The indexes and several sectors have bounced back up to their broken uptrend lines from November/December. We now watch to see if the back tests result in another selloff or if instead the bulls can run the market higher.

Market Stats

Equity futures had rallied a little more during the overnight session but then gave it up into today's open. The rest of the day was spent slowly chopping higher and S&P futures can within a couple of ticks of testing its overnight high. The drop back down at the end of the day, after back testing broken uptrend lines might have been the first clue that the next leg down will start on Thursday. Countering the bearish is the possibility that the market will be held up into the end of the month. Thursday should provide clues for what it will be.

In another case of bad news is good news, the bad Durable Goods number this morning was good because it means the Fed needs to keep the pedal to the metal. Yes, we have a very distorted and extremely disconnected market from reality. The Durable Goods number dropped -5.7% in March, which was much worse than the expected -3.1% and a complete reversal of February's +5.6% (which was revised down to +4.3%). Even excluding transportation orders (always volatile) the number came in worse than expected -- down -1.4% vs. expectations for 0.0% and only slightly improved from February's -1.7%, which was also revised down from -0.7%. Between the February revisions and the March numbers, there's no other way to view it as negative for the economy.

And because it was so negative the market rallied! Woohoo, the Fed will give us more money! It's time for a reality check and soon I predict the bulls are going to be severely checked, as in up against the wall before they drop to the ice. Even this week's housing numbers showed neutral at best but that didn't stop the home builders from rallying strong yesterday. I guess the bulls in those stocks were just relieved the numbers weren't worse, or perhaps I should say the shorts in those stocks were worried when the numbers didn't come in worse.

The bad-news-is-good-news reaction to Europe's negative economic news and our economic news is nothing new. Most believe that as long as the Fed keeps pumping money into the market we'll be OK. But in reality all the Fed is accomplishing is making people THINK their money-printing scheme is working. In reality the only thing the Fed has been accomplishing is keeping bullish sentiment high and therefore interested in keeping the Ponzi scheme, otherwise known as the stock market, going.

John Mauldin's recent "Outside the Box" article included a paper from two economists, Lacy Hunt and Van Hoisington, which did an excellent job explaining why the Fed really isn't helping any (except to keep bullish hope, I mean sentiment, high). You can read the entire article at Review and Outlook. The bottom line is that the Fed's effort to increase the money supply is failing. They have no control over the money supply or the money velocity. They've been losing the battle with money velocity since it peaked in 1997. They have ballooned their balance sheet but the money supply is actually lower than where it was at the beginning of 2012. The only thing they've managed to do is jawbone the market higher, making it believe in this all-powerful Fed. Once the market realizes their Emperor wears no clothes there will be hell to pay. Fascinating process actually.

Jim covered the tweet-bomb hacking incident yesterday but I thought I'd add a little more to his discussion. I think yesterday's incident was another shot across the bow of the USS Bullship, showing what happens when the bots go bye-bye and leave the rest of the market to figure out how to trade. As we know, the AP twitter post about the White House bombing and Obama being injured was immediately followed by an AP retraction, letting everyone know they'd been hacked. I wonder how much money was made by the person getting mega short before launching that tweet. But I digress; the main point for us is that trading volume instantly dried up when the market tanked.

All of the HFTs and their algo trading provide a huge amount of volume (many believe 80%) and all the liquidity from their trading provides a smooth market for the rest of us. That's a good thing. But when they stop trading, as they did when the market had its little mini-crash, liquidity suddenly dries up and those looking to get out can't find buyers. So the computers go looking for lower prices to get a fill, stopping out more orders along the way. In less than 2 minutes the DOW was down 150 points. The recovery was just as immediate as the computers kicked in their buying, now hitting stops on new shorts on the way back up. In about 3 minutes everything was back to normal except that most traders then stepped aside, wondering what the heck just happened.

As one trader emailed to me right after the mini crash, "This has been a test of the Hackers Broadcast System. Had this been an actual emergency, the drop that you saw would have been 10 times as great in the same time period. We now return you to regular algo programming." It's certainly becoming clearer to all of us that Twitter and other social media sites are having an enormous impact on our markets. News is instant and computers react to the news instantaneously. Everything happens faster and we little traders have no chance to react fast enough to protect our account, let alone trade it. And downside stops in a flash crash are likely to give us very bad fills (and potentially only if they're market orders since limit orders might get jumped over).

