The bulls were probably starting to get worried that Santa was going to leave a lump of coal (if that much) in their stockings but he showed up on Thursday and the bulls rejoiced, including into Friday. The bears are feeling scrooged but down deep most are not surprised to see the rally finally getting started as we head into the holidays.

Market Stats

Friday, December 20, 2013

Week and Annual, 2013

Jim slipped on the ice and broke a couple of ribs so I'm filling in for him this weekend. Send him some good wishes for quick healing (just don't send anything funny to make him laugh ;-)).

Friday continued the rally from Thursday afternoon's Fed-inspired rally and that keeps bullish hopes alive that we'll see more from the Santa Claus rally, which typically lasts through the holidays. January could be a very different animal (bear) but for now we need to stick with the bull.

The 2nd table above shows how the indexes did last week (all positive by quite a bit, thanks to the Thursday afternoon-Friday rally) except for gold. At the right side I show the performance for the month of December as of Friday's close and how the year has gone. I've highlighted the outstanding performers to the upside in green (biotechs and brokers) and the only two losers (commodities and gold). I find it more than a little interesting that the brokers did phenomenally well in 2013.

As the year 2013 winds down there have been many pundits coming out with predictions for 2014. It's always fun to predict and just as much fun reading other's predictions (there's a reason we listen to psychics' predictions even when we say we don't believe in them). We know most of the market predictors were very wrong about what 2013 would be like and yet we still want to know what they're thinking. Most grossly underestimated what the strength of the market would be like, even though they knew the Fed's QE program was fully backing the rally with funny money. Most predictions are based on the past and they're usually extensions of the current trend. We're seeing that in most predictions today -- the majority are predicting a continuation of the bull market.

Friday we received the 3rd estimate for GDP for the 3rd quarter, which came in at +4.1%. This was better than the previous estimate of +3.6% and much better than expectations for +2.0%. The Fed might have had a heads up about this number and used it as part of their "data dependent" decision to start tapering QE purchases. This was the fastest pace since late 2011 and it has many analysts predicting stronger growth in 2014.

Not discussed much is the fact that GDP is a pretty useless metric to judge economic strength. For example, this latest upward revision came from a sizeable increase in inventories (about a third of the GDP came from an inventory build). Some analysts say this is a good thing because it means businesses are building inventory in anticipation of growing demand. But if holiday retail sales are a good indicator of how quickly that demand for inventory is going to grow I suspect we're going to see some disappointment in the Q4 numbers. If that inventory build is not cleared out by the end of this month we're going to see some sharp downward corrections to GDP as manufacturers slam on the breaks and write down the inventory. That could make January a rough month if the numbers start to reflect this.

We know that stock market participants attempt to get in front of an expected trend and up until now the stock market has rallied in anticipation of a growing economy. Well, a growing money supply into the stock market anyway (the growth of the money supply is a different issue, especially since the velocity of money growth has been slowing for about 15 years, regardless of the Fed's efforts). Rather than the stock market I think commodity prices are a better reflection of how the global economy is doing and I'll spend a little more time looking at some of those to see what they're telling us.

The stock market has been disconnected from reality a long time and hasn't really paid any attention to what commodity prices have been doing. As long as the Fed keeps stuffing more money into the banksters' hands it has kept sentiment bullish on the stock market. We have a rally built on hope and hype (sound familiar?) but there's very little supporting the current prices. That's what's so worrisome -- my concern is that the market is not going to just correct with a "normal" pullback. When it breaks I'm thinking it's going to break hard.

On Thursday I showed the chart comparing the rally into the 1929 high vs. our current rally. We of course can't predict a market crash after this market tops out (by mid-January if the analog holds true) but the sentiment at the current market high, as well as margin debt, is very similar to the condition that led to the 1929 stock market crash. The 1987 market crash was a similar setup. Considering the disconnect with reality and the record-setting margin debt I'm afraid we're just one hiccup away from a crash and the 1929-2013 comparison is scary in that respect.

With the high level of margin debt it won't take much selling before margin calls are made. At that point selling begets more selling and the baby tends to get thrown out with the bath water. Strong stocks get sold because that's where the trader can get money without losing money on his loser. Instead of selling losers, as they should, traders tend to sell their winners in the hope that the loser will come back and they won't lose their money. This is what gets so many traders into trouble because then the losers keep losing money and the margin calls keep coming. Then the margin calls on the strong stocks and pretty soon there's only sellers begging for buyers. Liquidity dries up, bids disappear, the HFTs go into hiding and sellers are left holding the bag.

Keep in mind that sentiment is so bullish right now that the market is now full of sellers-in-waiting. It doesn't take a major event to spark a market crash; it only takes something to start the selling and then the snowball gathers size and speed as it rolls downhill. When the selling event is over, everyone stands around wondering what hit them and why. It's often not any more complicated than the process I just explained and it catches most everyone by surprise.

