The bounce off Tuesday's low looks like the start of another rally, one that could take us to new highs into opex week. But the bears see it as just a quick oversold bounce back up to resistance and a good shorting opportunity. The market has reached a decision point.
Wednesday's Market Stats
Today got a helping hand from a pre-market rally that gave the indexes a gap up to start the day, which is typically how rallies in this market are done, but at least the sellers of the gap up weren't strong enough to reverse it. The bears tried to reverse it but the dipsters stepped back in and drove the market higher in the morning. There was a pause midday and into the release of the FOMC minutes at 14:00 and then a nice addition to the rally following the minutes. All in all it was a nice day for the bulls.
Now the question is whether the bounce was real or if instead it was Memorex. I'm showing my age with that commercial -- Memorex was selling magnetic tapes for copying music files and when they played back a high-pitched sound to break a wine glass you were asked if was the original sound or the copy on Memorex that did it, which of course today seems like no big deal. It's one of those commercials that lives on, kind of like Timex watches -- "takes a licking but keeps on ticking." Don't remember that one either? You're just a bunch of youngsters. But I digress.
Friday's and Monday's trading volume was higher than average and the bounce off Tuesday morning's low has been on declining volume to below average, which is bearish. The bulls would be in better shape if the selling was on low volume and then stronger volume came back in on the buying. Volume is only one measure of how well the market is doing but at the moment the message from it has to be viewed as more bearish than bullish. So far it's a Memorex rally and not a Timex (I know, mixed metaphors).
As I said, the market was doing well into the afternoon and the big boost following the FOMC minutes pushed the indexes over +1% today. The oversold tech indexes did the best, closing up +1.7%, while the RUT was nipping at its heels with a +1.4% rally. You would have thought the FOMC minutes came as a complete surprise with the way it spurted to the upside, which gave the DOW a 100-point boost from about 16330 up to 16438 by the end of the day, 85 of which were tacked on in 30 minutes. I have a feeling it wouldn't have mattered what was in the minutes -- as soon as they were released and there was nothing scary in them the computers were programmed to launch some buy programs.
The bulls will now see the Friday-Monday decline as another dip they should have been brave enough to buy. The bears are of course scrambling to get out of short positions out of fear that the bulls are correct. We've seen countless sharp stabs to the downside merely get reversed and head higher again. Buyers have been thoroughly conditioned to buy the dips and today's bounce has very likely convinced more than a few to jump back in if they were chased out. Those who didn't get spooked out of their trades are patting themselves on the back for ignoring the scary monster under the bed and just sticking with the longer-term uptrend. Who can yet say they're wrong? It's been a winning strategy for a very long time. There is of course worry about the bull market ending but for most it remains a bullish market and dips are to be bought.
But what if last week's high was THE high? The Friday-Monday decline would be the start of what will become a more serious selloff and a small-degree 1st wave down. The Tuesday-Wednesday bounce would be a 2nd wave correction to the 1st wave down. From a psychology perspective, 2nd wave corrections are designed to convince the majority that the decline (in this case) was just a scary selloff but the larger uptrend remains intact. The 2nd wave pulls in more bulls and spits out more bears. But then stronger selling hits the tape and all those new buyers worry that got sucked back in at the wrong time; they become sellers at any price as they recognize the low is not yet in place. The bears eagerly jump back in and the combined selling creates a strong 3rd wave down. The 3rd wave is called the recognition wave for this reason and that's potentially what we have next. We will likely find out which it will be after seeing Thursday's price action.
Another thing that would help create a strong 3rd wave down is the margin debt situation. This has been discussed recently and there are lots of different opinions about it (as to whether or not it should be a concern). There were two charts published by Doug Short at dshort.com that are interesting to say the least. The first chart below shows the percentage growth in margin debt vs. SPX, both adjusted for inflation (notice that SPX has not exceeded its 2000 high when adjusted for inflation), both starting from 1995. Each time margin debt set off on a parabolic rally (into the 2000 and 2007 highs) it was a sign to look for a market peak. One could classify the run up from 2012 as another parabolic climb and therefore not a good sign for the longevity of the current rally. But short term this suggests we might not have seen a market high yet -- the peak in margin debt tends to lead the stock market high by a few months. Whether that will be true again is anyone's guess.
