The World Bank announced a revision to their estimate for 2014 global growth and the revision was downward. This depressed European and U.S. stock markets as it's becoming harder to justify the 'P' in the P/E when the 'E' is coming down.

Wednesday's Market Stats

The market started off weak this morning following a drop in the futures overnight as European indexes turned down. As soon as the cash market opened NDX immediately got jammed back to the upside and closed the morning gap within the first 20 minutes. At that point it was easy to believe the morning gap down was just another dip to buy. But as the morning progressed the bounce looked weak and even though NDX stayed in the green (while the DOW remained close to -100) the bifurcated market and the choppy rise in NDX looked like the rally attempt was going to fail, which it did. However, the bears were thwarted once again as the bulls charged back in and drove the NDX back up near its high for the day. The other indexes didn't fare as well but the pullback is looking like new highs are coming.

There were no significant economic reports to sway the market this morning. The only report of significance came from the World Bank, which lowered its global economic forecast to +2.8% for the year, down from its previous forecast of +3.2%. I strongly suspect the 2.8% growth will be revised lower within the next 3 months and the actual result will probably be even lower. Next year's forecast will likely be negative as they keep ratcheting down their estimates (as economists continually do when they're trying to catch up with actual economic results).

The lower revision for growth means lower 'E' in the P/E equation and that will mean the stock market will have to factor in these lower expectations. The decline in Europe followed by the decline in the U.S. was very likely a reaction to this. But it doesn't mean a market top is in place yet. The stock market has long ignored the fundamentals, believing instead in the power of the central banks. Bad economic data? Woohoo, more stimulus from the CBs and that means more money for our party -- another round for my bullish buddies please.

Another chart that suggests there could be trouble ahead for stock prices if they start to reflect actual corporate profits. The chart below shows the sharp drop in adjusted corporate profits in 2014 and was discussed by Albert Edwards, a global strategist at Societe Generale SA. He measures profits a little differently and incorporates inventory values. As older inventory is depreciated there is an accounting charge that reduces the value of assets held by the company. Edwards uses these figures to adjust reported earnings to get "real" earnings and the chart below shows adjusted pretax earnings, which declined -9.8% in Q1.

Adjusted U.S. Corporate Profits, chart courtesy Societe Generale SA

The sharp decline in Q1 was the sharpest drop since Q4 2008 when profits dropped -26% in the middle of the 2008-2009 recession. Edwards' conclusion is that this measurement can be an early warning of a coming recession, something the majority of economists today believe is not even on the horizon (which alone is a good contrarian signal that one is a lot closer than believed). While corporate earnings have reportedly risen +5.8% in Q1, this was profit before inventory and depreciation adjustments. Against Edwards' report showing a -9.8% decline there's quite a split and the inventory write-off will also be a reduction to GDP.

The stock market has long made a mockery of fundamentals and has been disconnected from what's happening on Main Street for a long time. But one early indication of trouble for the stock market is the recent decline in margin debt. The market is obviously dependent on more money coming in to pay for higher prices and the increase in margin debt has been one of the things fueling the rally. But as can be seen on the chart below, market tops tend to follow a downturn in margin debt as traders start to get more nervous about the market and therefore decrease their exposure. One way to decrease that exposure is to reduce your use of margin. That in turn means more selling and less buying and a stock market top is born. Margin debt peaked in February and dropped in March and dropped again in April.

NYSE Margin Debt vs. SPX, chart source dshort.com

The chart above was last updated through the end of April and therefore does not reflect the spike higher in SPX since mid-May. I do not have the latest numbers for margin debt but if the stock market high is being made with a lower margin debt it's going to give us a topping signal like we had in 2000 and 2007. It's not a market-timing signal but it does offer us another warning sign (as if we need more).

