After a relatively minor pullback from Monday's high it's a pretty bold statement to say the top is now in place. But that's what the price pattern suggests and it means short the bounces from here.
Today started with a gap down following a steady decline in the overnight futures. The Nikkei index gave up 4% and broke back below 14K and is looking like its bounce correction could be over. Worry over China's slowing economy continues. Today's decline marks the third day in a row for the S&P 500 to finish negative on the day, the first time it's done this since June. But not since November 2012 has it had more than 3 days in a row. Will Thursday break the record for the year or will it be positive? There's actually a good chance it will be a green day on Thursday but it doesn't look so good after that.
Following a little bounce attempt into this morning's open the futures and cash index dropped even further. But a low was found by the end of the first hour of trading and the dipsters arrived on schedule. Depending on the index there was a decent recovery off the morning lows but from a technical perspective I think the damage has been done to the bullish pattern (the uptrend has come to an end).
One sign that buyers are still anxious to buy the dips is the fact that the ISEE call/put ratio finished at a high 133 today, which indicates a lot of call buying was going on. Perhaps traders are gearing up for an expected bullish opex week next week. It's a trend that has worked for a long time so I can't say I blame them for trying. However, this time it might not work out so well for them. There's a good chance that all those buying this dip will add to the selling pressure on the next leg down. But they still have a chance to get out a higher price on Thursday if the bounce pattern makes it a little higher before tipping back over.
On Monday I said we should know by Wednesday whether or not we put in a top and with the impulsive decline off Monday's high I think it's a good bet that we saw the high on Monday (Friday for some indexes). The only disappointing thing, from a purely technical perspective, is that we did not get the "one more new high" that I expected to see on Tuesday. It was the final little 5th wave that I wanted to see but as so often happens, it was a no-show. Tuesday's decline out of the gate, which was expected, never turned back up and instead turned into the 1st wave down into this morning's low.
The bounce off this morning's low looks like the first part of an expected higher a-b-c bounce and hopefully that will play out (rather than have another failure to bounce). A higher bounce into Thursday afternoon should be an outstanding setup for those who want to play the short side (and for those who are long to pull out...hmm, that statement could be misconstrued...and maximize their profits). I'll lay it out on the chart to show what the setup should look like.
The weaker sectors today were the SOX, BKX, RUT and TRAN. These are not the sectors the bulls want to see weak and it will be important to see if they instead become leaders to the downside. The stronger sectors today were healthcare, drugs and utilities -- all defensive plays.
I've discussed ad nauseum how disconnected the stock market is with reality. Whether it's a comparison to world indexes, commodities or economics I've shown many charts that demonstrate just how disconnected this stock market is. We of course know why -- Uncle B-B-Benny and the Feds showering the market with pixie dust and making everyone feel there's no danger in leveraging to the hilt and buying all the stock your account can hold. The problem of course is that the market's rise is purely on sentiment and not on fundamentals, and sentiment can shift very quickly.
The financials have built themselves a house of cards because they believe the Fed will save them (again). On top of this house of cards is a stock market that's been built on even less support. A stock market rally with no underpinnings is a disaster waiting to happen and the only thing we don't know is what black swan is going to come flying into the picture.
Bloomberg's Chief Economist, Michael McDonough put out a chart of GDP estimates that have been declining since the beginning of 2011 and he commented that he thought the stock market was quite disconnected from reality. Especially since the August-October 2011 lows in the stock market, which was followed by a strong rally, economists keep ratcheting down GDP estimates while the stock market keeps whistling past the graveyard believing the Fed will keep us safe. That's not a safe assumption.
U.S. 2013 Bloomberg Consensus GDP Forecast vs. S&P 500, chart courtesy bloombergbriefs.com
In his Saturday update John Mauldin had an interesting observation related to the stock market's ignorance of fundamentals. He stated, "Let's take the S&P 500 as an example. It returned roughly 42% from September 1, 2011, through August 1, 2013, as the VIX Index fell to its lowest levels since the global financial crisis. Over that time frame, real earnings declined slightly (down about 2% through Q1 2013 earnings season), while the trailing 12-month price-to-earnings (P/E) ratio jumped 44%, from 13.5x to 19.5x. That means the majority of the recent gains in US equity markets were driven by multiple expansion in spite of negative real earnings growth. This is a clear sign that sentiment, rather than fundamentals, is driving the markets higher."
On Monday I showed a chart of the VIX and how it has now dropped down to this year's lows and how the complacency of this year's rally, along with how overbought it is, is a dangerous time for the bulls. One example of how overbought the market is can be seen on the Nasdaq Summation Index, which is a market breadth measurement derived from the McClellan Oscillator, which looks at advancing-declining issues. The Summation index rises when the McClellan Oscillator is positive and falls when the McClellan Oscillator is negative. The longer it remains positive or negative the higher or lower the Summation index will go and when it gets stretched to the upside or downside you can use it as an overbought/oversold indicator.
