Market Internals

Introduction

U.S. futures headed up in the pre-market session this morning. Market participants staring bleary-eyed at their monitor screens early this morning must have wondered if the gains would stick, given the propensity lately for Monday to be a down day.

U.S. markets spurted higher but could not maintain their highs of the days. I shook my head at an explanation offered by the title of a Reuters article that appeared mid-afternoon: "Wall Street Up on Factory Data, but Off Highs on Bernanke." Yes, markets gained this morning as economic numbers were released, but they didn't all warrant a rally mode, and that rally mode probably had as much to do with technical factors as fundamental ones. And, yes, markets dropped back as the Fed speakers began talking, but they also dropped back from tests of important resistance. As we'll see from examining charts, the setup on daily charts offered another explanation for what happened regardless of what was reported or who spoke.

What did happen? The SPX gained percent; the Dow, percent; the NDX, percent; and the RUT, percent. Financials as represented by the BIX traded in a tight range, while the BKX index shot higher only to be knocked back to a slight gain by the end of the day. The Dow might have produced a strong gain, but it closed well below its 13437.66 high of the day, and its sister indices the Dow Jones Utility Index and the Dow Jones Transportation Index fell well off their day's highs to close near their opening levels. Semis were weak. Retailers as represented by the RLX dropped.

Monday's Developments

The Asian bourses produced mixed evidence as to whether global bourses would bounce or sustain gains today. Most Asian bourses started in negative territory. Some ended there, too, but not all did. The Nikkei 225 closed lower by 0.83 percent, and the Straits Times, by 0.08 percent. However, the Hang Seng gained 0.38 percent.

The Shanghai Composite's performance probably provided the most hope to bulls both in Europe and the U.S. as today dawned. That index spent most of the day climbing off its opening low, ending higher by 1.45 percent. Some market pundits pinpointed the catalyst for the gains as concrete steps China's government made late last week for the leadership transition. A November 8 date has been set for the National Congress meeting.

The performances in Europe also provided some reassurance to those who hoped to see a U.S. rally today. Market participants had sent European bourses higher, but they were flattening near their day's highs as the U.S. open approached. When U.S. bourses bounced at the open, European ones added to their gains. The FTSE 100 gained 1.37 percent; DAX, 1.53 percent; CAC 40, 2.39 percent; and Spain's IBEX 35, 0.98 percent.

European rallies occurred despite unemployment remaining at 11.4 for August and contraction-territory PMI numbers across the eurozone today. What could have been even more important than those PMI numbers to traders' psyches? Perhaps, among other reasons, they could point to the dip of yields on Spanish 10-year bonds back below 6.00 percent. Those yields closed at 5.869 percent, down 0.075 or 1.26 percent.

Friday, speculation had risen that Spain might ask for a bailout this weekend. Instead, yesterday, Spain's Budget Minister Christobal Montoro unveiled plans to borrow 207.2 billion euros next year. He further advised that the budget deficit for this year will be 7.4 percent of economic output but that the exclusion of the costs associated with bank rescue will allow Spain to meet its 6.3-percent target.

The Economy Ministry and Bank of Spain announced Saturday that banks would require 59.3 billion euros of additional capital to make up for losses from real-estate investments. While that revelation could be considered one more step toward asking for bailout funds, Prime Minister Rajoy had yet, as far as could be ascertained, to officially ask for funds or agree to conditions that have yet to be set before Spain receives bailout funds.

While Spain has set an ambitious plan that might allow it to avoid asking for funds, that plan depends on the government's growth and other estimates being accurate. Some economists believe that Spain's economy will contract far more than the government's 0.5-percent estimate for 2013.

That plan also depends on Spain's estimate for banks' recapitalization needs being accurate. Today Moody's questioned those amounts, as reported by Agence France-Presse. Moody's estimates between 70 and 105 billion euros rather than the 59.3 billion euros Spain estimates. Nevertheless, the behavior of Spain's 10-year-yields implied that bond-traders, at least, believed today that this weekend's developments had ameliorated risk. We'll see what they believe tomorrow.