Once the algo computer trading recognized the market was in free fall they stopped trading. Many programs are designed to immediately close all positions and step aside. In an up market this will generally mean a bunch of sell orders dump at once. Zerohedge showed a very interesting chart yesterday (Twitter Hack), which points out how quickly liquidity dried up. The chart below shows ES in the top pane (showing the depth of the bid-ask with the band around price, if I'm reading it correctly), then the size of the bid-ask orders in the middle pane, and the volume in the lower pane. The time runs from 13:00 to 13:14. The takeaway here is that liquidity simply disappeared. I've talked about this plenty -- when the algo trading stops it leaves those of us who are looking to sell in a market decline with no one on the other side. This is what causes the flash crashes and it's likely to get worse before it gets better.

Liquidity Goes Poof

Yesterday's event was fair warning to all about what can (and very likely will) happen when the market gets hit with something and free falls again. Supposedly we've got circuit breakers to stop the trading for 5 minutes to allow humans to get involved (to get the specialists in the middle of the fray). A lot of damage can be done in 5 minutes and by that point there are going to be a lot more sellers wanting out of their positions.

This ominous warning sign follows two others that we received in the second trading week of April -- the Hindenburg Omen (HO) and the Titanic Syndrome (TS). The HO signal was the first one since August 2010, which was when the Fed stepped in the way of a market crash with the announcement of their 2nd round of QE. The rules for a HO are:

1. The daily number of NYSE new 52 week highs and the daily number of new 52 week lows are both greater than or equal to 2.8% of the sum of NYSE issues that advance or decline that day (typically about 84 out of approximately 3000 stocks). 2. The NYSE index is higher than it was 50 trading days ago. 3. The McClellan Oscillator is negative on the same day. 4. New 52 week highs cannot be more than twice the number of new 52 week lows (though new 52 week lows may be more than double new highs).

The HO signal is valid for 30 days and remains active as long as the McClellan Oscillator is negative. That means the current signal has been negated with McClellan Oscillator turning positive this week. Now we wait to see if another HO will trigger soon (they tend to cluster together at market highs if a turn is imminent).

The TS is triggered when NYSE 52-week highs minus 52-week lows (NH-NL) turns negative within 7 days of an all-time high in equities. The chart below shows a reading of -35 was achieved on Wednesday the 17th, only 4 trading days following the NYSE high on April 11th.

NYSE vs. NH-NL, daily chart

It is of course common to see the NH-NL turn negative following a more significant decline but the reason the TS signal is a danger sign for the market is because it makes it clear that the new high was made on the backs of very few stocks. When new 52-week lows outnumber 52-week highs so close to an all-time high you've got to wonder how many stocks are not participating in the current rally.

The NH-NL started diverging with price following the February high and can also be seen in the lower advance-decline highs since February, which is never a healthy sign for a rally (although you can see why it's not a trading signal by itself). So we've got some ominous signs for the market and another reason to be very cautious about playing the long side. The signals can be negated and not all HO or TS signals result in a market crash. But no market crash has occurred without first being warned by a HO.

There's an interesting sentiment measure that comes from magazine covers -- typically they're great contrarian signals. By the time a trend is identified and most people have jumped aboard it, magazines will then start to report on it. A magazine like Barron's reports the news but rarely makes predictions and when they do make predictions it's because a trend has been in place for a while. By the time the magazine gets the story into their editorial calendar for publication you can be sure the trend has definitely matured and probably close to ending. Hence the magazine-cover sentiment indicator. So it's interesting that the April 22, 2013 edition is predicting DOW 16,000.

Barron's April 22, 2012 Cover Page

As quoted from the Barron's article, "The stock market isn't the only thing that has set records this spring. Barron's semiannual Big Money poll of professional investors also is setting a record -- for bullishness, that is. In our latest survey, 74% of money managers identify themselves as bullish or very bullish about the prospects for U.S. stocks -- an all-time high for Big Money, going back more than 20 years." Does this sound like a trend that might be mature? All those who want to buy have probably now bought in. Where are the new buyers going to come from? The stock holders are now sellers-in-waiting. The same poll showed only 54% were bullish in 1999 so it's truly at an extreme now (only 7% are bearish).

John Hussman's weekend update referred to the cover and made note that the Big Money Poll has typically turned most bullish at market peaks, as he showed on his chart below. As he said, "Rule o' Thumb: When the cover of a major financial magazine features a cartoon of a bull leaping through the air on a pogo stick, it's probably about time to cash in the chips."