The Summation index for the Nasdaq (NASI) is shown below (the dotted line) vs. the Nasdaq. NASI is currently very overbought and is the highest it's been since the high in 2007. There's no bearish divergence on the NASI so it's not a timing tool for bears to pile in here but it is certainly warning us that things are getting a bit frothy to the upside.
Nasdaq Summation Index, NASI, Weekly chart
Another chart to show how overbought the market is can be seen using the monthly chart of the Nasdaq and its Bollinger Band. When it has closed the month up against its BB it has typically reacted with a pullback. When it has closed above its BB, as it did in 2000 and 2007, it reacted with a very strong decline. Will it be different this time? Considering the bearish divergence shown on the rate-of-change I think it would be a bad bet to be on the long side here.
Nasdaq Composite index, COMPQ, Monthly chart
The weekly chart of the Nasdaq shows price pushed marginally above its parallel up-channel from August 2011 and is currently finding support at the top of the channel near 3650 (this is similar to what I showed for the RUT on Monday, with the top of its channel still holding as support near 1045). But on Monday it banged its head against the top of its up-channel from November 2012, which looks good for the completion of the leg up from November, which in turn should be the completion of the corrective move up from October 2011, which in turn should be the completion of the 3-wave correction off the 2009 low.
Nasdaq Composite index, COMPQ, Weekly chart
The daily chart of the Nasdaq shows the confluence of trend lines (tops of channels) and the 62% retracement of the 2000-2002 decline, at 3595. The 20-dma is currently near 3619. Based on all this I think it would be confirmation of a top in place if the Naz drops below its July 24th low at 3573. It remains potentially bullish above that level but as mentioned, the pieces are now in place to call a top and I'm just waiting for confirmation of that call. With the sharp rise off the June low I suspect we'll see the techs (and small caps) leading to the downside.
Nasdaq Composite index, COMPQ, Daily chart
Key Levels for COMPQ:
- bullish above 3695
- bearish below 3573
As mentioned above, the leg up from June counts well as the final leg of the rally from October 2011 and as such it should be showing weakness. The strong shove to the upside from June is not showing much in the way of momentum weakness (except Monday's high against its July 18th high) but as can be seen on the QQQ chart below, the volume has been drying up as the rally has progressed from the June low. This sets up a weak top because there weren't many players behind the move, which leaves it vulnerable to a fast retracement. As a side note and from a candlestick perspective, today's hammer on support (trend line along the highs from September 2012 - May 2013) is potentially bullish.
QQQ daily chart
SPX found support at its May high at 1687 (slight break with a low at 164.91) and closed marginally above its 20-dma, which hasn't been tested since SPX climbed above it in early July. This is a good short-term indicator used by many traders -- long above, short below. It should be good for a bounce on Thursday (continuing the bounce off this morning's low) but another break below it, near 1692 on Thursday, would spell trouble for the bulls. Many fund managers would use that as a clue to lighten their inventory further.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1710
- bearish below 1685
This morning's gap down broke the short-term uptrend line from July 26th, which confirmed the leg up from that low finished with Monday's high. We've got a small impulsive move down (shown in more detail on the 10-min chart following the 60-min chart below) and I expect only a bounce to correct this week's decline before heading lower. The broken uptrend line will be near 1700 tomorrow morning but if we first get a small pullback and then another leg up for the bounce I don't think we'll see that high of a bounce. Regardless, the bounce should be used as an opportunity to get short the market, with a stop above Monday's high.
S&P 500, SPX, 60-min chart
The 10-min chart shows more detail of this week's decline and the expected bounce before heading lower again. The decline from Monday is a 5-wave move down, which tells us the trend has changed to the downside (we reached the bend at the end of the uptrend). The bounce off this morning's low should be just wave-a of an expected larger a-b-c bounce. A pullback in the morning followed by another leg up would give us an ideal bounce correction to short. Assuming the pullback is to about 1689 we'd then have an upside target near 1697 for two equal legs up from this morning. That would be a 50% retracement of the decline and it would close this morning's gap down (at 1697.37). The next leg of the decline, if it's to be a 3rd wave in the decline from Monday, could target the 1660 area before the next consolidation/bounce.