Here's another warning sign, a chart I've show before, which uses the ratio of XLY to XLP. XLY is an ETF of consumer discretionary stocks and XLP is an ETF of consumer staples stocks. When people are feeling good about their financial position they'll buy more of the discretionary goods (with money left over after buying their staples). This is reflected in higher stock prices for the discretionary stocks, such as the larger holdings in XLY -- Disney, Comcast, Amazon, Home Depot and McDonald's. But when consumers are starting to live more paycheck to paycheck they'll back off on their discretionary spending and concentrate on the necessities. The top holdings in XLP include Proctor & Gamble, Coca-Cola, Philip Morris, Walmart and CVS. This group includes the stocks that tend to do better (at least relatively) in an economic downturn -- "if you can eat it, smoke it or drink it, buy it."

S&P 500 vs. XLY/XLP, Weekly chart

There are two takeaways from the above chart. The first is that SPX has rallied for the 3rd time up the top of its bearish rising wedge for the rally from 2009, the top of which held down the December and March rallies and was tested again with Monday's high at 1955. This creates a 3-drives-to-a-high topping pattern so the risk for bulls here is a turn down that won't be just a pullback (that bearish rising wedge pattern calls for a complete retracement).

The second takeaway from the chart above is that the XLY/XLP ratio has significantly underperformed SPX since the 2009 low, which indicates the consumer has not been as bullish as the stock market would suggest. We know there's been a disconnect between Wall Street and Main Street for a long time and this is a graphic portrayal of that. And recently it has barely lifted off its May low while SPX dashed higher, a clear bearish divergence. This is a clear indication that the stock market is out of touch with reality as the consumer digs in and goes into protection mode. The divergence is a clear warning and the price pattern says the warning is about to lead to a significant break to the downside.

Another sign of trouble is what we're seeing in the high-end retailers and the lower-end ones. The affluent continue to spend their money in places like Tiffany's, a company that had +9% higher revenue in Q1. In the meantime middle-class shopping in places like Sears and Walmart has declined precipitously. Walmart's Q1 revenue declined -5%. But at the other end from Tiffany's, stores like Dollar Tree, which cater to the real bargain shoppers, also saw a Q1 revenue increase of +7%. It's the middle that's getting squeezed and it's the middle that is the biggest chunk of consumer spending. And it is this reduced spending, especially on discretionary items, which poses a significant risk to our economy, a risk that the stock market is apparently not concerned about, yet.

Continuing with more charts of SPX, the weekly chart below is using the arithmetic scale to show the parallel up-channel from October 2011 (the 2nd leg of the 3-wave move up from 2009), which it has reached again after hitting the top of the channel in December and March. Another example of a 3-drives-to-a-high topping pattern. I show the potential for a throw-over finish (light green dashed line) but the higher-odds scenario is for a top to form here and now.

S&P 500, SPX, Weekly chart

One of the reasons why I show the potential for a throw-over finish on the weekly chart above is because of the parallel up-channel for the rally from February, the top of which is currently near 1997. A 3-wave move up from April (in case the EW count is corrective instead of impulsive as I've labeled it) would have the 2nd leg achieving 162% of the 1st leg at 2004. But two equal legs up from February points to 1960 and two equal legs up from April points to 1950, which is a reason why I've been thinking recently that we could see a top in the 1950-1960 area (and Monday's high at 1955 split the difference).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1964
- bearish below 1925

SPX 1950-1960 is also the location of the top of the parallel up-channel from April, as well as the top of the up-channel from October 2011, as well as the top of its rising wedge from 2009. There's a lot here to say why the market should be topping here and now and I'm watching the shorter-term pattern for clues as to where that high will be. Notice too the increasing slopes of the up-channel since February, an indication the rally is going parabolic. Parabolic rallies never end well.

The decline from Monday's high looks corrective (choppy overlapping highs and lows within a down-channel that looks like a bull flag) and that suggests we've got higher prices ahead of us. As shown below, SPX found support where it closed Friday's gap at 1940.12 with a low of 1940.08. In a 5-wave count up from May 15th the 5th wave would equal the 1st wave at 1963.72, which is why I have 1964 as a key level for the bulls to break in order to keep the larger pattern bullish. That projection crosses the top of the up-channel from April on Friday, which just so happens to be a full moon as well. Is it lunacy to think we might have a high on a full moon? A drop below 1937, that stays below it, would be a break of its short-term down-channel, which would leave a failed bull flag pattern and would instead likely be followed by stronger selling.

