Market Internals

Introduction

Market participants stepped onto the grounds of a carnival today. Despite headlines this morning such as the one threatening the temporary firing of 800,000 Pentagon civilian employees if no fiscal-cliff deal was reached, futures soared in the pre-market session. Hairpin progress-is-being-made turns and soaring deal-is-close climbs provided plenty of adrenaline rushes throughout the day, with a marked absence of heart-stopping drops. Those old enough to remember old-style roller coasters could practically hear the clanking of the wooden cars moving inexorably toward a rise that they couldn't see beyond. Would the cars barrel over that rise and plummet downward or just level out before climbing toward yet another distant peak?

That heart-stopping dip wasn't delivered during the trading day. After the close, House aides announced that there would be no vote before midnight tonight. In current terminology, we're going over the cliff. What's waiting on the other side? Lots of hours will pass between now and Wednesday morning, and we'll have to await the headlines and market reaction to determine what's next. Remember that tax hikes and spending cuts can be made retroactive. Purportedly a deal has been reached resolving all tax issues, Senate Republican Mitch McConnell claimed as this article was going to press.

Deal hopes strengthened solid yearly gains for the major U.S. indices. Those amounted to yearly gains of about 13 percent for the SPX, 7.3 percent for the Dow, and 16 percent for the Nasdaq Composite.

Today, the SPX gained 1.69 percent; the Dow, 1.28 percent; and the NDX, 2.09 percent. The RUT soared 2.07 percent, and the SOX, 1.91 percent. The Dow Jones Transports, an important gauge of underlying health in the economy, rose 1.64 percent. Financials as represented by the BIX and BKX, rose 1.02 and 1.36 percent, respectively. The S&P Retailing Index, the RLX, rose 2.12 percent, and homebuilders, as represented by the $DJUSHB, jumped an even more impressive 2.39 percent. Apple, as important these days as any index, gained 4.43 percent.

The CME Group's report noted low volume on crude futures and pointed to uncertainty about fiscal-cliff negotiations as pressuring crude futures in the morning, but those futures bounced in the afternoon into the highest close since October 18. Gold prices tended to hold their own this morning despite fiscal-cliff uncertainties and long liquidations at the end of the quarter and end of the year, the CME Group noted, and bounced to end the day with respectable gains. Silver futures acted similarly, trading near the unchanged level in the morning and then bouncing in the afternoon.

Monday's Developments

Let's set the stage and see how the day at the carnival unfolded. Despite the lack of a consensus in the fiscal-cliff issues by last night, futures traders must have felt enough progress was made. They must have believed that a deal would be inked sometime in the near future, if not by today's deadline. Futures steadied and even bounced by the time Asian bourses opened for trading.

Japan's Nikkei 225 was closed last night and will be tomorrow, when it will be joined by China's Shanghai Composite. Some others had a shortened day. The big news among open bourses was China's Shanghai Composite's 1.61-percent gain, pitted against lower levels on most other bourses. China's final PMI was revised higher to 51.5, propelling the Shanghai Composite to a 1.61 percent gain. In contrast, the Hang Seng lost 0.04 percent, and the Straits Times lost 0.77 percent.

Japan's currency manipulation moves and planned future moves garner increasing attention and will force more attention after we get past our fiscal-cliff issues. However, Japan's finance minister and newly returned prime minister reject protests from other countries. They plan further steps to weaken the yen against other currencies, if necessary. Their efforts so far to are apparent on a USD/JPY chart.

USD/JPY Chart

That's a wild currency move. Such moves theoretically help Japan combat deflation and also increase growth as their goods become cheaper on global markets. They work the opposite on the countries whose currencies strengthen against a weakened yen. Japan would--and does--argue that the Group of 20 had made promises several years ago to avoid "competitive currency devaluing" (Bloomberg, "Japan Rebuke to G-20 Nations"). Japanese officials claim these promises haven't been kept so that Japan's hand has been forced.

In Europe, Germany's markets were closed today, joined tomorrow by bourses in most European countries. As our open approached, performances on just-closed other European bourses were mixed. The FTSE 100 dropped 0.47 percent; the CAC 40 rose 0.58 percent; and Spain's IBEX gained 0.45 percent.

If market participants have acted as if European developments have receded into the background, that might be because some European leaders have been anxious to reassure the world's markets. Germany's Finance Minister Wolfgang Schaeuble has been one of those offering reassurances, saying last Friday that Europe had moved beyond the worst of the crisis. However, German Chancellor Angela Merkel's New Year's address highlighted the concerns again. She believes reforms have begun to ameliorate risks but warns that the "crisis is far from over."