S&P 500, SPX, 10-min chart
The DOW has clearly broken its uptrend line from June and closed below its 20-dma (15331) and its July 31st low at 15492, both of which tell me the top is in for the rally from June and in turn from October 2011 and, which completes the big 3-wave move up from 2009. It's time for the bears to start feeding while the fattened bulls go get slaughtered.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 15,660
- bearish below 15,490
The RUT has also broken its uptrend line from June and closed below its 20-dma (1047.79). It's trying to hold at the top of its parallel up-channel from October 2011, which it had broken above in mid-July. It had the weakest bounce of the 4 main indexes, which is a negative sign for this index. Fund managers are bailing and it's not allowing the index to get a decent bounce. Expect this index to be one of the leaders to the downside.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1064
- bearish below 1045
After using its uptrend line from May for the past week TNX broke it today and also dropped below the low of Friday's big red candle. It should continue lower from here (buying in the bonds) and once it gets below the mid-July lows near 2.46 (as well as its 50-dma coming up to the same level) we'll have better confirmation that a top was made in yields (at least for now).
10-year Yield, TNX, Daily chart
Back in early spring we were hearing all kinds of reports about how strong housing was and that it was a great time to buy a house. Add in the increase in mortgage rates and there was a mad scramble to get into a house before prices/costs got away from them. I thought it was a mistake because I believed then and still believe we're going to get another leg down in the housing market (and interest rates). When the home construction index peaked in 2005 it was ahead of the peak in home prices (it took a while to recognize that the housing market was overheated). Once again I think the home builders have been warning us and since the peak in this index in May we've seen a strong decline, wiping out gains made from December to May. Expecting a high in May, I thought it was a warning sign for the housing market in general. This week's decline in the home construction index might be the beginning of an even stronger decline, which would confirm there's recognition that all of the bullish hopes for the housing market are not coming to fruition.
The home construction index has been holding above a trend line along the lows since February (what I thought might be the bottom of a diamond topping pattern in the making) but today it broke below the line, which could be an indication that much stronger selling is to follow. The bearish wave count since the May high suggests a 1-2, 1-2 to the downside which points to a strong 3rd of a 3rd wave down to follow. A break of the series of lower highs is needed to negate the bearish price pattern.
DJ U.S. Home Construction index, DJUSHB, Daily chart
On Monday I showed the weekly chart of the banking index, BKX, to show an upside projection at 67.95 that I thought it might make it to. But today's decline below its July 29th low at 65.18 (albeit only by 8 cents) says the top is likely in place now. Obviously it would be more bullish with a push above last Thursday's high at 67.11, which would open the door to the 67.95 projection, if not the 50% retracement of its 2007-2009 decline at 69.45, but at the moment I think we should be looking for a bounce to correct the decline from last Thursday and then lower again.
KBW Bank index, BKX, Daily chart
I had thought the U.S. dollar would find support at/above 81.50 but today's decline took care of that thought. It gave up -0.38 today and dropped down to a low of 81.27 before closing at 81.30. The next potential support level is an uptrend line from February-June, only marginally lower near 81.21 and then a longer-term uptrend line from August 2011, currently near 80.85. It's going to be a challenge figuring where the dollar will find support but I continue to believe the current pullback from early July will be reversed from a higher low than June's 80.50.
U.S. Dollar contract, DX, Daily chart
Similar to gold's chart, silver would look best with another leg up for its bounce off its July 1st low. Its bounce looks more like a bear flag correction than something more bullish but another leg up within the flag pattern, potentially up to about 21, is possible before heading lower again. The downside target from 21 would be about 16.
Silver continuous contract, SI, Daily chart
With the decline in the dollar since early July one would have thought it would have been good for commodity prices. One would be wrong in that assumption. As can be seen on the DJ UBS Commodity index, DJUBS, it was only good for a bounce in the first half of July but the index has now dropped below its June 28th low. To me this is one of the strongest indicators of two things: one, there is no expectation for inflation; and two, there is no expectation for economic growth (a strong reason why I believe the Fed will be doubling and quadrupling its asset purchases long before they start tapering). There are hints of bullish divergence at the current low so there could be at least an oversold bounce soon.
DJ UBS Commodity index, DJUBS, Daily chart
Other than the usual unemployment numbers Thursday morning we do not have any significant economic reports to worry the market.
Economic reports and Summary
The price pattern looks good for the completion of the 1st wave down from Monday's highs (or last week's highs, depending on the index). The impulsive (5-wave) decline tells us the trend has changed. The trend is your friend until the bend at the end (and the bend is the hard part to figure out for trend followers) and the wave pattern now tells us the bend was Monday's highs. Today's bounce will ideally be followed by a pullback Thursday morning and then another leg up into the afternoon. It will be a bounce to short since we should get at least another leg down. The larger pattern suggests you'll want to short bounces from here rather than buy dips.
The completion of an a-b-c bounce on Thursday (maybe Friday, depending on how long it takes to get another leg up) will be your setup to get short, including swing and position traders. If you're a position trader, waiting for a little better evidence of a market turn, such as a larger 5-wave move down, probably into next week, will then set up a larger bounce. The larger bounce will be the one where you'll want to be out of long positions and looking to get into longer-term plays on the short side. We'll see how that's setting up this time next week. In the meantime trade carefully but start thinking like a bear.
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