After the bears caused some fright into last week's low, with the VIX shooting above 20, it's the bears who are now running for cover and the VIX has dropped back down into complacency territory. Bullish sentiment has quickly climbed back up as most look for new highs.

Market Stats

It was a quiet morning for economic reports and the market was left to fend for itself. It did well by not giving up much, if any of its gains from the previous 6 days. The techs tacked on a few more points and now have a 6-day bullish streak that has NDX completely retracing its decline. No harm, no foul.

The market is quite split at the moment and the strong techs have not been matched by the others. It reminds me of the October 2007 high where NDX made a minor new high that was not matched by the others. Deja vu all over again? Clearly the bulls need more buying in the other indexes to support the rally in the techs but as I'll review in tonight's chart, that could be a tall order.

The bulls should hope for at least a small pullback at this point otherwise the rally is going to look like another too-much-too-fast kind of move and it would fit as a blow-off completion to its rally. It could of course go considerably higher before finishing the blow-off top but the harder it rallies from here without a break the harder it will likely fall.

There's still the risk that the strong bounce has been mostly short covering and without the shorts in the market there is risk of a liquidity squeeze in the event of a strong selloff. We know the HFTs are programmed to step aside if selling becomes too strong and as the largest provider of liquidity there becomes a significant problem for the market when sellers go looking for buyers and the only ones they can find are the ones way down below. Hence the flash-crash risk. So the bulls could use a pullback with some back and forth filling and shake out the loose hands and bring in more buying at lower prices.

The setup tonight is for at least a pullback and then depending on the form of the pullback/decline, whether it's choppy or a strong impulsive move down, we'll get some clues as to what should follow. A strong impulsive move back down would suggest a 3rd wave decline has started. But a choppy pullback, with the backing and filling, would suggest we'll get another rally leg and drive all the indexes to new highs. I suspect we will get the answer to this question in the next few trading days.

We're heading into opex week next week, which is typically a bullish time for the market, so a choppy pullback into Friday would do a nice job setting up another rally leg. But if we're going to start a more bearish 3rd wave down then next week will likely be bearish. And when opex is bearish it tends to be very bearish. By Friday we should have a clue for how the following week will go.

With no significant news to mention I'll jump right into the charts, starting off with a weekly view of SPX. The January decline looks pretty miniscule and other than the intraweek spike below its uptrend line from November 2012, support held on a weekly basis. With the strong rally back up in the past week it's looking like most have their eyes on new all-time highs. The wave count for the leg up from June 2013 does support the need for one more high to complete the count but it's not clear enough to rely on but if the rally continues we could see it climb up to 1880-1900 before topping out.

S&P 500, SPX, Weekly chart

Today's star doji is a potential reversing candlestick, which would be confirmed with a red candle tomorrow. But even if we get a reversal we can't know yet if it will be good for just a pullback or the start of the next big leg down. Both possibilities are shown on the daily chart below and it will be the form of the pullback/decline that will provide clues for what will follow. If price starts dropping rapidly in an impulsive pattern it's going to look like the next leg down has begun. But if price chops it's way back down it will instead look like a corrective pullback that will set up the next rally leg. And of course if it just continues higher it will be bullish but probably not for long since it will look like a blow-off top.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1828
- bearish below 1738

As can be seen on the 60-min chart below, SPX retraced 78.6% of its decline (actually, it stopped 15 cents shy of the retracement at 1826.68 with a high of 1826.55), a retracement level that's been very popular with this market for a few years now (it used to be 61.8%). The sharpness of the rally makes it look impulsive and that's what keeps the door open for higher prices following a pullback (shown in green). But when viewed on a shorter time frame I can see an a-b-c bounce that achieved two equal legs up at 1827.61. Therefore I could easily argue that the rally is simply a sharp 2nd wave correction to the 1st wave down and the next move will be a strong 3rd wave decline (red).

S&P 500, SPX, 60-min chart

Again, as for whether or not we're setting up for the mother of all puts or if instead the bulls have wrestled the ball away from the bears again. We'll need further clues from the move down before we'll have a better idea for what next week will be like. Just be real careful about holding a long position with the anticipation that a pullback will be followed by another rally. It's the job of a 2nd wave bounce correction to turn the majority of traders bullish again and it's the 3rd wave's job to ruin the bull's dreams.

