Market Internals

Introduction

What does that title have to do with the economy and our stock markets? Its import perhaps doesn't extend past our local economy, but if I wanted to start the week by offering a happy or hopeful headline, that was the only one I could muster. If we could have brought all of the decision makers in Washington together here while temperatures and rain were finally falling, perhaps their tempers might have been cooled, too.

This week opens with each side in our political drama further entrenched. Some spent yesterday digging those trenches deeper. Many headlines focused on yesterday's and today's pronouncements by Speaker of the House John Boehner. Speaking this weekend, he vowed that he would not schedule a vote on the clean funding bill passed by the Senate. Twenty-one House Republicans have said that they would support a clean funding bill, and some speculate that's enough to pass the measure. A few Tea Party-affiliated members of the House have even affirmed that they would sign it in return for discussions they want regarding the debt ceiling, saying essentially that it's time to give up this battle and move to the next one. Speaker Boehner counters that there are not enough votes to pass a clean funding bill. Nor will he bring a vote to raise the debt ceiling without concessions being made from the other side, he also said. He warns that we're on a path to default and that it's President Obama's fault.

The other side is just as entrenched. President Obama said today that he will speak to the Republicans but not while threatened with shutdown or default. Furthermore, when Speaker Boehner also said yesterday that he doesn’t have the votes for a continuing resolution, President Obama challenged him today to put that contention to a test and vote today on a continuing resolution. A "continuing resolution" is a type of legislation that can fund government if the fiscal year ends without a formal appropriations bill being signed into law. Such continuing resolutions are not a rarity. They are frequently used: in recent history, 21 continuing resolutions were needed before the 2001 U.S. federal budget was finalized. Seven were needed for the 2011 U.S. federal budget.

One possibility for some movement away from these entrenched positions is the speculation that the Democrats in the Senate are preparing debt-cap legislation. That legislation would reportedly allow President Obama to lift the cap unless Congress moves to bar him from doing so. By the time these words have been edited and uploaded for publication, we've probably had a few more verbal volleys back and forth. If there's some rapprochement that will resolve these entrenched positions, and there certainly will be, its timing and structure are not yet clarified.

Meanwhile, warnings escalate about the impact of a failure to lift the debt ceiling, with that deadline fast approaching. Warnings of a global catastrophe are bipartisan and issue from the likes of Tim Bitsberger, who served as a Treasury official in the administration of President George W. Bush and now sits as a managing director of BNP Paribas SA. He warns that Lehman's failure was that of an isolated company, but "now we are talking about the U.S. government" missing payments. In a Fortune magazine article, Warren Buffet likened the specter of a failure to lift the debt limit and a choice to default on some debts to "nuclear bombs, basically too horrible to use." Others counsel that global markets will experience fear of the unknown since the U.S. has never technically defaulted on a debt payment, and will be more volatile. Market participants remember the last time the U.S. came close to a failure to raise the debt limit but finally did so at the last moment. In that 2011 case, global stocks still lost $6 trillion in value (Onanran, Bloomberg)

Others counsel that the effect would be tempered by the length of time any default persisted, if any ill effect occurred. The markets haven't appeared too worried until now. Jim Brown has been offering some counter arguments to the escalating worries about a default, and I would urge you to read his weekend Wrap for a counterbalance to this report on today's rhetoric, if you haven't already done so. A failure to raise the debt ceiling doesn't automatically lead to a default on the most important of debt payments, for example, as the U.S. government would prioritize its payments just as a family running out of cash after a job loss would do.

Treasury Secretary Jacob J. Lew warns that a default will be risked, however, if the debt limit is not raised. That's what we would expect him to warn but does that mean we should discount the warning? That's what we and our fellow investors and traders across the globe will be deciding and that's where our focus should lie on these pages. For example, I typically enter my monthly RUT trade during this week, and I will be deciding whether I want to enter it on schedule and whether I will enter the same size trade as usual or pare down the size to reduce risk. I'm not bailing out of long-term investments, of course, but I do have put insurance below the market. Those are the decisions for us at this moment. Make the decision. It's your money in your control.

The good news for the economy, especially for your personal economy if you're a furloughed civilian employee of the government, is that Defense Secretary Chuck Hagel has called those employees back to work this week. Those employees were reportedly filtering back into work today. Also, the Senate and President Obama are widely expected to approve a House of Representatives measure to offer full pay for government employees shut out of their jobs. As of this writing, I could not verify whether that measure had been approved today.