NYSE Margin Debt vs. SPX, 1995-2014, chart courtesy dshort.com
The next chart from Short shows the sum of investors' credit balance, which is calculated as the sum of cash in credit accounts and credit balances and then subtract the margin debt. The latest data is through February 2014. When it's above zero (green) it shows investors have a positive credit balance while below zero (red) shows a negative credit balance. The spike low in 2000 was followed by a higher low in 2007, which led to a spike high in 2008 as investors sold their positions and went to cash. The current spike down into a negative credit balance, far below the low in 2000, is downright scary. The amount of margin selling could become severe at times following this.
NYSE Investor Credit Balances vs. SPX, chart courtesy dshort.com
The above charts are reason enough to be very cautious about this bull market. Chasing prices higher could be hazardous to your financial health. When it stops and reverses it could feel like a steam roller just flattened you. But it's not a timing tool so it's not a reason to mortgage the house and short the market here. We look for better timing signals and for one of them I like to watch the European indexes.
The FTSE-100 and DAX charts tend to be leading indicators for the U.S. and we've seen them typically make their tops and bottoms before the U.S., which makes them good leading indicators for us. At the moment both are looking potentially bearish, as with the U.S. indexes, but the DAX is a little stronger at the moment and could make a new high before it's finished. I would expect the DAX to look a little stronger since the German economy has been the stronger one in Europe but even their banking system is surprisingly weak and highly leveraged, as are most of the banks in Europe (much more so than U.S. banks). This might become an aggravating situation should credit become an issue, perhaps when Greece starts asking for more money again, which is just around the corner.
The DAX shows 3 peaks since January with bearish divergence, not a good indication. But short term I see the potential for a minor new high to complete a 5-wave move up from its March low. Following what could be an a-b-c pullback from January, the 5-wave move up would do a very nice job completing its longer-term rally. So at the moment I would say the DAX is not helpful enough in determining what message it might have for us.
German DAX Composite, DAX, Daily chart
The FTSE has been working hard to make it back up to its May 2013 high, near 6870, after the strong selloff into its June 2013 low. With 4 rally attempts since the June 2013 low it finally made it up for two tests of the high in January and February but with sharp selloffs following each attempt. So far not very bullish, especially with a rounding top pattern. However, the bulls are still hanging on and the bounce off its 200-dma yesterday could be followed by another rally attempt.
London Financial Times index, FTSE, Daily chart
The one change in the FTSE's pattern that's bearish is what I see around the 50-dma (blue MA) -- notice how each break below the MA since April 2013 was followed by a spike back above the MA (highlighted in yellow) and a rally that lasted for weeks thereafter. The one minor exception is the struggle to stay above the 50-dma in August-September. Now look at the latest attempt to get back above the 50-dma in April, and the immediate failure to hold. That's the first time that has happened in a year and it's a change in character. Whether it will develop into something more bearish will be known shortly but for now it's a bearish development and could mean the same for the U.S. market. Today's rally attempt was beaten back by the 50-dma at 6652.
Moving on to the U.S. indexes, SPX is a good index to represent the broader market since it splits the difference between what I see on the daily charts as potentially very bearish for the RUT and NDX but bullish for the blue chips. The biggest problem in getting a clearer reading for what's next is the choppy and whippy price action since March 7th high (actually the choppy price action since mid-February). I could argue both directions here -- the bullish interpretation says the choppy consolidation near the highs is a continuation pattern and will be followed by more rally once it completes; the bearish interpretation says a choppy rise into a high is an ending pattern and the next move will be a sharp decline out of this choppy pattern.
The sharp decline from last Friday looks like an impulsive start to what would likely be a strong selloff and the bounce off Tuesday morning's low is therefore a bounce to be shorted. But the sharp decline could also be the completion of the choppy consolidation and that makes Tuesday's low a very good dip to buy. What's a trader to do? We'll take a look at some key levels for guidance and let price lead the way.
The SPX weekly chart below shows the alternating white and red candles since the March 3rd low (1834) and March 7th high (1883), which has pretty much contained the price action for the past month (with the exception of last week's failed breakout attempt). It's not difficult to view that sideways chop, following the February rally, as a bullish continuation pattern. I show the potential for another stab at a new high, hitting the trend line along the highs from April 2012 - May 2013, which will be near 1905 next week (opex). It would be bullish above 1905 although some price projections at 1912 and 1920 would be watched carefully. The bearish price pattern suggests this week's bounce attempt will fail and a break below Tuesday's low near 1837 would be bearish.