S&P 500, SPX, 60-min chart

NDX spent much of the day in the green today but that didn't help the DOW, which spent most of its day down about -100. A big reason for its decline was Boeing and that was blamed on Republican House Majority leader Eric Cantor, who had the audacity to get defeated in the Virginia primary by a Tea-Party candidate. Apparently Cantor has been a big supporter of the Export-Import Bank, which assists in financing exports of U.S.-manufactured goods. For Boeing's big airplanes (hence BA) this is a big deal and its -2.3% decline today, starting with a gap down, put a big dent in the DOW.

The DOW's big red candle follows a test of the top of its parallel up-channel from April 11th and the trend line along the highs from March 7 - April 4. It looks like a great setup for lower prices and that's the risk for anyone thinking the market has higher prices yet to go. I show that potential on the chart, with a high near 17000 by Friday, but it's almost a coin toss here as to whether it will head immediately lower or only after a minor new high first. Today it found support at a trend line along the highs from April 4 - May 13 and therefore there's the potential for a bullish back-test and new high to follow.

Dow Industrials, INDU, Daily chart

As noted on the DOW's chart above, the wave pattern would turn more bullish if it rallies above 17062 since it would make the 3rd wave in the move up from February the shortest wave and that violates an EW rule. Therefore short against 17062 is a recommended position but flat or long above 17062 (I don't like the risk:reward on the long side but short would not be the right place to be above 17062).

Key Levels for DOW:
- bullish above 17,062
- bearish below 16,670

NDX has been in a flat trading range since last Friday and today it tested both sides of the range -- the top near 3404 and the bottom near 3784. Today's low was a slight break of its uptrend line from May 16th but it held with this afternoon's recovery. It's been pressing up against its broken uptrend line from June 2013 - February 2014, currently near 3404, and it could be doing a back test which will be followed by a bearish kiss goodbye. If it continues to chop up and down in a big sideways/down correction (light green dashed line) we could be looking at a boring month of June and then a final high in July. But at the moment I see the potential for a new high by the end of the week, to put in the final high, and then start a decline next week.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3827
- bearish below 3738

The projection shown on the chart above, at 3826.51, is the 127% extension of the previous decline, which is the March-April decline. This is a common reversal Fib so it makes a good upside target for the completion of its rally. But trading on the long side for that is not worth the risk in my opinion. Matching that 3826 projection is another projection shown on the 60-min chart below. For the 5-wave move up from May 9th the 5th wave would equal the 1st wave at 3824.77, giving us close correlation with the trend lines and why it could be an important top if achieved. The risk is an immediate breakdown.

Nasdaq-100, NDX, 60-min chart

There's an interesting setup on the semiconductor index (SOX) that's worth watching closely here. As go the semis so go the tech indexes and as go they so goes the broader market. At today's high, at 625.91, the SOX tagged the top of its parallel up-channel for the rally from 2013 (starting with a trend line drawn across the highs from February-July 2013 and attaching a parallel line to the August 2013 low). At the same time it met its price objective out of the sideways triangle that ran from the April 4th high -- taking the widest part of the triangle and projecting it from the breakout (on May 22nd) we get an upside price objective near 625. By the oscillators you can see the index is extremely overbought. It can stay overbought but considering it has reached the top of its up-channel following a pattern (sideways triangle) that called for a final leg up to complete the rally, it's a risky place to hold the semis long here. Today's spinning-top doji has the potential to be a reversal candlestick.

Semiconductor index, SOX, Daily chart

Following Monday's high I was thinking there was a good possibility it made a final high for its bounce off May 15th low. It came within 39 cents of achieving two equal legs up at 1180.23 for an a-b-c correction to its March-May decline and was a good setup for a reversal back down. But so far the decline from Monday has held inside a bull flag pattern, which looks more like a correction to the rally instead of something more bearish. It also held price-level support near 1165 and both keep the short-term pattern bullish. The RUT would be bullish above 1180 but with multiple resistance levels just above (bounce highs at 1194, 1205 and then its March 4th high near 1213) it would be a difficult trade to hang onto). The bottom of its short-term down-channel from Monday is currently near 1158 so a break below that level would leave a failed bullish pattern, which in turn would likely be followed by strong selling.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1180
- bearish below 1118

There's also an interesting setup for a top to the banking index (BKX), which actually is the March 21st high where it met the price objective for two equal legs for its 3-wave move up from 2009. Following its decline into the May 15th low it has now bounced back up to its broken uptrend line from June 2012. It's a back test that should be followed by a bearish kiss goodbye if the top is in place. The bounce also fits as the right shoulder of a H&S topping pattern (it looks small on the weekly chart below).