I hate to bring up the issue of P/E ratios because so many people use them differently to bolster their argument for why the market should go up/down, but by whatever method you use (forward or backward looking, price-to-sales ratio, EBITA or GAAP, etc.) this market is expensive and it doesn't support much more of a bull market. The median P/E ratio on the S&P 500 is now at a record-high level, higher than it got in 2000. One of the better P/E numbers, the Shiller P/E ratio, is also at a record-high level, now above 25.

There are many different ways to measure market sentiment. One includes the number of IPOs and for 2013 it's the largest number since the lead-up to the 2000 high. Last week the number of bearish investment advisors in the Value Line survey dropped to just 14.3%, which is the lowest it's been in the past 25 years. Similar readings of low bearish sentiment and high stock prices (P/E) were in 1972 (followed by a 50% stock market decline), 1987 (followed by the crash) and 2007 (followed by the crash). We can't use this to say there will be similar event ahead of us but it does provide a warning.

Call buying is another bullish market sentiment and it's been growing steadily since the end of October, as can be seen on the ISEE chart below. This is a measure of opening long options positions and a reading over 200 is an indication that call buyers are getting aggressive. Readings 200 or more occurred on November 21st high and December 16 and Friday closed at 192 after staying above 200 for the entire day until the late-day pullback. You can see the steady increase in the 20-dma, which is now at the highest level it's been since the end of 2010. There tends to be a rise into the end of the year as traders play the Santa Claus rally and then it declines after the 1st of January. The seasonal factor is at play here but that means look for a correction after the holidays.

ISEE index, May-present

Of all the market measurements right now it's the level of margin debt that is the scariest. In my opinion it just about guarantees we'll have a market crash. This rubber band has been stretched to its limit and as engineers would say, we're beyond the design limits of where it should break. Now throw in recent Hindenburg Omen and Titanic Syndrome signals (they don't predict a market crash but no crash has occurred without first seeing these warning signals) and we've got plenty of reasons to be nervous about what's coming and probably soon. The Fed-inspired rally could turn into the Fed-induced market crash. Caveat emptor.

And being ready means sticking with us as we wind our way through what could be a volatile 2014, which should provide some outsized trades on both the long and short side.

While I'm bearish for 2014 it doesn't mean we can't get more rally out of this market. The setup remains good for higher prices into the new year, as I'll show on the charts. But minimum upside targets are now being reached, especially by the DOW, and therefore any bets on the upside must be protected. Holding positions overnight become a little riskier. I think we're now at the point where upside potential is significantly dwarfed by downside risk and trades must be managed accordingly. Be especially careful with sold puts (either naked or as spreads).

NDX continues to push up along a group of trend lines near the current price level. The top of its up-channel from June and the top of its up-channel from 2009 intersect the trend line along the highs from January. That's a lot of resistance to push through so while it can be done, it's a time for caution to see how well the bulls can do this coming week. As long as the bulls hold above 3400 the pattern remains bullish but toppy.

Nasdaq-100, NDX, Weekly chart

A slightly different perspective of some trend lines is shown on the daily chart below. A trend line along the highs from July is currently near 3570 and crosses the projection near 3607 January 3rd (this is projection for the c-wave in the move up from October where it would equal the a-wave). So far the broken uptrend line from October through November 20th low continues to be resistance, as it was on December 16th, 18th and Friday. It's showing a lot of bearish divergence since the October high, showing a lot weakness in the current rally. The bulls remain in control but the weakness of the current rally requires caution.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3520
- bearish below 3400

In Thursday's wrap I showed a weekly chart of AAPL to show the stock looks ready to start back down after its a-b-c bounce off the April low. One of the other stocks I'm watching, as far as another "sentiment" indicator, is GOOG, which I showed a couple of weeks ago. I pointed out an upside target zone at 1175-1195 where two Fib projections coincide and that remains the upside target until something changes the picture, such as a break of the higher lows since November 12th. The December 13th low near 1058 is where I'd place a stop if trading the stock on the long side.

There are a couple of resistance levels between here and 1175-1195, starting with the trend line along the highs from September 2012 - May 2013, near 1095. Friday's rally popped GOOG about 6 points above the trend line so now that needs to hold otherwise it would look like a head-fake break. Next is the top of an up-channel from November 2012, currently near 1130. So GOOG remains bullish for now but with the daily chart showing bearish divergence since its late-October high I would be more defensive than aggressive about the long side. When GOOG breaks down it's going to set up a significant reversal, even if it will be just a pullback correction of its rally from June 2012, but I think the decline will be much more bearish than that.