S&P 500, SPX, Weekly chart
Next up is the daily chart and it shows today's rally made it up to a broken uptrend line from February 5th through the March 27th low, near 1872 at the close and where SPX closed today). If the bounce is a back-test followed by a bearish kiss goodbye we could see strong selling in the coming week. I show a projection down to about 1800 next week, consolidate and then lower the following week, potentially finishing a 5-wave move down to about 1750 before the end of the month. The bullish potential is for a rally into opex week (not that we've seen many of those, wink) and a rally up to the 1900 area. That's a big spread for opex week -- perhaps a settlement price at either 1800 or 1900. Spread/strangle anyone?
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1885
- bearish below 1837
Moving in closer, the 60-min chart shows the bounce up to the broken uptrend line from February, which was also a 50% retracement of its decline (at 1869.358). That's a typical retracement for a 2nd wave correction so the bears have a good trade here if in fact the next move will be a 3rd wave down. But if we see a choppy pullback/consolidation, giving us a small 4th wave correction in the move up from Tuesday, it will likely be followed by another rally to complete a 5-wave move up, depicted in green. Following a sharp pullback into Monday-Tuesday we'd then see another rally leg, one that could achieve 1900 for settlement on opex Friday. It's the price pattern for the next pullback/decline that will provide clues for next week.
S&P 500, SPX, 60-min chart
Just before the FOMC minutes were released this afternoon the DOW had been hanging just below its broken uptrend line from March 14th, near 16365 at the time and near the 38% retracement of the decline. It was a natural place for bears to be lined up to short the bounce. So when it immediately jumped above the line there was likely a scurry to get out of short positions. The little afternoon pause was followed by another leg up into the close once those in short positions realized it wasn't going to work today. At this point the daily chart looks bullish with the bounce back into the broken bear flag pattern. But it too stopped on its broken uptrend line from February 5th through the March 27th low, near 16435. As with SPX, we'll get either a gap up above resistance Thursday morning or resistance will hold and we'll start the next leg of the decline. Other than a quick stop run higher in the morning, stay aware of the reversal potential here.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 16,535
- bearish below 16,150
I'm showing the Nasdaq Composite index tonight instead of my usual Nasdaq-100 index because of the potentially bullish setup here. It bounced off support at its uptrend line from November 2012 - June 2013 so that line is being recognized by traders as important. If it breaks, confirmed with a break below Monday's low near 4052, it would shake out all the buyers at support. The significance of that is in the bearish wave count, which is a series of 1st and 2nd waves to the downside. The next leg in this series would be a 3rd of a 3rd of a 3rd wave and basically that would be a mini-crash leg lower. Take a break below 4052 very seriously if it happens.
Nasdaq Composite, COMPQ, Daily chart
Key Levels for COMPQ:
- bullish above 4286
- bearish below 4052
Typically when I see the kind of bearish wave count shown on the chart above it's bullish instead -- the choppy pullback is usually a correction to the rally and points higher. So I'm watching for a break out of its down-channel to help confirm it's likely bullish instead of bearish. A line along the lows since the March 14th low is also where Monday's decline stopped and I've got two parallel lines attached to the March 21st and April 3rd highs. Today's rally stopped at the lower parallel line and it's another reason I felt cautious about any further upside from here. The higher parallel line will coincide with the downward crossing 20-dma over the 50-dma on Thursday at 4222-4223 so that remains upside potential for a higher bounce. It takes a rally above 4225 to help the bulls and then above the April 2nd high near 4286 to negate the bearish wave count so stay cautious about the long side until that happens. The bearish setup could start with a bang to the downside.
NDX has a very similar pattern to the COMPQ and on its 60-min chart below I'm showing some price projections that it achieved and bounced off of in its decline. This supports the bullish view that the decline is a choppy pullback correction and that a new rally leg is coming. Countering that, and plenty reason enough to stay cautious is the same 1-2, 1-2, 1-2 wave count to the downside potential. Stopping at its broken uptrend line from October 2013 was another reason to consider the short side, considering the downside potential. Not shown on the chart is the 62% retracement of its decline, at 3601.99, which it tagged with a high at 3602.35 and closed slightly below. The risk of course is a gap up over resistance Thursday morning so we'll find out soon enough which side will take it from here.
