In our Bizarro world where bad news is good news, the disappointing economic numbers continue to give traders hope that the Fed will be forced to stop their taper program and support the market.
Wednesday's Market Stats
Equity futures reacted negatively this morning on the release of the GDP and Durable Goods numbers, both of which were very disappointing, but as soon as the cash market opened there were some buy programs to scare the bears away. The bounce then continued through the day as traders started to believe the bad news was actually good news for the stock market. Perhaps it means the Fed will have to back away from their taper program and continue to support the market, OK, economy.
The 3rd estimate for GDP was expected to show a decline to -1.8% from the last estimate of -1.0% (which itself had declined from the 1st estimate) but was in fact -2.9% and much worse than even the most pessimistic of dozens of economists that were polled by Bloomberg. It's also the weakest number since early 2009, which was at the bottom of the stock market crash, and the third-worst quarter in the past 50 years. The reversal from +2.6% for Q4, 2013 to -2.9% for Q1, 2014 is quite significant.
And here we are at the top of a strong rally and the market rallied today on the news! Seems to be a slight disconnect here somewhere (certainly an ignorance of a fast-slowing economy). There's a lot of hope out there that it was weather related and "can only get better from here." There's likely a lot of hope being pinned on the Fed's ability to step in and save the day. Any minute now the Fed is going to tell us they're going to stop their taper program, I just know it...stand by...hellooo, anyone there?
What's significant here is the sentiment. There's a lot of hope that the market will survive these "temporary" negative signals. And since the market is holding up on sentiment, which is the weakest reason for it to hold up (as compared to fundamentals), it's also the most dangerous time for the market since sentiment can turn on a dime from greed to panic. Whether it's a Black Swan event or just selling begetting more selling, it typically doesn't take much to turn sentiment on its heels and all the justifications in the world for a higher stock market will not amount to a hill of beans.
The market has been irrational for quite some time, thanks to the Fed stoking those irrational feelings. The summer and fall of 2013 saw a market rally that was predicated on expected SPX earnings improvements, which did not happen. The market kept rallying anyway. The first estimate for Q1 GDP, back at the end of April, was +0.1% and a drop from +2.6% in Q4. SPX earnings estimates continued to drop. It was all "weather related" (even though the GDP slowdown had more to do with inventory and other non-weather-related activities) so the market rallied.
Today's excuse for the slowing GDP was a downward revision to health-care spending that resulted from the implementation of Obamacare. Hmm, that seems like something we've known was coming. Isn't that what economists are supposed to incorporate into their models? It's simply a continuation of the age-old problem where economists consistently get it wrong in their predictions. Someone really needs to write them a new model for forecasting. The changes in health-care spending should have been expected and incorporated. Let's try another excuse.
Even though many are saying the GDP number is old news, the economists have not been correct for each of their 3 estimates. It's not old news; it's just ignored news. Today's market rally is further evidence that bad news is somehow good and that all the bad numbers will reverse. We just know it; don't ask how we know it but we're confident that it will. The Fed will protect us. OM...
The other disappointing economic news this morning was the Durable Goods number for May, which came in at -1.0%, a drop from +0.8% in April and well below expectations for +0.4%. It's further confirmation that the economy is slowing down and significantly so. The market rallied anyway. It's the Bizarro world where the Fed controls the sentiment dials and hopes no one looks behind the curtain.
What this is all amounting to is a continuation of irrational behavior of fund managers continuing to buy into the rally and looking to buy any and all dips. Despite the reasons for why the market should be dropping the buying continues and prior occasions when we've seen this happening it hasn't ended well for those who stick around when they should have exited.
When you look at how the market has typically reacted to slowing GDP you can see how the market "forecasts" the slowdown by peaking ahead of it. This is why we've heard so many times that the market predicts the economy about 6 months out. Now we have a slowing, and negative, GDP but the stock market completely ignores it. This is highly unusual behavior and can only be attributed to an unhealthy expectation that the Fed can continue to distort reality. When the real reality hits investors it's likely to come as a great shock to the system.
We're also seeing a return to liar loans and auto-loan securitizations, all the same kind of behavior that we saw leading up to the 2007 high. Student loan defaults have now been added to the list. Homeowners are once again tapping their home equity. It's deja-vu all over again and this time the Fed has made it even worse, which is a reason to believe the next leg of the bear market is going to be much worse than the 2007-2009 decline. Are you ready for it?
I'll start tonight's review with a top-down look at SPX again and show a couple of different perspectives of where this rally has taken us to. Some of it is interesting while other parts are warnings. Based on a number of technical signals, along with the over-the-top bullish sentiment and low VIX, I'm leaning to the downside currently but clearly the upside for this market needs to be respected by the bears. Regardless of the reason, this market has shown an amazing ability to rally in the face of many reasons why it shouldn't (both technical and fundamental). We have very early signs of a reversal but what can't be known yet is whether or not it will be just another small pullback before heading higher again. Today's bounce certainly has many bears wondering if this market will ever go down.