Against this background, our financial markets opened. The first move was a dip to accelerate the heart rate and then a hairpin turn upwards, with power boosts from several senators saying that a deal was likely. News that a deal might be reached but that a deal might not prevent sequestration temporarily stalled those roller coaster cars at dizzying heights, just so heart rates could speed up again in anticipation. "Sequestration," when used in this manner, refers to mandatory cuts to federal programs that come about when federal monies have been authorized but cannot be spent, in this case due to reaching the debt ceiling. Those monies are sequestered or locked away. Then deal-in-sight rockets powered the roller coaster cars up again. There is little good to be gained from speculating on the permutations of what might be done because we don't know what the final result will be.

Today's economic releases proved few and far between. If market participants felt them, it was only as a little extra speed or added bumps under the wheels of the carnival ride. At 10:30 AM ET, the Dallas Fed released its production and business activity index for Texas. The prior business activity index had measured -0.28. The consensus for the current announcement had been 1 with a range from -1 to 5. Instead, the number jumped to 6.8. The production index rose from 1.7 to 2.7, but new orders slipped to -0.9 from its prior positive 0.4.

The employment component slipped to -1.0, a number the Dallas Fed noted as the lowest reading in two years. Hours worked was positive, but the number hadn't changed markedly from the prior number.

What produced that big jump in the business activity index, then? The Dallas Fed reported that the number of respondents reporting worsening conditions dropped. Expectations rose sharply, to 7.9 from the prior -5.3.

At 3:00 PM ET, the Department of Agriculture released its agricultural prices, an index of prices received by farmers. This index is not adjusted for seasonal variation. The preliminary All Farm Products Index of Prices Received by Farmers decreased 5 points or 2.4 percent from November's prices, the Department of Agriculture announced. Prices dropped for milk, lettuce, turkeys and eggs and rose for soybeans, broilers, cattle and grapes. The index is up 22 points or 12 percent from the year-ago level.

Story stocks today included Bristol-Myers (BMY, 32.59, up 0.69 or 2.16 percent). BMY announced FDA approval of Eliquis, an anti-clotting drug.

Later in the week, we'll see auto sales figures, but Ford (F, 12.95, up 0.08 or 0.62 percent) jumped ahead of the other manufacturers. F announced sales of 2.2 million U.S. vehicles in 2012, the second year in a row of sales of more than two million.

Another story appeared at the early closing of the bond markets. Yields on ten-year treasuries closed at 1.76 percent. Bloomberg reported that yield to be the lowest since 1962, at least. Hope might have been sending equities higher, but bond-buying didn't exactly corroborate the seeming enthusiasm for equities.

Let's look at daily charts and see what we can see.

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:

Beginning late last week, the SPX threatened a much lower downside target, at the nearest red rectangle. Although technically some closes were at or just below the green 120-ema that serves as a marker for setting that next lower target, the support essentially held, if somewhat tenuously. Today the SPX bounced from that support and ran up to the potential resistance converging overhead, where it stopped until shorts perhaps gave up and joined with buy-on-closers to propelled the SPX through that resistance.

We've had one daily close back above that red 9-ema. Is that enough to set a new upside target? The SPX needs consistent daily closes above the red 9-ema. Today's move can't be entirely trusted. We think a deal is within reach and hope markets will react positively, but we just don't know that. At the end of the day, shorts who hadn't yet covered were forced to do so, but that didn't mean that they were cheerfully adding to their longs.

A problem exists for those planning trades. The daily chart is set up to show that we could get a day or two of small-bodied candles before we know the ultimate direction, but that the ultimate direction could be accompanied by a fast move when it gets going. If the SPX rolls down again beneath the 9-ema and that downside target is set, stocks can be dumped quickly enough to set and hit that target in quick succession. If a deal is reached and markets propel higher, shorts will help fuel the climb at first, but real buying could take hold, too. A relief rally could move every bit as fast as a sharp decline. Bulls know what they want and need: they need the SPX to close above that red 9-ema consistently enough to flatten and then turn it higher. For now, be wary of a morning gap Wednesday morning if it's quickly met by selling or a gap down if it's quickly met by buying.

Annotated Daily Chart of the Dow:

The Dow has set a potential target at the nearest red rectangle. That target remains a potential target as long as the Dow maintains daily closes at or below the grouped red 9-ema, peach 45-ema and green 120-ema. The Dow has set a pattern of daily closes beneath a turning-lower red 9-ema, a pattern that is often in force during Dow declines. Dow bulls need to see this pattern changed with respect to daily closes.

