1420. From there we'd be due a bigger bounce, perhaps up to 1450-1460, which would then set up an even better shorting opportunity. The bullish pattern, labeled as an a-b-c pullback (green), calls for only one more minor new low, maybe the 1427 area, and then the start of another rally leg. While I don't see this happening, I will defer to price action, not my opinion.

S&P 500, SPX, 60-min chart

The DOW is holding up relatively better than the other indexes and that's likely a result of money rotating out of the techs and small caps and into the relative safety of the bluest of the blue chips (and it's easier to sell the large caps when they want out in a hurry). The DOW hasn't even reached its 20-dma (13361) or uptrend line from July 24th (13230), both of which have been broken by the other indexes. Its pattern still supports the idea that the current pullback could be followed by another push higher.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 13,640
- bearish below 13,325

NDX has been hurt by the selling in big cap techs, especially AAPL. GOOG's bounce today helped but not enough and it has now solidly broken below its 20-dma, which has supported pullbacks since its July 25th low. It also broke below its September 12th low (2775.40) and while it closed above that low it has now negated the possible wave count calling for one more new high. At this point the wave count strongly suggests shorting bounces from here.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2282
- bearish below 2237

The decline over the past two days has the RUT now below both its 20-dma and uptrend line from August 2nd. A drop below 838 should be good confirmation that the top is now in place. If it drops a little lower and then gets a bigger bounce that does a back test against its broken uptrend line it would be a good opportunity to short resistance.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 860
- bearish below 838

This week the 10-year yield (TNX) dropped further and on Monday it tried to find support at its broken downtrend line from April 2011 as well as its 20-dma. Both were broken with Tuesday's decline and then today's decline broke below its 50-dma and uptrend line from July 24th. This increases the probability that the 3-wave bounce off the July low is an a-b-c correction and not a more bullish 1-2, 1-2 wave count and that in turn points to new lows into the end of the year. But today's break of support is only one day and could be reversed tomorrow, especially since the 30-year (TYX) closed on its uptrend line today and could be set up for a bounce from here.

10-year Yield, TNX, Daily chart

Follow the money and the banks should help us figure out whether to buy the dip or sell the bounce. While BIX marginally broke below its 20-dma today it found support at its uptrend line from June 4th, which is the bottom of its up-channel. This follows the tag of the top of the channel on September 14th. It's still by definition in an uptrend and buying support could work very nicely here. By the same token, a break below 161 would be a confirmed breakdown so let price lead the way here and following the banks should keep us on the right side of the market.

S&P Banks index, BIX, Daily chart

After breaking its uptrend line from June 4th, the TRAN then broke its uptrend line from March 2009 - October 2011. A bounce back up to the longer-term uptrend line on Tuesday was rejected and the bearish kiss goodbye is not good for the bulls. But the pattern of the decline from September 14th suggests only a minor new low before getting a bigger bounce to correct the decline from the 14th. Following that should be a stronger decline.

Transportation Index, TRAN, Daily chart

As pointed out last week, the U.S. dollar had dropped to support near 78.60 on September 14th and the setup was for a dollar bounce and a stock market pullback. So far so good for both. The dollar has broken out of its steeper down-channel from the end of August and it has also climbed above the bottom of its first down-channel from July 24th, both of which is bullish price action (vs. just a bounce correction before heading lower). But the dollar has run into its 20-dma so dollar bulls still have some work to do to prove they're now back in control. Again, we could be at a point where the dollar reverses lower while the stock market reverses back up. It will be important to keep an eye on both to see if they remain in their inverse relationship.

U.S. Dollar contract, DX, Daily chart

With the dollar's bounce it's not surprising to see commodities down, including the metals. Just as the dollar has bounced off support, gold has pulled back from resistance. Only time will tell if each has reversed their recent trends, which is the current setup. Gold stalled at its broken uptrend line from October 2008 and its 62% retracement of its September-December decline, both near 1771. It could be just a small pullback before heading higher and clearly it would be bullish if gold rallies above last week's high at 1790. It has to come down a ways before a top can be declared to be in place (with a break below 1647) but until proven otherwise, that's what I'm expecting to see from here. I still believe deflation is the future problem, not inflation, at least over the next year or two before the Fed loses control of inflation with their irresponsible policies.

Gold continuous contract, GC, Weekly chart

Last Wednesday oil had dropped back below its broken-recovered uptrend line from 1998-2001, near 93.60 (log price scale). On Friday it bounced back up to it for a quick back test but then sold off again, leaving a bearish kiss goodbye. It was also a test of the 50% retracement of the March-June decline, at 93.91, and you can see on its chart how it has acted as support/resistance since first tested in early August. It was also the area of its 50-dma, currently at 93.50. So there was a lot holding the bounce down and now the decline is trying to find support at the 38% retracement at 89.99. I suspect that will break and oil will keep heading lower, potentially in a strong decline in the coming month.

Oil continuous contract, CL, Daily chart

Tomorrow's economic data will include Durable Goods Orders, the 3rd estimate for Q2 GDP, and pending home sales. The numbers are not expected to be good so any upside surprise could at least get some short covering started. Equity futures are up a little this evening, like they were Tuesday evening, but then they got knocked lower when the European news started and their market sold off. The same thing could happen again tonight. Germany will report its monthly unemployment change and the eurozone will report monthly consumer confidence. Economists are expecting no change month-to-month for either so if Europe manages to bounce we could see the same thing for the U.S. market on Thursday.

Economic reports and Summary

Price action over the past few days looks bearish but we all know how quickly that can change. Most traders are still looking for a good pullback to buy and now they have one. It's a time for caution by both sides since it looks like the market has turned down but there are still bullish possibilities, even if it's for only one more new high. We should know for sure this time next week.

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