What was the result today after all this? The SPX fell 0.85 percent; the Dow, 0.90 percent; and the NDX, 0.83 percent. The RUT tumbled 1.16 percent, and the SOX, 0.53 percent. The Dow Jones Transports dropped 1.09 percent. The financials, as represented by the KBW Bank Index (BKX), dropped 1.75 percent. Homebuilders, as represented by the Dow Jones U.S. Home Construction Index ($DJUSHB), fell 0.50 percent. Even the defensive Dow Jones Utilities dropped 0.43 percent. Telecom services outperformed today, however, gaining 0.6 percent. Still, today's decline was pegged today as more of an absence of buyers than a rout engineered by sellers. Volume proved light.

What didn't drop was the volatility indices. The VIX gained 15.89 percent; the RVX, 14.34 percent; and the VXN, 14.61 percent.

Treasuries moved higher today, sending yields lower. Ten-year yields closed at 2.634 percent, and thirty-years, at 3.702 percent. The spread between the yields on one- and three-month bills widened to its biggest gap since 2008, with that gap attributed to fear of default on the bills maturing closest to the October 17 deadline, Bloomberg noted.

Gold and silver futures moved higher today as traders sought a way to hedge equity risk. Some metals traders believe that China may also be prepared to begin buying after the country's long holiday from last week and extending into last night. Gold futures (/GC) for December delivery settled at 1325.1, up 15.2 points. Silver futures (/SI) for December delivery settled at 22.386, up 0.634. Copper futures (/HG) for December delivery settled at 3.2965, down 0.0045. Reports are that 35 percent of Gulf oil and 37 percent of Gulf gas output was shut due to tropical storm Karen (RANSquawk). Crude futures (/Cl) for November delivery settled at 103.03, down 0.31.

Monday's Developments

Last night, the Bank of Japan's Monthly Report detailed an economy that "is recovering modestly," in the central bank's assessment. Exports, business fixed investment, employment and income have all been "picking up." Industrial production and business sentiment have also improved, albeit modestly. The central bank predicts modest recovery into the future while acknowledging a heightened ambiguity about the global economy. I wondered if the U.S. situation would be mentioned as one cause of that uncertainty, but it was not in the official summary, at least.

Most Asian bourses headed lower. The Nikkei 225 dropped 1.22 percent; the Hang Seng, 0.71 percent, and the Straits Times, 0.05 percent. China's Shanghai Composite was again closed last night for the last day of the recent week-long holiday.

Some news sources reported today that the World Bank has trimmed its growth estimates for China and Developing East Asia for 2014. The bank now estimates China's 2014 growth at 7.7 percent, down from the prior 8.0 percent, and Developing East Asia's at 7.2 percent, down from the prior 7.6 percent. The bank blamed slowing growth, of course, as well local government debt in China and weaker commodity prices. Those lower prices have hampered exports and investments in some Asian countries.

European bourses turned lower this morning, but most spent the afternoon recouping some or all of those losses. The FTSE 100 lost 0.26 percent; and the DAX, 0.36 percent; but the CAC 40 gained 0.03 percent. Spain's IBEX 35 lost 0.41 percent, but Italy's FTSE MIB gained 0.66 percent. The threat of a government upheaval in Italy was removed late last week when Silvio Berlusconi's bid to force a new election failed and the country's Senate committee voted to expel him from the Italian Senate, a first step in that process.

Today's economic release schedule proved light. Moody's weekly Business Confidence surged up to 28.7, with expectations for early next year continuing to strengthen. Respondents still weren't confident in present conditions, but two-thirds look forward to improved conditions next year, presumably after the budget and debt-ceiling crises are long behind us. Both hiring and office demand, long categorized as soft in this report, appear to be improving, Moody's says, although still soft. The economy is expanding near its potential, the firm reported, although the report has not returned to using that "near the high end of its potential" clause that was a routine part of the summary until a few weeks ago.

August's Consumer Credit amount rose $13.6 billion after July's gain of $10.4 billion. That was far more than the $12 billion expected. Part of that increase was due to money spent on education, but consumers also proved confident enough or loans proved available and cheap enough that they spent money on new vehicle purchases. Those are part of the non-revolving credit component which gained $14.5 billion. Credit card debt, part of the revolving credit component, shrank again, by $883 million, and that clouds that picture of consumer optimism.

Story stocks included Airbus, with that company today announcing that Japan Airlines Co. Ltd. has placed an order for 31 wide-body A350 jets. Those new jets will begin being put into service in 2019. The company also has an option for 25 more jets. This is bad news for Boeing (BA, 116.69, down 0.51 or 0.44 percent) and for BA's parts suppliers and manufacturers in Japan. BA's loss was on less than daily average volume.