Then it was the U.S.'s turn. Monday's U. S. economic and event schedule normally proves light, but that wasn't true today. Final Manufacturing PMI or Purchasing Manager's Index published by Markit was released at 9:00 AM ET. As this was a final number, not much change from the prior 51.5 had been anticipated. Last week's surprises on regional surveys--an upside one in Texas and a downside one in Chicago--might have unsettled expectations and fears had heightened that these various national numbers would disappoint.

That's exactly what happened with the Markit Final Manufacturing PMI for September. Markit reported Final PMI at 51.1, down from the prior 51.5 and the forecast 51.5. Market's bullet points noted that this reading was the lowest since September 2009 and job creation was the weakest since December 2010. Input price inflation rose, not a good combination.

However, new orders expanded at a faster rate, rising to 52.3 from the prior 51.9. The headline number did point to an expansion in manufacturing output that Markit termed "marginal." As compared to August, Markit summed up the change by saying that there was expansion but at a slower rate. More attention was probably on the next release, with the more familiar Institute for Supply Management's take on production.

The 10:00 am release slot was full. The Institute for Supply Management's Manufacturing PMI and Prices, and the Census Bureau's report on Construction Spending filled that slot. The ISM's Manufacturing number had been expected to climb slightly to 50.00 from the prior in-contraction-mode 49.6, but Chicago's disappointment on Friday and this morning's Markit number certainly questioned that prediction.

Instead of fulfilling fears, the ISM PMI produced an upside surprise, rising to 51.5. A hopeful blue bar poked above the benchmark 50 level after a few months of minor dips below it.

ISM Results:

U.S. indices jumped higher immediately after the release. Echoing the earlier Markit PMI, this number showed new orders growing. Employment and inventories also grew, however, and an expansion in inventories isn't always good news.

Production contracted, however, and that's almost never good news unless an economy is running too hot. The production index measured 49.5, ISM said, in contraction territory for only the second time since May 2009. However, this represents a 2.3-percentage-point increase from the prior number.

Prices had been expected to rise to 55.6 from the prior 54.0. This component rose more than expected, to 58. The panel of surveyed manufacturers expressed a mixture of optimism and concern. The "unsettled political environment" and "soft business conditions" contributed to the concern.

When glancing at the comments from differing industries, some bifurcation appeared to be present, so perhaps the slight expansion is still uneven? Eleven out of eighteen surveyed industries reported growth. Six industries reported contraction. Those included nonmetallic mineral products, electrical equipment, appliances and components, transportation equipment, machinery, chemical products, and computer and electronic products. Anyone watching the Dow Jones Transportation Index's performance lately--as I think all market participants should do--would not be surprised to learn that it's one of the industries showing contraction.

If the ISM surprised to the upside, Construction Spending joined the Markit PMI in disappointing. Pundits had predicted a rise of 0.6 percent. They got the 0.6 percent part correct: the problem was that the direction was wrong. Construction spending dropped 0.6 percent. However, that drop was from a revised higher prior drop of 0.4 percent, revised from a previous drop of 0.9 percent. In a more hopeful comparison, the U.S. Census Bureau pointed out that construction spending for the first eight months of this year was running 9.0 percent higher than spending for the same period last year.

How did the components line up? Spending on private construction dropped 0.5 percent below the revised July estimate. Residential construction was 0.9 percent above the revised July estimate. Nonresidential construction was 1.7 percent below the July estimate. Public construction was 0.8 percent below the revised July estimate. Because the residential-construction component reported better news than other components, I checked the $DJUSHB (Dow Jones U.S. Home Builders Index) to determine its immediate reaction to the news. There wasn't much of an immediate reaction.

Construction Spending numbers have proven quite volatile over the last couple of years, zigzagging back and forth across the 0.0 benchmark. July and August contractions followed four months of expansions, which preceded two months of contractions, and so it goes. Perhaps we should wait for a trend rather than focusing on specific months.