Bull Market Tops with Barron's Bullish Projections, chart courtesy John Hussman

Note that the 2000 high was timed with a cover pronouncing DOW 13,000, but the peak at 11750 had already passed. The 2007 high called for DOW 14,000, which was reached. But then what? Now they're pulling out the stops and suggesting DOW 16,000, which is assuming 15,000 is a given and not worth projecting. The DOW's high on April 11th was 14887 and we are left wondering whether even 15,000 will be reached.

So that's our sentiment picture, replete with warning signs, but let's see what price is telling us. Price is king and as traders that's what we need to keep our eye on. The rest of the indicators are ways to stay aware of potential changes in the market, and how significant they might be, but price is what we trade. With that, let's start with the SPX charts.

The SPX weekly chart shows the back and forth that's been going on since the week of March 11th. Since that little white candle we have alternating red and white candles with price bunched up into a resistance zone in the 1575-1595 area. We're going on seven weeks now since the March 14th high at 1563, which is the middle of the trading range (1536-1597) that we've seen since that time. The weekly oscillators have turned down and I continue to believe price will follow.

S&P 500, SPX, Weekly chart

At the moment the important trend line that I'm watching is the broken one from December-February, which was back tested yesterday and again today. As long as it continues to hold as resistance I'm looking for a kiss goodbye and selloff. The next leg down should be at least equal to the leg down from April 11th but likely will drop down to the 1474 support area before consolidating again.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1595
- bearish below 1536

The 60-min chart below shows more clearly how the broken uptrend line from December-February is acting as resistance. At the same time it's losing momentum (bearish divergence since yesterday's high) and this afternoon's late-day pullback could be the start of the next leg down. Obviously we'll know better on Thursday but it was a good setup for the bears heading into this afternoon's high. The left shoulder of the H&S topping pattern is the April 2nd high and interestingly, the bearish price objective for the pattern is down to 1475, the same support level shown on the daily chart.

S&P 500, SPX, 60-min chart

As with SPX, the DOW has back tested its broken uptrend line from December-February (the difference with the DOW is that this one is with the arithmetic price scale vs. the log scale for SPX). The current bounce should be followed by another leg down and once below the short-term shelf of support near 14450 it could find at least temporary support at its 50-dma, near 14395, and its uptrend line from October 2011-June 2012, which is currently just above its October 2007 high at 14198. Below 14198 would likely open up the flood gates lower.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,865
- bearish below 14,1450

The Nasdaq's bounce off last week's low took it right up to an intersection of trend lines in the 3275-3285 area and today's high at 3277 could prove to be too much for the bulls to power through. Above 3285 would be more bullish and likely would lead to a new high above 3307. But at the moment the back test of the broken uptrend line from November (probably the more important trend line at the moment) and the trend line along the highs from March-September 2012, as well as its broken uptrend line from 2009-2011, followed by today's pullback leaves a bearish kiss goodbye. The next move should be down below last week's low near 3155 and its 200-dma near 3084 makes for a good target.

Nasdaq Composite, COMPQ, Daily chart

Key Levels for COMPQ:
- bullish above 3307
- bearish below 3155

The RUT was the more bullish index today, which is typically bullish for the market since it indicates fund managers' comfort with adding risk to their portfolios. Only in hindsight will we know whether or not that comfort was misplaced. Considering the bullish sentiment by Big Money managers, mentioned earlier, it's understandable why they're comfortable adding more risk. It's also bullish that the RUT was able to close above its crossing 20- and 50-dma's, near 929, as well as above its broken uptrend line from November through the April 5th low, although this line is untested and therefore may not be important. The bearish setup on the RUT is the 1-2, 1-2 wave count to the downside, which calls for a very strong selloff. That would happen if all those bullish fund managers decide to start selling en masse.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 952
- bearish below 900

The banks are always important to watch and the banking index was one of the stronger sectors today. That's what the bulls want to see and if the index can climb above its broken uptrend line from November-February, which it back tested today, and its downtrend line from March, near 56.75, we'd clearly have a bullish looking chart. Bears want to see today's back test followed by a kiss goodbye

KBW Bank index, BKX, Daily chart

The home construction index had a great day yesterday and it broke its downtrend line from March, as well as its 20-dma. It even closed marginally above its 50-dma. What's not to like about all that? Now all it has to do is break back above its broken uptrend line from November-February, which it back tested today (noticing a common theme yet?).

DJ US Home Construction index, DJUSHB, Daily chart

The dollar has bounced back up near late-March high and could make it a little higher if it's going to back test its broken uptrend line from February-March, near 83.70 by the end of the week. My guess for a big sideways consolidation, as depicted on its chart below, remains to be seen but that's the best fit in its larger wave count.