Late Friday, Outerwall (OUTR, 59.18, up 2.08 or 3.64 percent), formerly Coinstar, jumped after a disclosure that Jana Partners has a 13.5 percent stake in the company. Today, price jumped again although OUTR fell well back off its early morning high of 64.31. Volume was more than six times average daily volume, so many were taking an opportunity to sell into today's rise and take profits.

Activision Blizzard (ATVI, 16.51, down 0.37 or 2.19 percent) has filed a patent infringement lawsuit against Worlds Inc. and Worlds Online Inc. These companies are involved in creating software, content or technology related to interactive entertainment products. Worlds Inc. had previously filed a patent infringement lawsuit against ATVI.

Cooper Tires (CTB, 25.72, down 3.79 or 12.84 percent) is back in the news this Monday. A previous Monday report detailed a planned acquisition of the company by Apollo Tire. Now there are questions about CTB's valuation, U.S. labor agreements and some details of a joint venture in China. A possible price reduction is allegedly being considered. CTB officials denied any problems with valuation, according to one report, although an earlier one had characterized the company as agreeing that there might be grounds for a reassessment.

Several companies received upgrades or downgrades. Ahead of its earnings report tomorrow, Alcoa (AA, 7.97, up 0.01 or 0.13 percent) received a downgrade by Morgan Stanley. The new price target was $90. Goldman Sachs downgraded Toll Brothers (TOL, 30.76, down 0.28 or 0.90 percent).

Barclays downgraded IBM (182.01, down 2.09 or 1.14 percent), mentioning the adverse impact on the company of cloud computing and software-as-a-service. A Jefferies analyst upgraded Apple (AAPL, 487.75, up 4.72 or 0.98 percent). Before Twitter even goes public, SunTrust Robinson Humphrey weighed in on the company, setting a price target of $50.

Blackberry Limited (BBRY, 7.97, up 0.28 or 3.64 percent), rumored to be in talks to sell off parts of itself to the likes of Google, Cisco, and SAP. The deal by shareholder Fairfax Financial to buy the entire company may not find the needed financing, some speculated.

In afterhours trading today, insurer Tower Group International, Ltd. (TWGP, 7.41, down 0.22 or 2.88 percent) headed lower again after the company announced that it needed to add $365 million to its reserves and would also take a $215 million impairment of goodwill. JPMorgan Chase has been retained to advise the company on its "strategic options." Fitch cut the company's rating six steps. As this report was typed in the immediate aftermath of that release, the stock was bid 5.74 and ask 5.79.

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

Charts

Those new to my Monday Wraps might find the following 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 rectangles, usually green for upside and red for downside. Orange rectangles 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 rectangle, 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:

The SPX has been descending beneath a turning-lower red 9-ema. Daily closes have mostly been at or beneath that moving average, a pattern we'll see on several indices. As long as that pattern continues, chances are heightened that the SPX will continue to probe the support level just beneath, extending from about 1661-1679. So far, such support tests have stopped at the top of that potential support level on daily closes, but a drop closer to 1661 and the support of the long-term regression channel can't be ruled out.

If that deeper potential support fails on sustained daily closes, the next potential support level lies near 1633-1647. More traditional technical analysis suggests that a sustained break of that trendline's support near 1660-1661 would mean a deeper drop because it means that the SPX is breaking down out of a long-term regression channel. However, that particular Keltner support configuration tends to be strong, too, so I wouldn't discount the possibility that any break of the long-term regression channel's support could find a safe haven level just below at that potential Keltner support. If the 1633-ish support fails on sustained daily closes, however, a much lower potential Keltner target is suggested.

So far, none of that has happened. Nearest support is holding and may continue to hold, even on a deeper dip to the 1661 level. The SPX could even climb, especially if there's some quick and satisfying-to-all-parties resolution to the political drama. Even without that resolution, it perhaps wouldn’t be too surprising from a technical-analysis standpoint to see a quick jump up to test the top of the smallest (grey) Keltner channel. That channel's potential resistance hasn't been tested since the middle of September. If that resistance from about 1704-1715 holds on sustained daily closes and the SPX rolls down again, the SPX still heads down within a turning-lower channel. A breakout above that resistance might next find potential resistance from about 1720-1735. It's only on sustained daily closes above about 1735 that the SPX is free and clear again, setting a new upside potential target at about 1756-1768.