As soon as those releases were out of the way, it was time for Fed Watch. Federal Reserve Bank of San Francisco's President John Williams, a 2012 FOMC voting member, was first on the podium, speaking at noon ET at a "Capital Markets for Impact at Scale" conference. I was watching market performance as it was time for his speech. Whether coincidence or not, U.S. indices dropped. Often the text of the prepared portions of these speeches are available to reporters and on the various Federal Reserve websites a few minutes before the speech begins, but Williams' speech wasn't a speech as such. Rather, it was characterized as "brief remarks." Those were unfortunately not available on the Federal Reserve Bank of San Francisco's website.

FOMC Chairman Ben Bernanke followed thirty minutes later, speaking in Indianapolis, Indiana. His speech, "Five Questions about the Federal Reserve and Monetary Policy," was followed by a question-and-answer session. Those hoping to view the full text of his speech found themselves disappointed, too, as the Federal Reserve's site was offline around the time of the speech. After several banks saw their sites go down due to denial-of-service attacks last week, one has to wonder if the Federal Reserve's site was subject to the same kind of attack.

FOMC Chair Bernanke attempted to calm worries about quantitative easing, characterizing it as "the same as it has always been" in terms of the basic monetary policy strategy. The Federal Reserve has only shifted to "reducing longer-term interest rates more directly," he explained. He denied that the intention to keep interest rates low until mid-2015 was a prediction that the economy would remain weak that long. The Federal Reserve has not backed away from its efforts to control inflation, he added. He reminded attendees that the Federal Reserve had achieved an excellent price stability record.

He challenged various criticisms, veiled and overt, that the Federal Reserve has become politicized. He addressed the concern that savers are hurt by continued low interest rates by pointing to more pressing need "to try to get the economy stronger." When some mentioned concerns about the exit plan, Bernanke said that exiting correctly was always a challenge, but it was no more a challenge this time than others.

Talk TV was keying in on FOMC Chairman Ben Bernanke's statement that easing would continue for a period after the economy strengthens as a surprising statement that had lent concern and impacted equity performance. However, this was information known and much discussed last week, so I discount the possibility that big money was newly upset by this statement.

Story stocks today included Intel Corp. (INTC, 22.75, up 0.10 or 0.44 percent). A Bloomberg article tagged INTC for holding up tablets that will run Microsoft Corp's (MSFT, 29.49, down 0.27 or 0.91 percent) Clover Trail processor. These tablets are rumored to be able to play high-definition video up to ten hours and have weeks of standby time. INTC has delayed delivery of power-management software that will conserve computer battery life, the article concludes. According to that same article, INTC's CEO Paul Otellini told overseas employees that Windows 8 requires improvement. Some rumored difficulties include drivers that connect software to printers and other hardware.

Tablet manufacturers who hope to get their Clover Trail-based tablets ready to ship in time for the holiday season might be impacted by these delays. Those include HPQ, DELL, and Lenova Group Ltd., according to the Bloomberg article.

MSFT had other announcements to make. It will launch a new MSN, a news operation, when it does launch Windows 8. I guess the company must not have signed a non-compete when it sold MSNBC.com to NBCUniversal in July. Mostly, the company plans to aggregate news from sources such as Reuters, a Reuters article announced. However, the new MSN would also produce content. MSFT was downgraded today by an analyst and perhaps by investors who took their money elsewhere.

In other news in the sector, Bloomberg marked today as the day Google (GOOG, 761.78, up 7.28 or 0.96 percent) passed up Microsoft (MSFT) in market capitalization to take the number-two slot. We know which company holds the number-one slot, don't we? Speaking of that record holder, AAPL lost 7.71 or 1.16 percent today.

Chinese internet stock Baidu (BIDU, 112.77, down 4.12 or 3.52 percent) joined MSFT in receiving a downgrade today. Jefferies downgraded the stock and lowered the price target to $125 from the prior $135.