The DOW has made it up between the 50% and 62% retracement of its decline, at 15964 and 16111, resp., and is also between its broken 20- and 50-dma's, each near the above retracement levels. But today's small pullback has it back below the 50% retracement level and it looks ready for at least a pullback correction. The bullish pattern, if it's just into next week, calls for a pullback and then another leg up for its rally off the February 5th low. If it pulls back to its uptrend line from November 2012, near 15650 next week, a 2nd leg up equal to the 1st would target the same level as the 78.6% retracement, at 16321. SPX has already accomplished the same retracement with today's high and any higher for it would suggest new all-time highs are coming. But it's possible the bounce off last week's low is all we're going to see for the 2nd wave correction to the 1st wave decline. That interpretation calls for a strong decline from here.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,700
- bearish below 15,340

The 1929 analog pattern continues to track and as long as it does I'll continue to show weekly updates. Once it breaks, and they always do at some point, there will be no need to continue tracking it. The initial decline off the 1929 top was followed by a sharp bounce and then the meat of the '29 crash followed that bounce. We're currently in that bounce and the risk from here is a crash leg lower. Once again, don't take this as a prediction, especially since more and more people are being alerted to the potential (and when too many expect something it's when it doesn't happen), but see the risk. Actually the meat of the crash was the longer decline following the larger bounce off the November 1929 low into the April 1930 high -- it proceeded to lose 86% in the April 1930 - July 1932 decline. But the -49% loss from the September-November 1929 crash was obviously much faster and scarier. Most people today can't even fathom a 50% loss in 3 months (DOW 8000 by the end of March).

DJIA analog pattern between 1928-1929 and 2012-2014, chart courtesy mcoscillator.com

There's another analog pattern that's worth watching and that's with the Hong Kong Seng index back in 1997 (the Asian Contagion market crash). This one also looks very similar with the December 31st high, which called for a January 30th low and then a month-long a-b-c bounce pattern into a February 26th high before letting go to the downside in March. This one suggests a pullback for a test of the low into next week and then a higher bounce into the end of the month. The bounce projection that I show on my chart would be lower and might finish at the 62% retracement at 16111 before dropping hard in March. Note the green vertical lines denoting the new moons. This year's new moons were December 31, January 30 and the next will be March 1. The full moon is this Friday, the 14th.

1997 Hong Kong Seng stock market crash

The techs have been very strong and following a decline that was not as deep as the other indexes it wasn't as hard for them to get back up to their January highs. This morning NDX made a minor break above its January 22nd high, at 3634.65, with a high at 3635.92 and then consolidated sideways for the rest of the day. The sideways consolidation looks bullish and if it can continue higher tomorrow it could make it up to its broken uptrend line from October 2013, near 3660. A back test and a double top would make for an interesting setup for the bears. So far the test of the high with bearish divergence is something for the bears so we'll see how the rest of the week goes.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3635
- bearish below 3425

The RUT is not nearly as strong as the tech indexes, having retraced a little more than 50% of its January decline, at 1132.38, and it has run into some serious resistance. Its broken uptrend line from November 2012 - June 2013, near 1135, was back-tested today, as was its 20- and 50-dma's, at 1136.85 and 1138.82 (with a high at 1137.44). The three amigos of resistance here are going to be a tough nut to crack for the bulls, especially after an extended 5-day rally. Looks like it's time for someone to run the futures higher overnight and help this one over resistance (said tongue-in-cheek but not far from the truth).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1121 and more bullish above 1147
- bearish below 1080

The setup for the RUT, up against strong resistance, is a setup made for a bear and it's one of those that has to be taken every time. Only in hindsight will we know whether or not it will work but when it does it's almost always a real money maker. Assuming we'll get at least a pullback we'll then learn more about the downside potential once we get to see the pattern of the decline (that's if it doesn't gap up over resistance).

In my last update on bonds, two weeks ago, I mentioned the decline in yields from the December 31st high, should soon be followed by a bounce correction and then continue lower in what I believe will be a larger decline in yields this year (rally in the bond market). What's interesting here is that the bond market, by selling off some this week, is telling us it believes the Fed will continue to taper its purchases, thereby decreasing demand for bonds. And yet the stock market is rallying. But the selling in bonds has freed up capital that's flowing into the stock market, which is why we tend to see bond yields trade in synch with the stock market.