Nasdaq-100 index, NDX, 60-min chart
The RUT has the same potentially bearish wave count as the techs so if the market breaks down it will very likely be the techs and small caps leading the way lower. Considering the amount of margin debt currently being used and the retail traders' penchant for owning the sexy techs and small caps, it's not hard to imagine a sudden and strong disconnect to the downside. Again, see the risk even if it doesn't play out that way. A rally above a 78.6% retracement of its decline from April 3rd, near 1180, would be the first bullish sign, especially since it would be a recovery back above its broken 20- and 50-dma's and a break of its down-channel. Its 50-dma, near 1164 on Thursday bears watching for possible resistance if reached.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1180
- bearish below 1120
The U.S. dollar has taken a nose dive in the past 2 weeks, dropping 1.24 from a high at 80.77 on April 4th to today's low at 79.53, a drop of -1.5%. That doesn't seem like a big move when comparing to the stock market but for the currency market, which typically moves at a glacial pace, that's a big move. But when viewed on the weekly chart below you can see it's only part of a sideways consolidation that it's been in since October 2013. While it looks bearish longer-term, we need to see the dollar break below 79 to confirm we're probably looking for a decline to the $75 area this year.
U.S. Dollar contract, DX, Weekly chart
For the past couple of weeks I've been showing an expectation for a bounce in gold's price before continuing lower and now that we've got a bounce I'm wondering if it's ready to start the next leg of its decline. The dollar's large decline in the past 2 weeks helped gold rally some but not as much as one might think. The bounce off its March 31st low has run into its 20- and 50-dma's, now crossing near 1313 (as well as its 50-week MA, also near 1313), and it has retraced 38% of its March decline, at 1312. The chart below is using the log price scale and shows how the rally into the March 17th high was stopped by the downtrend line from October-November 2012. When viewed with the arithmetic price scale that downtrend line is right where the current bounce has stopped. So at the moment we've got a Fib retracement, a downtrend line and the MA's all conspiring against the bulls. It will obviously be bullish above 1313 but at the moment it's a bearish setup until proven otherwise.
Gold continuous contract, GC, Daily chart
Oil has been helped by the dollar's decline but it will be important for oil bulls to keep up the buying from here. It has run into its downtrend line from August 2013 - March 2014 at the same time it has achieved two equal legs up from March 17th, completing a possible a-b-c bounce before starting back down. Above 103.75 would be bullish while it takes a drop below its April 2nd low at 98.86 to confirm the next leg down has probably started.
Oil continuous contract, CL, Daily chart
Tomorrow will be another quiet one as far as economic reports go so the market will be on its own following the initial reaction to any move in the pre-market futures.
Economic reports and Summary
The market has reached a decision point, a fork in the road. As Yogi would have advised us, we should take it (or maybe wait for someone else to show the way). The bears had a setup at the end of the day to short the bounce since the indexes rallied up to resistance and price targets for the bounce. The risk of course is that this market loves to make mincemeat out of the bears with gaps up over resistance the following morning. The strong bounce off Tuesday's low also makes it scary to even think about shorting. But that's usually when the trade works and we'll find out quickly Thursday morning if the setup was real or just another sucker hole for the bears.
As an aside, for non-pilot types, a sucker hole is when you're flying under the clouds, using visual flight rules, and you want to get above the clouds. You see a patch of blue sky through the clouds and you climb through the hole to get above the clouds. As soon as you do that the hole closes up and you can't see the ground for hundreds of miles. It's a very scary place to be for non-instrument-rated pilots. That be a sucker hole. So bears getting sucked into shorting resistance are understandably tired of sucker holes.
But there's a possibility that the bulls got suckered into their own hole this time by responding to yet another bounce. JBTFD has been their mantra and it could very well work again. But considering the bearish setup it's not a trade I'd want to take any more when up against resistance. One of these days that resistance is going to hold and buyers are going to be left holding the bag as the market gaps down and drops way below them. It's a time of great caution and nibbling on small trades until we get a clearer signal which side is going to take the reins into opex week. Trade safe.
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