Moving to another sector, Transocean (RIG, 46.22, up 1.33 or 2.96 percent) announced that the Brazilian Superior Court suspended part of the injunction order that would have halted Transocean's operations in Brazil within 30 days. With the exception of the Campo de Frade field, RIG can now continue to operate its rigs in all offshore fields. Jim Brown covered this controversy in some detail in the weekend Wrap for readers who would like more information.

Late in the day, news surfaced that Nokia (NOK, 2.76, up 0.1850 or 7.18 percent) will allow Oracle (ORCL, 31.67, up 0.21 or 0.67 percent) customers to access its maps. Nokia's maps are recognized as reliable.

Charts

Those new to my Monday Wraps might find the following two paragraphs useful when interpreting my charts. Those who have read the Wraps can skip straight to the charts. I set up nested Keltner channels on my charts. It's a run-of-the-mill channeling system like the more familiar Bollinger Bands. As with those more familiar BB's, channel boundaries are often targets for upside or downside moves. They also mark levels where prices might find support or resistance on closes. When several channel lines converge, that potential resistance or support might appear stronger, just as it would if 20-, 50- and 100-sma's all converge in one spot.

For the benefit of subscribers, I mark potential upside and downside target/support/resistance levels with ovals, usually green for upside and red for downside. Orange ovals are sometimes used when the darker-colored ones would not allow for a clear examination of the next target. From now on, I will mention the nearest potential support or resistance level in the discussion on the chart, but not the further-out ones. They can be located on the charts if price breaks through the nearest levels on consistent daily closes. If an interpretation such as "support levels appear stronger than resistance, so up looks more likely than down" is possible, I'll tell you. Often we traders must be able to defend our trade against a move in either direction.

As with any type of potential support or resistance, those with profits should be protective of those profits as support or resistance is tested. If prices find support and climb, look to the next higher oval, even one just broken through, as potential resistance. Do the reverse when resistance is breached. Hopefully, this format provides you with the information you need without requiring all night to read as happens when I list each potential support or resistance level individually.

Annotated Daily Chart of the SPX:

When we examine charts, we'll see prices caught up in another tangle of nearby support and resistance. At today's high, the SPX tested that resistance, but price could not sustain a daily close above it. The setup now suggests that the SPX is just as likely to drop back and test support again, and perhaps even a bit more likely due to that failed resistance test. The next support band begins at last week's low and extends down to about 1420, where it would be testing the bottom of the rising price channel in which the SPX has been rising since the June low.

However, if the SPX musters more strength later this week and maintains daily closes above today's high, that action increases the chances that it will push back toward a possible resistance band, beginning at about last month's high of 1474.51 and extending just above 1480. I see intervening light resistance near 1463, but that will get shoved higher if there's a strong gain. Just be aware that it's a possible light resistance zone.

Further out upside and downside targets are marked on the chart. For now, I didn't see anything that dissuaded me from the possibility expressed last Monday that the SPX could roll down to test the bottom of its rising regression channel.

Annotated Daily Chart of the Dow:

Whenever we look at the Dow, we should also pay some heed to its sister index, the Dow Jones Transports. The transports attempted a bounce today but were repelled by the descending daily 9-ema. They are testing a zone that has been support in the past, however and should be watched to see if they either break sharply lower or bounce hard. Similarly, the Dow's other sister index, the Utilities, was knocked back sharply from the day's highs.

I agree with Jim Brown that the Dow Jones Industrials is so narrow as to be less valid as an indicator than the SPX. However, to many mom-and-pop investors, the Dow is "THE" market, with important psychological import. For example, I heard multiple times today about the triple-digit day in the markets at a time when the Dow had already pulled back sharply from its morning highs. It was already well on its way toward building a candle that didn't look all that healthy when those comments were made.