Annotated Daily Chart of the Dow:

An automatically drawn regression channel on the Dow's chart, extending across the same time period, shows how badly the Dow has been underperforming the SPX on this basis, too, as well as on a Keltner basis. The Dow has broken beneath that channel, risen to retest it, and again fallen beneath it. Sustained daily closes beneath the August lows near 14762 would also set a new potential Keltner target near 13975-14100, although I would not discount the potential for support near the June low, too.

The Dow hasn't even tested that support near 14762-14897, however, much less broken it. If the Dow can hold that at or above that support and especially if it can hold the support near 14975 on most daily closes, chances increase that it will again rise toward a red 9-ema retest. Of course, the Dow did not hold above 14975 on today's close, but that's a single close on a day with lots of political wrangling. We don't know what will happen tomorrow, but the charts suggest an increasing likelihood now, due to today's close, that the Dow will test 14762-14897.

Unfortunately, between about 14762-15222, we don't really know much except that the Dow is chopping around mostly beneath the red 9-ema but mostly above the strongest potential support. All we know is that it's not showing strength.

Bulls would like to see the Dow maintaining daily closes back above about 15222 and then at least retesting the top of its smallest (grey Keltner channel). Sustained breakouts above that channel would suggest a possibility that the Dow would rise to retest 15595-15710, with presumed strong resistance lying in wait there. The Keltner channels and trendline levels both currently suggest that resistance might be strong from about 15595-15710. If the Dow could sustain closes above that zone, the next potential upside target is set. It's marked on the chart.

Annotated Daily Chart of the NDX:

The NDX's automatically drawn regression channel displays its outperformance of the SPX and Dow. Rather than falling toward the bottom of its rising regression channel, it's been hanging onto support at the midline, attempting to scale above the potential Keltner resistance that spans from about 3224-3260. If the NDX can maintain daily closes above that zone, it sets the next marked potential Keltner target from about 3273-3305.

If the NDX cannot soon maintain daily closes above that 3224-3260 resistance, however, it might do what other indices have done: fall back to next support to regroup. That support on the NDX is now from about 3159-3187. Keltner channels suggest that a failure to maintain that support on daily closes would send the NDX straight down to the next support near 3035-3065, where Keltner and historical support converge. We see the intervening support of the rising regression channel, but the NDX's version is not as long-term a channel and its boundaries are not as well established. The boundaries should be acknowledged and watched but shouldn't be counted on too strongly. This summer, the NDX shot up at a steeper angle than the other indices and established a climbing pattern that has been narrowing. That's not a pattern that's as stable as those seen on other indices, but its instability can be demonstrated as easily by another break skyward as by a decline. In the algorithm-driven climate of the last few years, it would be foolish to rule out either possibility.

A testing of the potential support near 3035-3065 and a failure to sustain support there on daily closes sets the next potential downside target. That's marked on the chart.

Annotated Daily Chart of the RUT:

Like the NDX, the RUT has been clinging to support at the midline of its rising regression channel rather than dipping toward the bottom of that channel. Today, it slipped a little. Also like the NDX, the RUT has not been able to break above the Keltner resistance that it's been testing. That spans from about 1075-1088. If the RUT were able to sustain daily closes above that resistance, it sets a next potential target at about 1095-1108.

However, the RUT probably needs to break out to the upside within a few days or it risks doing what other indices have done: dropping down to stronger potential support. That's a risk that increased today due to the closing level. That next potential support zone is currently near 1050-1063. A failure to sustain daily closes there suggests a drop down to test the bottom of its rising regression channel, currently crossing at about 1029, or perhaps to next Keltner support near 1010-1020. The RUT has tested this regression channel's support several times on the way up and does appear to have been responsive to its support. We shouldn't discount the possibility that support should start kicking in there. I also would not discount the possibility that the RUT could drop all the way into that next Keltner target if it sustains daily closes beneath 1050 and then starts heading down from there. A failure to find support at 1010-1020 on sustained daily closes sets the next potential downside target, marked on the chart.

Annotated Daily Chart of the Dow Jones Transports:

The DJT, a bellwether index, has been behaving a lot like the NDX and RUT. Because it can move fast, too, and sometimes diverges from other indices, we can use it to alert us to changes in the underlying outlook. So far, there's no divergence to guide us.

Tomorrow's Economic and Earnings Releases

This week's important economic events are carried forward from Jim Brown's weekend Wrap.

Late news today was that the Job Openings and Labor Turnover (JOLT) release appearing above on tomorrow's schedule will be delayed due to what is now being termed the "partial government shutdown."