The Dow already made much progress last week toward that next potential downside target. Ordinarily, a daily candle like today's would constitute a potential reversal signal, but I'm keeping a cynical outlook given the trading environment. It was about time for the Dow to bounce up and retest the 9-ema anyway, and that did occur.

Further tests and even a leap above that potential resistance could result, but it's also possible that the Dow could instead drop to test 12700-12800 support. Dow traders should consider vulnerability to either further progress toward that potential downside target, where they should watch for potential support, or further tests of and a possible breach of 9-ema resistance on daily closes.

Annotated Daily Chart of the NDX:

Although several daily candles from the middle of December are still missing from my think-or-swim charts, I've waited until we had enough subsequent candles to switch back to the NDX rather than the COMP. Technically, the NDX's drop below the red 9-ema, peach 45-ema and green 120-ema's and subsequent daily closes beneath a turning-lower 9-ema have set the stage for a potential drop to the nearest red rectangle, or would have, without a late-day run up that finally pushed the NDX above the red 9-ema. As with the other indices, I am keeping all possibilities open when I know that shorts giving up and covering their positions helped propel the NDX higher.

Unlike the previously discussed indices, the NDX had been chopping back and forth through a chop zone. Its movements back and forth did not prove predictive. Late last week, the NDX did slip lower, below the bottom of the roughly rectangular chop zone. Technically, both on a formation basis and on a Keltner basis, it broke support. However, that breach proved no more predictive than the chop that preceded it. All NDX and MNX options traders should consider potential vulnerability to a drop to the nearest red rectangle as well as continued tests of the grouped potential resistance tested today. Unless the NDX gaps up or quickly runs up through that resistance and stays above it for at least several hours, bulls should remain wary of rollover potential. The NDX has certainly chopped back and forth across this zone often enough the last month, hasn't it, to make us wary of pronouncements about next direction? Even with the missing daily candles, it's easy to note at least a couple of examples when the NDX has charged right up to the resistance being tested today and then pulled back again along. We can find other examples when days like today were followed by days when the NDX pushed above the resistance. That's chop. Next potential targets are marked if the nearest ones are breached on sustained daily closes.

Annotated Daily Chart of the RUT:

The RUT's case proves different from the previous three. The RUT never closely approached the peach 45-ema and green 120-ema, much less breached them on daily closes. It did, however, produce three daily closes beneath a red 9-ema that is now beginning to flatten. Theory tells us that consistent daily closes beneath that moving average set a potential target in a zone near the 45- and 120-ema's, but today the RUT charged right back through the red 9-ema as easily as the NDX has been chopping back and forth across it. A retest of last week's high and maybe the September high or of the 9-ema seem about equally likely as the RUT now faces significant resistance. What is happening in Washington, D.C. and among fund managers ready to sell or buy the small caps trumps anything on charts. I'd be foolish to suggest otherwise. These charts guide us and help us set benchmarks to watch. Later, we'll see if intraday charts provide any further guidance.

Tomorrow's Economic and Earnings Releases

Two important economic events, marked in red, will bracket morning and afternoon trading on Wednesday. I must note, however, that the two economic calendars I use most often have different dates set for the FOMC Minutes. One lists the release as being Wednesday as is shown here; the other, Thursday. Another I consulted to resolve the issue doesn't list the Minutes at all. When there's doubt, I typically go to the source: the Federal Reserve's website, in this case. The date is not marked on their website, although the information states that the release is three weeks after the FOMC meeting. The last meeting concluded December 12. Three weeks after that will be Wednesday, so I have included the release for Wednesday. Be aware, though, that the other site listing it for Thursday may have some knowledge that this week's holiday will postpone the release of those minutes by a day.

Similarly, one calendar sets Wednesday for the reporting day for motor vehicle sales, while a Forbes article claims those sales will be reported Thursday. I've included them here because the calendar I trust most lists them for that date.

What about Tomorrow?

The abrupt twists and turns of this carnival ride over the last week has left us with scrambled intraday charts. Because many indices were hitting downside targets on their 30-minute versions this morning, I have rolled up to one-hour charts to give us next near-term downside targets, if they're needed. They certainly weren't needed today, at least on the downside.