The Dow did manage a close above the 9-ema. If the Dow were the only chart I was watching, I would conclude that was a sign of potential if still somewhat tenuous strength. That would have suggested that the Dow was at least as likely to retest resistance from today's high up to last month's 13653.24 high as it was to drop back to test support. In this case, I'm not leaning toward that interpretation. If the Dow were to gap below or trade below the flattened red 9-ema for any length of time, I would think it just as likely that the Dow would drop toward a potential support band that extends from last week's low down to about 13255. A number of highs, lows, opens and closes through that zone over the last few months makes it impossible to pinpoint one specific level that is the absolute marker.

Further-out potential targets are marked in case the ones discussed are breached on daily closes. It goes without saying that bulls do not want to see the Dow or any of the indices break down out of the rising regression channels in which they've been traveling higher the last few months.

Annotated Daily Chart of the NDX:

This is not pretty. The NDX has dropped back inside a rising regression channel it had once broken above and then used for a trampoline for further rallies. Moreover, daily candles are beginning to hang from the beginning-to-descend red 9-ema like overripe berries about to drop from a sagging vine or branch. This setup suggests a stronger likelihood that the NDX will drop to retest support near last week's lows than climb above today's high on a daily close.

However, the NDX and RUT delight in surprise endings to their stories. (I apologize to English majors the world around for these anthropomorphisms.) Therefore, we need to examine the setup if the NDX should produce a daily close near or above today's high. That sets up a potential target that extends from about 2855 up to last month's high of 2878.38.

Further out potential targets are marked on the charts, in case these discussed levels are breached on consistent daily closes. It goes without saying that bulls would prefer that the NDX not break through about 2750. That sets up the potential for a fast drop down to the bottom of that former rising regression channel.

Annotated Daily Chart of the RUT:

Today, the RUT attempted to break above the descending red 9-ema but couldn't maintain values above it. That failed resistance test sets up a potential retest of the support band that extends from last week's low down to about 826. You can see that I've set an alert for 824.75 on my own charts. I left that alert here rather than hiding it, for the purpose of suggesting that readers might set similar alerts on breakdown or breakout levels they want to watch.

If the RUT can gap higher or climb higher and sustain closes above the red 9-ema, it sets a potential target near 855-858, where next resistance might lie. Further out potential upside and downside targets are marked on the chart.

I warned a couple of weeks ago that in the RUT's case, at least, a breakdown could result in the first move down being a bit of a jolt. It certainly was. The RUT had climbed so fast the last part of its rally that it hadn't build up much intervening support. We could see another jolt lower, but beginning at about 820, the RUT does have a few more prior congestion zones that could provide support. The Keltner setup is suggesting that if about 824-826 is lost on a daily close, 798-806 is next, and that the RUT could move quickly to that level, so I offer that as a cautionary tale but not a prediction. The Keltner setup proves helpful to me but it can be wrong just as any other one can be.

Tomorrow's Economic and Earnings Releases

What about Tomorrow?

Annotated 30-Minute Chart of the SPX:

I like Keltner channels, but sometimes other formations can help us sort out what's happening. The SPX has zigzagged quite a lot since last Wednesday's low. If we snap a price channel on the action, we see that it has established a rising price channel off that low. This morning, when it was testing resistance on 30-minute closes based on the Keltner channels, it was also testing the top of that price channel. Since there's an existing climbing channel, over the short term, we can look for potential resistance at the top of that channel and potential support at the bottom. That's why I've left it on the charts, despite the fact that the chart now looks quite messy.

We must put this rising channel into context. It's rising off last week's low after a precipitous decline. That observation and also its zigzagging shape, leads to a likely interpretation as a bear flag climbing off the low. Bear flags would be expected to break to the downside, unless they retrace more than about 61.8 percent of the decline. Today's SPX high did just test: retraced about 61.8 percent of the decline from last month's high. If the SPX hadn't dropped back sharply from that test, the bear-flag scenario might have been undone, but it was instead validated for now.

If the SPX should break to the upside, above Keltner and channel resistance, and sustain 30-minute closes above them, the next potential upside target is marked. However, for now, I would factor in the possibility that the 1432-1438 zone might be tested, and that a failure there would target the lower level marked on the chart.