Google Inc., GOOG, Weekly chart

SPX has made it back up to the top of its parallel up-channel from June and its broken uptrend line from October through its December 4th low, both of which could be enough resistance to hold the bulls back. I show an expected pullback on Monday/Tuesday and then a continuation higher into early January. If it pops a little higher on Monday keep an eye on the 1831 projection, which is where the 5th wave in the move up from August would be 62% of the 1st wave. It's possible that's all we'll get to complete the rally. Again, while I show upside potential to the 1850-1870 area, I'd be very cautious about the long side from here. I'd love to see it play out as depicted (in green) because it would make an outstanding setup to get short for a longer-term play but we'll have to evaluate the pattern as it develops.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1825
- bearish below 1750

The DOW came within 3 points of hitting a projection at 16290, which as discussed for SPX (at 1831), is where the 5th wave in the move up from August is 62% of the 1st wave. With this minimum upside projection having been achieved it's possible the rally is now complete. Hopefully we'll see it work its way higher into mid-January, as depicted in green, and then we can get a good setup for a reversal.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,325
- bearish below 15,700

The RUT played some catch-up last week and made both a new all-time intraday and closing high on Friday. I'm looking for a 3-wave move higher into January and hopefully we'll get a pullback this coming, which could continue into the end of the month, and then one more rally in January to complete its rally.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1136
- bearish below 1087

Bonds have been consolidating this month and it's hard to tell if they're basing in preparation for a rally or consolidating before heading lower (yields higher). I continue to lean long the bonds but I'm waiting for price to lead the way.

Since the broker index (XBD) has done so well this year I thought I'd take a look at it to see where it might be headed. The table at the beginning of the wrap shows the XBD has seen a +67% increase this year but when viewing the rally from its August 2012 low it has more than doubled. From an Elliott Wave perspective that rally leg looks like a classic c-wave of its A-B-C bounce off the November 2008 low. I don't show the wave count for the c-wave but last week's rally fits well as the completion of the final 5th wave of the move up from August 2012, thereby completing the A-B-C correction. Price is nearing the top of its up-channel for the c-wave and is close to achieving a 50% retracement of the 2007-2008 decline, at 160.05. This is setting up very nicely for a major reversal (IAI is an iShares ETF to play it).

AMEX Securities Broker/Dealer, XBD, Weekly chart

I like the way the TRAN is setting up for a high in January as well. Two price projections line up nicely at 7428-7444 and a trend line along the highs from May - November/December crosses that target zone the 2nd week of January. The higher projection, to 7444, is where the rally from 2009 will achieve two equal legs up. Getting in closer to the final move, which is the 2nd a-b-c of the double zigzag move up from the sideways triangle that finished in November 2012, the c-wave would be 162% of the a-wave at 7428.

Transportation Index, TRAN, Weekly chart

The weekly chart of the U.S. Dollar below, shows the spike down last Thursday held the uptrend line from May 2011 through the October 2013 low. It's also holding the H&S neckline, drawn from the February 2012 low. The strong reversal off Thursday's low should see some upside follow through, otherwise it will turn at least short-term bearish.

U.S. Dollar contract, DX, Weekly chart

While the dollar has been drifting higher since its 2011 low we've seen commodity prices in decline. The dollar's bounce has put pressure on commodity prices but it certainly doesn't explain the larger drop in prices vs. the rise in the dollar's value. The better explanation comes from a slowing in the global economy, which in turn decreases demand for commodities. But recently there have been signs that the global economy has at least stabilized and improved in some sectors. This has many pundits predicting global growth in 2014.

One index that has been used by many to support their bullish predictions is the Baltic Dry Index (BDI), which is a measure of the cost to transport raw material commodities by dry bulk ships. Cora had asked me what I thought about this and I thought it would be a good time to explain a little bit more about this index and what it might mean. The BDI has rallied strongly this year and that in turn has turned more than a few analysts bullish on the economy and therefore a reason to stay bullish the stock market.

There are many components that go into the BDI, such as commodity demand, ships available, seasonal pressure, fuel costs and even piracy costs, so while it's a reflection of commodity demand there are additional factors and probably the biggest one recently is the reduction in the number of ships available. There was a big build-up of ships a few years ago and even some VLCC oil tankers were converted to dry bulk carriers. But when prices for ships collapsed (the BDI dropped from almost 12,000 in 2008 to about 650 in 2012) some of those VLCCs were converted back to oil carriers and many of the older ships have been taken off line. The supply of available ships is now considerably less and that has helped ship owners raise their prices on the remaining available ships.