The chart below is a monthly view to show how SPX is bumping up against a long-term broken uptrend line from 1990-2002. Following the reactionary price action around the 1987 market crash and recovery, the 1990 low provides the first good pullback and the start of the roaring 90s. I also show an uptrend line from 1994-2002 (grey) since that's also an important trend line. One could easily argue the parabolic portion of the rally in the 1990s started from the 1994 low. In 2011 and 2012, especially with the bearish divergence following the highs in those years, as price bumped up against the 1994-2002 uptrend line, I thought a top of significance was forming. And then from the November 2012 low, thanks to a little help from the Fed, the market shot higher and now price sits just below the 1990-2002 uptrend line. Both of those trend lines were broken in the 2008 market crash and it's taken more than 5 years to get back up to the broken 1990-2002 uptrend line for a possible bearish back test.
S&P 500, SPX, Monthly chart, 1994-present
The price projection at 1966 shown on the above chart is a projection based on a 3-wave move up from the 2002 low (an expanded flat correction where the b-wave pullback drops below the a-wave low). The 2009-2014 rally is 162% projection of the 2002-2007 rally. Tuesday's high was 1968. Close enough for government work, especially with the market overbought on all time frames and a DeMark sell signal on daily, weekly, monthly and soon-to-be quarterly time frames.
The next weekly chart below shows some time relationships between prior highs based off the time between the June 2010 and August 2011 lows. You can see the Fibonacci relationships to the highs along the way to the current one. The 261.8% time projection is next week but as you can see at the previous highs, they were either one week early or right on the money (May 2013). Between the chart above, showing price resistance, and the one below, showing time resistance, it's a time for the bulls to be very careful here (that goes without saying for the bears). Throw in sentiment and there's a lot stacked against the bulls here.
S&P 500, SPX, Weekly chart, time relationships 2010-present
Moving in a little closer, but still with a weekly chart, I'm showing a wave count that calls the rally from April as the final 5th wave of the rally from November 2012 (the Fed-inspired rally that jumped back above the broken uptrend line from 1994-2002 discussed above). This fits as the completion of a larger corrective wave count for the entire rally from 2009. So the wave count supports the longer-term price/time relationship that suggests great caution by the bulls. SPX is also up against the top of the green parallel up-channel from the October 2011 low and showing the kind of bearish divergence I would expect to see for the final 5th wave. All the pieces are in place for a top -- time for the Fed to launch QE4.
S&P 500, SPX, Weekly chart
There are a couple of up-channels at play for SPX, in addition to the longer-term one from October 2011, shown a little closer with the daily chart below. The top of an up-channel from February will be near 2020 by the middle of next week so if the market continues to rally into month/quarter end and then the first two days of the new month (and in front of a holiday weekend, typically bullish) we could see that happen. A little lower, near 1984 on Friday, is the top of an up-channel from April. A rally above Tuesday's high near 1968 would open the door to either of those projections. But in the meantime, the setup for a reversal was a good one on Tuesday and the afternoon decline now has us on a short-term sell signal against that high (1968). We can only know in hindsight how important Tuesday's high will be but it has the potential to be a significant one.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1968
- bearish below 1925
Coming into this morning I thought we'd see a minor new low and then a bounce that would take the whole day and make it up to the 1958-1959 area to correct a portion of Tuesday's decline. That played out and as of the end of the day it was another good setup for the bears to short the bounce. SPX bounced back up to its broken uptrend line from May 20th and the top of its parallel up-channel from October 2011. Those lines crossed near 1958 today and I thought it would hold as resistance. The bounce made it up to almost 1961 so at the moment it's a little overshoot but the bears need to see the market decline immediately out of the gate to support the bearish setup. At most the short-term pattern would tolerate a bounce up to 1962-1963 before dropping but any higher than 1964 would likely mean new highs are coming.
S&P 500, SPX, 60-min chart
The DOW's highs last Friday and yesterday were more tests of the trend lines across the highs from May 2011 - May 2013 and from March 7 - April 4. Both left bearish divergence against its June 9th high and it was a good setup for a reversal. Tuesday's selloff has us on a short-term sell signal but not surprisingly it found support at its 20-dma yesterday, as it did June 12-18 and the bulls certainly hope it will provide support for the start of the next leg up, which might have started today. But the bounce pattern looks corrective and more like a correction to Tuesday's decline instead of something more bullish. As with SPX, it looks like a bounce to short rather than a dip to buy. Confirmation for the bears that a top of significance could be in place will come with a decline below 16700 to get it back below its 2000-2007 trend line and the June 12th low at 16703.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,000
- bearish below 16,700
NDX has retraced the greatest portion of Tuesday's decline -- a little more than 78.6%. Tuesday's strong reversal has also been a reversal so will the real reversal please stand up. Into Tuesday's high I had been looking for NDX to potentially get turned around at its 127% extension of the March-April decline, near 3827, which is a common reversal Fib level to watch carefully. It rallied a little higher on Tuesday but the bulls then got kicked to the curb and the lower close produced an outside down day at that Fib level. Today's rally brought it back up to that level for a potential back test but it means the bears need to step back in immediately Thursday morning. This one can't tolerate even a little higher without opening the door to higher highs (at least the 3850 area). Another failure to hold above the trend line along the highs from March 7 - June 9 would also be bearish but the bears need to see NDX below its June 18th low at 3764 to prove a high of significant is in place.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3850
- bearish below 3764
I don't normally show intraday charts below a 30-min time frame in a market wrap because it gets a little too much into the day trader's territory but the NDX pattern that I was watching during the day deserves a mention only because it was a setup for a reversal at the end of the day, with a tight stop just above Tuesday's high. If the setup is correct we'll see an immediate drop lower on Thursday (to at least match Tuesday's decline but potentially much more). The bounce off yesterday's low looks like a double zigzag correction (two a-b-c's separated by an x-wave) and there are two price projections that correlate nicely near 3832, which are shown on the 2-min chart below. NDX stopped just short of the projection and started to roll over into the close. The setup calls for an immediate drop below its uptrend line from the morning, near 3826, and if that happens then the stop on the play can be lowered to 3832 (keeping it tight until we've got a confirmed reversal back down).