In addition to the earnings that Jim has listed for tomorrow, YUM! Brands Inc. (YUM), operator of restaurants such as Taco Bell, KFC, and Pizza Hut here and in other countries, reports after the close. I don't know if the report of any single company will draw attention away from what's going on in Washington, D.C., but YUM could provide an important look at the health of the economy here and in other countries. Alcoa (AA), the traditional opener of the reporting season but now not awarded as much importance as a bellwether of the earnings season, also reports after the close tomorrow.

What about Tomorrow?

Annotated 60-Minute Chart of the SPX:

The SPX's recent descent is easy to discern on this 10-day, 60-minute chart. The SPX has been descending mostly within the confines of a descending smallest Keltner channel, the grey channel. Potential support on 60-minute closes for that channel lies at about (or will be pushed to) 1669-1675. Potential resistance on 60-minute closes is at about (or will be pushed to) 1685-1692. Prices that zigzag within the boundaries of that channel are just confirming the downtrend that's been in place the last couple of weeks.

Sustained 60-minute closes beneath about 1669 set up a next potential short-term downside target of about 1653-1658, where next potential short-term support may lie. A break through that support will require a look at the daily chart for confirmation of the next potential downside target.

Sustained 60-minute closes above about 1692 set up the next potential short-term upside target, at about 1701-1706, where next resistance may lie on 60-minute closes. A next potential upside target is also marked, in case that one should be broken to the upside on sustained 60-minute closes.

Annotated 60-Minute Chart of the Dow:

The Dow's descent has been stronger on a Keltner basis, and the Dow ended the day not far from the last pictured potential downside support, from about 14864-14900. Sustained 60-minute closes beneath about 14945 set that potential downside target. Today's close was slightly below that level, but that close hasn't been matched by other 60-minute closes and came on last-minute selling or, perhaps, a failure of last-minute buying. The next target is theoretically set, but be aware that it's tentative. If the Dow were to break through about 14864 on sustained 60-minute closes, the daily chart would be needed to detail other potential downside targets.

Potential upside targets stair-step higher from the Dow's current level. It's not until the Dow can sustain 60-minute closes above about 15063-15123, however, that any change in short-term tenor has occurred. Then it faces what is a potentially strong resistance configuration, likely at about 15187-15261 by the time it could be tested. A further potential upside target is also marked in case the Dow should break through and maintain 60-minute closes above about 15261.

Annotated 60-Minute Chart of the NDX:

The NDX has chopped sideways, scattering potential support and resistance lines so that it's much more difficult to pinpoint the meaning of a particular move. Unfortunately, anything between the resistance at about 3253-3270 on the upside and the support at about 3189-3198 on the downside are just part of that recent pattern and don't predict anything about the next move . . . until the last time the NDX cycles toward one of those barriers and moves through it. We won't know in advance which time that will be, of course. It takes sustained 60-minute closes above about 3270 on the upside or below about 3189 on the downside to break the NDX out of that recent pattern and set new potential targets. Those targets are marked on the chart, but may have moved in the direction of the price movement by the time they can be tested.

Annotated 60-Minute Chart of the Russell 2000:

The RUT has set up a pattern much like the NDX's. Movements between the potential support zone on 60-minute closes near 1064-1067 on the downside and the potential resistance zone on 60-minute closes near 1083-1087 don't tell us much except that the RUT is continuing that choppy pattern. They don't predict the next movement or the eventual breakout . . . until the last move toward one of those boundaries when it does break out.

Sustained 60-minute closes below about 1064 set a potential downside target near 1045-1048, at least according to Keltner evidence. I would be aware of potential support near last week's low of 1061.79, however.

Sustained 60-minute closes above about 1087 set the next potential target near 1090-1094, although that target is likely to be shoved higher by price movement higher through the channel. A breakout above that level requires a study of the daily chart to determine a next target.

As the day ended, the markets look poised to dip to deeper support. You know, though, don't you, that ten minutes after this report appears, President Obama and Speaker Boehner could appear before us on split screens, scowling into separate television cameras but announcing some joint plan that undoes what we see on the charts. As I type, House member Republican Devin Nunes was again lobbing criticism at those in his party who pushed for the government shutdown. His dissent is not a new development, but some believe his strong conservative credentials give his statements more import than some of the other more moderate Republican party dissenters. Is this a sign of some movement toward that rapprochement? No sign of that yet.

Do use the chart evidence to set up some what-if type scenarios, some guidelines to tell you when trades are just testing normal boundaries and when the move is getting more serious. Don't put ultimate faith in them. Not in this climate. Be aware of the risk you have in your trades, and how much you're willing to lose.

Linda Piazza