U.S. Dollar contract, DX, Daily chart

There's a LOT of speculation about what gold is going to do from here. Big money has poured back into gold, believing the selling was overdone and that it was primarily a paper event (selling futures to hedge fund managers' long positions and gold holdings). That would explain the relatively sharp bounce off its April 16th low at 1321.50. Monday's high at 1438.80 was a nice "little" $117 bounce. The decline stopped a little short of the 50% retracement of its 2008-2011, at 1302.35, and might also stop short of its 38% retracement, at 1448.99, on its bounce. I think gold will head lower for a few more months in a stair-stepping pattern to unwind its wave count. We could see gold below $1200 before it finds a firm footing for a stronger recovery.

Gold continuous contract, GC, Daily chart

Silver is showing us a good technical pattern to trade so I thought I'd go through its different timeframe charts as a good example of what to watch for. Starting with its 120-min chart I show the sideways triangle that played out from last week's low. Following Monday morning's pre-market high (wave-iv at the end of its triangle pattern below) I suggested shorting it for another leg down since the triangle pattern looked complete and should be followed with a breakdown from it, which it did overnight into Tuesday. It then bounced back up during the overnight hours last night to back test the bottom of the triangle (stopping just shy of the line) and then fell away (bearish kiss goodbye). It should continue lower from here although there is the potential for one more bounce up to the apex of the triangle before dropping away.

Silver continuous contract, SI, 120-min all-hours chart

The daily chart below shows the little triangle fits as a 4th wave in the leg down from March 21st and the 5th wave down will complete one larger-degree 3rd wave in the move down from January 23rd. That will be followed by another bounce/consolidation and then lower again as it stair-steps lower to unwind a few more 4th and 5th waves in its wave count for the leg down from October 2012.

Silver continuous contract, SI, Daily chart

The bigger picture for silver, and again, gold is similar, is shown on its weekly chart below. The first downside target is 21.44 where it would test its May 2008 high. A little lower is a Fib projection at 20.81, which is where the 2nd leg of its decline from April 2011 (wave-C in the A-B-C decline) would be 62% of the 1st leg down (wave-A). I think a more likely target will be in the $18 area before it will be ready for a bigger bounce (for a good trading opportunity on the long side but not yet). The $18 area goes back to August 2010, which is where the parabolic rally started and is the usual target of a retracement. There is lower potential to 15, if not 12. For those who are anxious to buy silver and/or gold, you've got plenty of time. Give them time to go through a bottoming process.

Silver continuous contract, SI, Weekly chart

On April 11th oil broke its uptrend line from June-December 2012 and then found support near its December low. The bounce from April 18th is back testing its broken uptrend line, near 91.60, and will likely be followed by a bearish kiss goodbye. It makes for a good trade setup. Near the same level is its 200-dma (91.70), also tested today, and its 20-dma (91.94). That makes for a lot of resistance in the 91.60-91.94 area and even more of a reason why shorting the bounce makes for a higher-odds play.

Oil continuous contract, CL, Daily chart

It will be quiet tomorrow as far as economic reports go, with only unemployment claims. Friday will also be quiet but it will have two potentially market-moving reports -- the advance reading on GDP and the final Michigan Sentiment numbers. But will bad news be good news or vice versa? It's anybody's guess how this market will react to economic news.

Economic reports and Summary

Assuming the first leg down from the April high was the 1st wave, the bounce off last week's low is the 2nd wave correction and we're waiting for the start of the 3rd wave down. There are of course some alternative interpretations of the wave count but at the moment that's the preferred count. It's very common for 2nd wave corrections, which is the bounce in this case, to convince most traders that the prior move was a head fake. The bounce gets most traders feeling new highs are just around the corner but then the 3rd wave down begins. It's called the "recognition" wave because more traders begin to recognize that they got suckered into the correction and need to get out of their new (long) positions. This is why the 3rd wave is most often the strongest.

The high bounce correction has satisfied its mission -- the VIX has dropped back down and bullishness is up (ISEE call/put ratio is spiking back up, indicating lots of call buying happening). The pieces are in place to hand the new buyers an anvil before pushing them over the edge of the dock. The bounce up to broken uptrend lines is the bearish setup and now all we wait for is confirmation of the setup -- a down day on Thursday (or Friday if the market hangs up near the current high) would be the signal to get short and use the bounce high for your stop. The next leg down should easily break last week's low.

Good luck, mind the crash 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