Annotated One-Hour Chart of the SPX:

This chart is crowded. I wanted to show the automatically drawn regression channel and the way the SPX responded today to hopes that a fiscal-cliff resolution was close. The response today was to break out of that channel to the upside. It also broke through nearby Keltner resistance on 60-minute closes, confirming the breakout. As the market closed, the SPX looked most likely to rise and test the nearest green rectangle. However, a disappointment-driven drop Wednesday morning, even one that drops the SPX closes back below the nearest orange rectangle, questions that impression. Consistent closes below the red 9-ema would drive the SPX back inside that descending regression channel. If that happens, next potential downside targets are marked, with potential regression channel and Keltner channel support coinciding at the midline and lower level of the Keltner channels.

Annotated One-Hour Chart of the Dow:

I've left off the descending regression channel on the Dow's chart now that we can visualize it. A breakout to the upside would need to be confirmed by consistent 60-minute closes above the converging peach 45-ema and green 120-ema, and that didn't happen on the Dow's chart. The Dow stopped at resistance. A gap higher or early run up Wednesday morning could accomplish that goal, however. If so, the next potential upside targets, with potential resistance on 60-minute closes, are marked. If the Dow instead turns lower, midline and lower regression channel potential support levels coincide fairly well with potential targets marked by rectangles on this chart. Of course, as always, watch how the Dow responds with respect to the red 9-ema, when it's tested. Bulls want to see consistent closes at or above a turning-higher 9-ema.

Annotated One-Hour Chart of the NDX:

The automatically drawn descending regression channel is shown on the NDX's chart, and it's shown for a reason. The NDX clearly broke through the channel and then confirmed the breakout by running up through the nearby Keltner resistance and closing above it. Barring a breakdown Wednesday morning, the NDX has set an upside target at the nearest green rectangle. A needed pullback to test support is suggested by the shape of the last hourly candle and the distance the NDX has pulled above the rising red 9-ema. If such a pullback occurs before a push up toward the green rectangle, bulls want to see consistent 60-minute closes above the red 9-ema. They would prefer them above the green 120-ema.

If the NDX is driven below the red 9-ema and forms consistent 60-minute closes below it, bulls have a problem. That will knock the NDX back inside that former regression channel suggesting that today's bravado was overdone. Potential downside targets are marked in that case, with midline and lower regression channel targets and potential support levels coinciding well with Keltner channel targets.

Annotated One-Hour Chart of the Russell 2000:

No regression channel is included on the RUT's chart because the RUT, as it often does, has been overrunning boundaries and rendering them somewhat useless in predicting next direction. Last week, the RUT closed 60-minute sessions beneath an automatically drawn regression channel and today, it not only broke above it but charged to and through its next potential target. With a late-day high of 849.89, the RUT came tantalizingly close to meeting its 852.42 high from last week.

On a further climb Wednesday morning, watch that prior high and potential Keltner resistance, grouped together, for the possibility of resistance on 60-minute closes. I would expect that Keltner resistance to be driven higher, toward 855-856, if the RUT charges higher first thing Wednesday morning.

If the RUT drops lower instead or if an early morning rise is quickly reversed, watch approaches to the 60-minute 9-ema for potential support. Bulls want to see that support maintained on 60-minute closes. Because of the shape of the RUT's chart over the last fifteen days, the possibility exists that we could see several hours of small-bodied candles near today's close before the ultimate next direction is determined. Does what's showing upon this intraday chart matter in the context of what was happening today? Nah, it doesn't.

What's going to happen Wednesday? I count eight possible deal/sequestration/market reaction combinations such as deal/no sequestration/sell-the-fact reaction and no deal/sequestration/buy-the-rumor combinations. Markets have been front-running post-resolution rallies since the middle of November. Have they had the party before the holiday arrived and will they be too tired to celebrate the holiday itself or was this just a pre-party celebration that will continue into the beginning of next year?

After this last "year of the gaps," we know what it takes to render all that earnest chart analysis useless, don't we? It's just a gap that holds beyond the first few hours of trading. Beware the gap that's quickly reversed, however.

Here's a clue. Take a look at Asian and European markets in the pre-market session. Then look at how our futures are performing in relationship to those markets. If Asian and European markets have posted strong gains but our futures are at the flat-line or even negative, then there's at least some hesitation, if not something more serious.

Happy New Year to all our subscribers! I am looking forward to moving into new trading challenges and new challenges in the rest of my life, too. For all of us, I wish heartily for a year in which I never have to type the phrase "fiscal-cliff issues" again. Be safe and have fun this evening and tomorrow. Do something that restores balance in your life: time with friends, family or pets, time outdoors or creating art, music or computer codes that engage your brain. We'll see you next year.

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