KBW Bank index, BKX, Weekly chart

Like the broader indexes, the TRAN's pullback from Monday looks corrective and therefore suggests we could see another push higher into the end of this week. But the bigger picture is shown on its weekly chart below and like the other indexes, it's at an important point in its pattern here. The EW count can be considered complete at any time at the same time it has pushed up to trendline resistance near 8320-8330 (Monday's high was 8256). The trend line along the highs from May 2013 and the one along the highs from 2010-2011 create a barrier with an overbought market on the daily and weekly charts. This is a risky place to be thinking higher, even though there's at least a little more upside potential to the 8325 area.

Transportation Index, TRAN, Weekly chart

The U.S. dollar waffled a little bit in the past week, especially after the Euro did the same after the ECB announced again that they're ready to do "whatever it takes" to keep the stock markets, I mean economy flooded, I mean supplied with the financing that the banks, I mean companies need to keep their businesses growing. But the dollar bounced right back up on Monday and Tuesday and consolidated today. It remains on track for a strong rally this year but in reality we don't know which way it's going to go until it breaks out of the trading range it's been in (79-81.50) since last October.

U.S. Dollar contract, DX, Weekly chart

Gold has bounced off its June 3rd low but it looks like a correction to its decline, not something more bullish. It retraced 38% of its decline from May 22nd, which is the high I'm using as the completion of its sideways triangle consolidation pattern in April-May, and then turned back down today. It could progress a little higher but it needs to break its downtrend line from March 17th, currently near 1278 (this morning's high was 1265.50), before it would be more bullish. A continuation lower to at least 1155 is still my expectation.

Gold continuous contract, GC, Weekly chart

Oil is on the verge of breaking out of its sideways consolidation that it's been in since March 3rd high but so far has only managed intraday breaks above its shallow downtrend line from the March high, currently near 104.70. If it rallies above the March 3rd high at 105.22 (yesterday morning's high was 105.06) and then uses the downtrend line as support we'd likely see oil head up to its longer-term shallow downtrend line from May 2011, near 111. What's interesting about the sideways triangle pattern on the weekly chart below is that there's a very similar sideways triangle on the daily chart since the March high. The fractal pattern suggests a bullish break above 105.22 would likely lead to a break above resistance near 111 as well.

Oil continuous contract, CL, Weekly chart

If oil turns bullish here, it would likely have a negative impact on the fragile global economies. Usually higher oil prices are a reflection of a stronger economy but in this case something else is causing it and just as too-high interest rates can squash an economy, too-high oil prices could do the same.

There are a few more economic reports Thursday morning but not likely anything that will move the market. Friday's reports will include PPI numbers and could move the market if there's a significant change from what's expected. Otherwise we've got a quiet two days to finish the week.

Economic reports and Summary

The longer-term charts suggest we're in bear-infested waters here and at any moment one or more could take a big chunk out of the bull's hide. Price objectives, trend lines, EW counts and Fibs say there could be a little more to the upside into Friday and if that happens we might be looking at a negative opex week next week. If the market declines into Friday there's a good chance we'll get at least a bounce back up next week before tipping over stronger. I've been saying the past few days that the bears need to continue exercising patience while the bulls need to exercise extreme caution.

The risk:reward favors the short side but we could be a day or two away from a better short entry if the market does give us new highs. A new high by Friday would also give us a high on a full moon, which would make for an interesting setup. As for when the market would turn more bullish, I'm using the DOW for now to see if it can rally above 17062, in which case the bears would need to back off and let the bulls take this to an even more overstretched market and wait until the rubber band snaps.

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