The daily chart of the 10-year yield (TNX) shows the bounce achieved two equal legs up from its February 3rd low by hitting 2.78% (actually 2.777) and that might be all the bounce it will get. A little higher, near 2.80, is its downtrend line from 2007-2011 and then its 50-dma above that at 2.837. Those are higher levels to watch if the bond market continues to sell off and drive yields higher but if I've got the bigger picture correct we'll see a strong move down in yields once the current bounce finishes. That's likely to happen if the stock market gets in trouble and money rushes back into the perceived safety of Treasuries, which would of course make the Fed very happy. The Fed might want a higher stock market but they Need a higher bond market and I would expect Yellen to jawbone the bond market higher if she suspects it's in trouble.

10-year Yield, TNX, Daily chart

Like the RUT, the banking index has its own three amigos for resistance -- its broken uptrend line from 2011-2012 and its 20- and 50-dma's, all crossing near 68.50. BKX spiked above that level at this morning's open (the typical gap-it-over-resistance move) but it was immediately sold into and it closed below resistance, leaving a flaming shooting star at resistance. It was another must-take trade setup for the bears. We can't know if it will work or not but that's why God invented stops.

KBW Bank index, BKX, Daily chart

The TRAN's bounce off its February 5th low has not yet made it above its January 31st high at 7343 (Tuesday's high near 7282) and that keeps its pattern potentially very bearish with a 1-2, 1-2 wave count to the downside. I'm keeping track of this possibility only because it would support the idea that the market is getting ready for a disconnect to the downside. That's the risk at least. At the moment it's back-testing its broken 50-dma at 7272 and its 20-dma is coming down to meet it, currently dropping below 7290. The late-January/early-February bounce was also able to poke back above its 50-dma but was unable to reach its 20-dma and so far we have the pattern repeating.

Transportation Index, TRAN, Daily chart

The U.S. dollar continues its choppy price pattern and it's a coin toss as to which way it will head next. I see it's currently holding its short-term uptrend line from December 18th, currently near 80.75 and tested this afternoon, so it's possible it will continue higher from here. But I see the potential for it to drop down to its uptrend line from 2011-2013, near 79.80, before heading higher.

U.S. Dollar contract, DX, Daily chart

Gold has now firmly broken its downtrend line from February-August 2013, regardless whether I look at it with the log or arithmetic price scale, and that's bullish. But the bounce pattern off the December 31st low is what keeps me thinking there's another leg down coming. As I've been saying for a while, gold will be more bullish above 1300-1310 (50% retracement of its 2008-2011 rally and its 200-dma) so we'll see if the gold bulls can do it. Assisting the bulls has been a large short-position in gold that had been building for months.

Gold continuous contract, GC, Daily chart

Today's candle for oil is blocked by text on the chart but it's a shooting start after a failed rally attempt above its downtrend line from 2011-2012, which it had broken above in July 2013 and then back below it in October. The December rally almost reached the line and it looks like it will continue to be resistance, currently near 100.40, until proven otherwise. The shooting star candlestick, if followed by a red candle on Thursday, would be a confirmed reversal candlestick pattern.

Oil continuous contract, CL, Daily chart

After a very quiet day today for economic reports it will pick up a little tomorrow, but nothing market moving. Other than the usual unemployment claims data we'll get retail sales, which are expected to show a decline in January vs. December

Economic reports and Summary

The strong rally off last week's low has quickly turned sentiment back around and there are very few market pundits calling for lower lows from here. Most have their sights on new highs as if it's a foregone conclusion. That should worry bulls. Where's the wall of worry? Even getting past the worry about what Yellen would say or whether or not Congress would pass a debt bill (kicking the can further down the road) now leaves very little for the bulls to worry about. Perversely that's probably why they should worry.

When too many expect something (new highs from here), that's when the market slaps them upside the head to catch their attention and take their money. Money heaven is full of coins snatched from the eager bulls who weren't paying attention.

But the bears have almost nothing to go with here. Yes there were some juicy setups into the end of the day (RUT and BKX for example) but there's no evidence that the market will turn back down from here. Until we see what kind of pullback we get, whether it's an impulsive decline or choppy correction to the rally, we don't know if the pullback will lead to new highs or something more bearish. Short-term trading is in and longer-term trading is on hold. I liked the setups by the end of the day to short the market but whether it's a trade for a day or one that will last for weeks can only be determined by what the market will do next.

The biggest risk that I see is the potential for a downside disconnect. Whether it's the wave pattern or the 1929/1987 analog patterns, I see more downside risk than upside potential. If trading the long side I'd keep positions relatively small and well protected. I'd rather miss a move to the upside than get caught long in a downdraft. The next few days will provide clues for next week and hopefully beyond that and in the meantime trade carefully.

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