Annotated 30-Minute Chart of the Dow:

Although it's also possible to draw a rising channel on the Dow, the Dow's behavior has differed in several ways, complicating the interpretation of that channel. In the Dow's case, this intraday chart presents the case that it's about as likely that the Dow will climb as drop over the short term, or vice versa. Nearby potential upside and downside targets are marked, but it's impossible from this chart alone to give more weight to one interpretation than to another.

Not only does the immediate picture seem up to a flip of a coin, but the interpretation of that next move is, too. If the Dow moves up to 13600, for example, it is more likely to hold there and eventually set the next upside target or is it more likely to drop back again to support? The picture just isn't clear, and so traders must be prepared for any eventuality.

Annotated 30-Minute Chart of the NDX:

After being knocked back from its resistance test this morning, the NDX spent the middle of the day consolidating beneath the 30-minute 9-ema and then finally fell toward its next Keltner target. The immediate setup looks like a setup for a test of that same resistance that it spent the afternoon trying to break through, beginning at about 2798 and extending up to about 2805 on 30-minute closes.

However, there's a big "however." Since the NDX has been chopping back and forth across its 30-minute red 9- and peach-colored 45-ema's for several days, its position above or below those averages is not as predictive of its next target as might usually be true. Still, the tentative conclusion is that if the NDX cannot maintain 30-minute closes above those averages, further support tests and a drop to retest today's low are possible.

On a sustained break through those averages, tests of potential resistance up to 2810 could continue. Unfortunately, however, the NDX's chart is just "noisy" between about 2790-2820 and maybe up to 2830, with the moves through that zone somewhat unpredictable and without much predictive ability, either. Further out targets are marked on the chart if the NDX should break out in either direction on sustained 30-minute closes.

Annotated 30-Minute Chart of the Russell 2000:

In many ways, the RUT's 30-minute chart resembles the NDX's except that the RUT's displays more end-of-day strength than the NDX's. The RUT chops back and forth through a rectangular consolidation zone that it's been building since last Wednesday's low. The pattern's interpretation could be stretched into a rising price channel, but if so, the RUT temporarily broke down out of it at today's low and so rendered that channel defunct anyway. Mostly we just have noise between about 835-846. It's going to take sustained 30-minute closes outside that zone to predict next direction, and there's just not much predictability about movements within that zone.

If the RUT can sustain 30-minute closes outside that zone--it couldn't this morning when it attempted to break through on the upside--the next potential short-term targets are marked on chart. See the daily chart for targets beyond those.

So, what do I think? Sorry, but I wasn't convinced by the rally Monday. I'm not saying I can't be convinced or that markets can't climb, but when I switch to the $DWC chart to get a broader view, I see what I see on the SPX chart. That's an index that bounced last week from its first test of the smallest Keltner channel's lower boundary in weeks. The bounce was knocked back hard today at the lower edge of the expected resistance.

We're seeing a zigzagging climb off last week's low that looks decidedly different than the climb off the 7/12, 7/23, 8/2, and 9/4 lows, for example. This is a bear-flag type of climb, and the NDX isn't even managing that with its "overripe fruit hanging from a sagging vine" performance of the last few trading days.

So, the Dow's outperformance on Keltner and other measures just didn't convince me. Not yet.

I can be convinced. I certainly didn't do anything to my trade that leaned it in a bearish direction. I'm accounting for the possibility that a day's strong gains could undo this picture. But the picture today didn't convince me yet.

I've marked potential next targets for both upside moves and downside ones. Know how you'll deal with your trade if either should be approached or reached. If I personally lean any direction, I lean toward the possibility that markets could retest last week's lows.

As I do every week just before I sent this out for publication, I have just scanned news channels a last time for anything that might change the outlook or need mentioning. With announcements about political developments in China and economic ones in Europe of course not adhering to time slots that might be best for U.S. traders, that's always a concern. Today's last-minute announcement came from the U.S., however, with the U.S. Postal Service defaulting on another $5 billion payment, as it was expected to do.