As I had pointed out in the second table at the beginning of this wrap, commodity prices have declined this year (-8.3%) but the BDI has rallied about +260%. That's a pretty clear demonstration that a rallying BDI is not necessarily a good indication of commodity demand. Admittedly, when looking at the chart below, the rally in the BDI looks very positive for commodity prices:

Baltic Dry Index, BDI, Weekly chart, 2011-present

The chart shows the strong rally in the past year and it has climbed above the late-2011 high near 2200. There is a short-term bearish divergence though at this month's high compared to its October high. The October high was the momentum high and the December high is essentially a test of that high with a small throw-over. While it could continue higher that's not a good forecast. I suspect the uptrend line along the RSI from the beginning of 2012 low is going to soon break.

To keep things in perspective, this year's rally in the BDI to about 2300 is a little more than a 38% retracement of the decline from the end of 2009. But as can be seen on the chart below, this year's bounce is only a minor retracement of the decline from the 2008 high. To retrace 38% of its decline from 2009 it would have to reach about 5000, or back above its late-2009 low. So is this year's rally the start of something bigger or is it just a dead cat bounce? We'll know more after we get a pullback but for now I think it's not easy to project higher commodity prices based on this index.

Baltic Dry Index, BDI, Weekly chart, 2000-present

Below is a weekly chart of the commodity index, using the DJ UBS Commodity Index (DJUBS), and it gives us a view of how well they've done (or not done in this case). Currently, with Thursday's and Friday's rally, the index has rallied up to its downtrend line from September 2012. If it's just another dead cat bounce we'll see the index start back down to new lows from here. If it's able to rally more and break its downtrend line (considering the bullish divergence at its November low the chances of more bullishness is good) I see the potential for a rally up to the 138 area before heading lower again. I picked that level only because of the multiple 50% retracements it has made in the past (shown on the chart). First thing the bulls need to do is keep this rallying.

DJ UBS Commodity index, DJUBS, Weekly chart

Probably one of the best indicators for the economy comes from Dr. Copper. Copper is used in so many different goods and industries that its price is often a good predictor for how the economy is doing and what future demand looks like. And right now copper is not giving us any bullish signs. Since breaking below its H&S neckline (uptrend line from June 2010) in April it has traded sideways and below its neckline, currently near 3.40 and its May and August highs. Above 3.40 would be potentially bullish but so far the sideways consolidation following its decline is a bearish continuation pattern. Copper's pattern looks like it's ready to start the next leg down at any time.

Copper continuous contract, HG, Weekly chart

Gold bulls got hit again last week and now it's struggling to hold above 1200. Its June low was 1179.40 so we might see at least a test of that level. A little lower, at 1151-1155 is Fib support and a long-standing downside target I've had for gold. The 2nd leg of the decline from September 2011 would be 162% of the 1st leg down at 1151 and a 62% retracement of its 2008-2011 rally is at 1155. If that area does not act as support I'll be looking for a decline to a trend line along the lows from 2011-2013, which will be near 1030 by March. With bearish sentiment on gold near an extreme I think gold bears are pressing their luck here. What kind of bounce develops is anyone's guess but it could be close.

Gold continuous contract, GC, Weekly chart

Last week's rally in oil pushed it above its 50-week MA (200-dma) and we could see a further rally to price-level resistance at 103-104. Two equal legs up from November 27th points to 103.19. But I see potential resistance at 100, 101 and 102 so oil bulls could have a fight on their hands to try to get much more. Once the bounce correction to the August-November decline has finished I'm expecting oil to continue lower.

Oil continuous contract, CL, Weekly chart

On Monday we'll get reports on Personal Income and Spending (both expected to improve), Core Personal Consumption Expenditures (PCE) and Michigan Sentiment. We'll have a half day of trading on Tuesday and before the bell we'll get Durable Orders (improvement expected) and then New Home Sales right after the opening bell. It will be quiet for the rest of the holiday-shortened week.

Economic reports and Summary

The Santa Claus rally has arrived and it looks good for a continuation of the rally that started Thursday afternoon. We could get a pullback on Monday, maybe into Tuesday, but the pattern supports a continuation of the rally either on Monday or after a pullback. Cycle dates and price/time projections look good for a rally into the 2nd week of January. From there things could become a lot more difficult for the bulls but we've got time to evaluate what's setting up before then.

While my expectations are for a continuation of the rally into early January please keep in mind that minimum upside targets are now being achieved and the pattern can be considered complete at any time. Considering the upside potential vs. the significant downside risk I think it's extremely important to stay on top of your positions now. Tight stop orders could be gapped over and in a no-bid situation we could find sellers go begging for a buyer. Those buyers could have their buy orders parked well below current market prices. This is one reason why I say downside risk potential is significant. Play it safe since it's not a good time to be aggressive on the upside. Get out of your margin debt and if that means taking profits on winning positions to get back to no margin, consider that a great trade and pat yourself on the back for getting ahead of the pack.

Good luck and I'll be back with you after the holidays. Have a very merry Christmas and New Year holiday. Be safe and trade carefully into January.

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

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