Nasdaq-100, NDX, 2-min chart
The RUT came close testing its uptrend line from May 15th and its price-level S/R line near 1165. A drop below 1165 would be bearish and a drop below its June 13th low at 1154 would confirm a top is in place. But its up-channel from May is still holding so it would continue to be bullish with a rally above Tuesday's high at 1194.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 800
- bearish below 778
When the equity futures sold off on this morning's economic news the bond market rallied, which drove yields back down. This has TNX looking like it might roll over at resistance at its downtrend line from December, as well as its longer-term downtrend line from 2007-2011. But it's not a clear short-term pattern and I could also argue it's consolidating beneath resistance and getting ready for the next rally leg that was started off the May 29th low. A break above last 2.66% would be bullish but at the moment it's leaning bearish.
10-year Yield, TNX, Weekly chart
I'm watching the banks carefully here (follow the money) to see what happens now that it's back-testing its broken uptrend line for the leg up from June 2012. BKX broke below the line in early April and is now back up for a back test. All the bears need now is a bearish smooch goodbye. A drop back below its June 16th low at 70 would be the first sign of trouble for the bulls and then below its 50-week MA at 67.53 would be stronger confirmation that an important high is in place.
KBW Bank index, BKX, Weekly chart
Since the end of May I've been looking for the U.S. dollar to pull back to correct its rally off the May 8th low and we're slowly getting the correction. So far it has retraced 38% of the rally and I'm showing a depiction for about a 50% retracement and back test of its broken downtrend line from January, perhaps down to about 79.90 in early July, before starting another rally leg.
U.S. Dollar contract, DX, Daily chart
Gold has been struggling underneath its downtrend line from October 2012 - March 2014, currently near 1323, which was tested again today. A drop back down would continue to support its larger bearish pattern but if it rallies from here we could see a test of the 1350 area before pulling back to retrace a portion of the rally from June 3rd and then continue higher. It could be in a large sideways triangle pattern since the June 2013 low so even a rally up to 1350 would not necessarily be longer-term bullish. I'll review the potential if and when it breaks the current downtrend line.
Gold continuous contract, GC, Daily chart
On June 12th oil broke above the top of a sideways triangle that started from March 3rd, near 105, in a 1-day spurt higher (short covering as stops just above the top of the triangle were hit) and has consolidated for the past 8 trading days. It's bullish that it's hanging above 105 but would turn bearish again if it drops back below 105. There's additional upside potential at least to the shallow downtrend line from May 2011, shown on the weekly chart below. The line is currently near 111 and it would become much more bullish above that level. It's possible it will complete a bounce in a very bearish longer-term pattern but we'll have to see how it looks if and when it reaches 111.
Oil continuous contract, CL, Weekly chart
Tomorrow we'll see how the consumer is doing in this age of "contained inflation" when we get the Personal Spending and Income numbers. As long as the income stays ahead of the spending it keeps things positive. Increasing consumer debt, through greater spending than income, would continue to make the consumer a potential liability for the economy.
Economic reports and Summary
We had a good setup for a downside reversal on Tuesday and by the end of the day many of the indexes were sporting a key outside down day for a reversal pattern. The sharp decline on Tuesday looked impulsive and that was confirming the reversal signal. The expectation for today was for a bounce to correct a portion of Tuesday's decline and today's bounce fits the bill. If the reversal pattern is correct we should see the market head lower on Thursday, ideally right out of the gate.
Today's rally, brought to us courtesy of a slowing economy (don't ask), might have had some "assistance." There have been many stories recently about the central banks of the world looking for yield just like everyone else and they're finding it in the stock market. When we say the central banks are supporting the stock market we mean literally and they're doing it with money printed out of thin air. There's got to be something illegal in that. Be that as it may, the central banks have a personal interest in keeping the market up and the negative futures reaction to this morning's economic news was met with some buy programs out of the gate this morning. A little help from our friends?
But the market is much bigger than the central banks and therefore depending on them to hold the market up in the face of deteriorating economics and nervous investors, it won't take much to run them over. And when that happens (not if), it will likely happen at a very fast pace. As I've been saying for a while now, upside potential is dwarfed by downside risk and I would trade accordingly.
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