The stock market has been consolidating near its highs for a month, which appears bullish. But the bearish interpretation is a rolling top. In either case we should get a break of the log jam soon.

Wednesday's Market Stats

The blue chips were weaker than the techs and small caps yesterday and today and interestingly, the RUT's relative strength yesterday, as the other indexes dropped lower into the close, provided a bullish heads up for how today might go. It didn't help the DOW stay in the green today while SPX struggled to stay in the green, closing up only +0.12. As can be seen in the numbers in the table above, it was a mixed but neutral day today. The RUT and techs again showed relative strength and that supports the bulls for now but the overall structure of the market is looking weak. The month-long consolidation should soon break and the only question is what will provide the spark.

Today's economic reports included the Q2 GDP-Advance look and it came in better than expected. Following Q1's disappointing -2.9% there's been a lot of positive expectation for how Q2 will do and the estimate coming into today was +3.2% so the +4.0% was a nice surprise. Q1 was also revised up to -2.1%. Futures reacted positively following the 8:30 AM report but then started to pull back and the cash market sold off some after it opened. Keep in mind that a strong GDP number gives the Fed a lot more room to remove their stimulus

In actuality the GDP numbers are not all that helpful since it doesn't give us a true measure of how the economy is doing. Like so many other government reports, many simply don't trust the numbers anymore. There's been too much manipulation of employment, inflation and other economic data and the stock market doesn't really respond well to the data anyway. It's much more about emotions and risk tolerance and what the Fed has been able to accomplish all these years is to increase investors' risk tolerance.

An acceptance of greater risk is why we see such low volatility and now a stronger interest in the stock market by individual investors. "The Fed has our back" has been the rallying cry. The stock market has rallied in spite of bad economic and employment data (the disconnect between Wall Street and Main Street) and it will likely sell off when we're getting better economic data. Many will bemoan the fact that the market is selling on good news. It's a repetitive pattern and there's no reason to believe that pattern has been negated.

We received some more employment data today with the ADP number this morning, coming in at 218K and in line with expectations for 215K. It's a drop from the 281K in June but a lot of that might be summer related -- it's often harder to find a job in the summer when hiring managers are taking their vacations. Friday's Nonfarm Payrolls (NFP) is expected to show a gain of 220K, which would be a decline from June's 288K.

The big report today was the FOMC announcement, although there were no expected changes from the Fed. Regardless, everyone listens carefully for what word was changed, where they placed a period instead of a comma, and then how to interpret what Yellen said vs. what she meant to say and wonder if we heard what she didn't say while trying to understand what she actually said. The bottom line though is that the market needs to decide whether it wants worse economic numbers, for a more accommodative Fed, or better economic numbers and a less accommodative Fed. Actually it hasn't mattered much since the market has been rallying no matter what the news.

One indication of investors' desire to own more stock is the climbing margin debt. Following a peak in February it was declining but since April it's been climbing back up. When I last discussed margin debt a few months ago, when it was reaching all-time highs with the stock market, I had mentioned it as another sign of bullish enthusiasm for the stock market. Buying more and more on greater amounts of margin is a positive sign for the market but not when it becomes excessive. It can provide a warning when there are too many bulls running over to one side of the boat.

As I had mentioned a few months ago, the pattern of previous market highs shows price peaks occurred a few months after the peak in margin debt. We might be there and it's a warning sign for the bulls because the market is pulling in less money to support higher prices.

The chart below is the one I showed last time, which has been updated by Doug Short (dshort.com), and you can see the higher price since margin debt peaked in February. Notice the similar pattern at previous market highs in 2000 and 2007. Also interesting is a view of SPX in constant dollars (adjusted for inflation). Everyone has been so excited about the new all-time highs since 2013 but in reality all we're seeing is a test of the 2000 high (with a lower high so far). It's looking like we could end up with a massive double top.

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

The other important point about the above chart is the faster growth in margin debt during each of the past 3 bull markets (in both dollars and percentage growth). In constant dollars the 2007 high was a lower high compared to 2000 and the current high is still below the 2000 high and yet each rally produced higher highs for margin debt. Similar to the banking industry, traders have taken on even more debt and in turn have become even more vulnerable to a downside disconnect. Some try to explain this away by saying it's because we have more hedge funds getting into the game with heavy use of margin. My response is "and your point is?" Do you think hedge fund managers will sit in their positions waiting for a margin call or will they be quick sellers? I suspect the latter and that means we're sitting on a lot of "long interest" that could suddenly collapse when the selling starts.

Individual traders in particular have been thoroughly conditioned to believe they should hold on during any downturn because the market "always comes back," especially since the Fed has our back. That will be proven to be one of the greatest false beliefs that market participants will have ever had. The time they'll realize what kind of trouble they're in will be when the margin calls come pouring in, sparking further selling and in the process wiping out the majority who used too much margin and held on too long.

Another way of looking at this is with another of Short's charts, this one showing an inverted SPX (blue line) against a measure of investor credit balance. When investor credit balance reached a large negative position in February 2000 the stock market started to get choppy as it put in a final high in March 2000 and then tested it in August 2000, which coincided with a higher low in the negative credit balance. You can see the opposite at major stock market lows (SPX highs when looking at the inverted line below) -- the credit balance made lower highs while SPX made lower lows (higher highs since it's inverted). This year we've had a low in the negative credit balance in February and now a test of that low in July with a higher high in price (lower low since it's inverted). This doesn't tell us the market will reverse here and now but it should be telling the bulls to be afraid, be very afraid.

NYSE Investor Credit vs. SPX (inverted), chart courtesy dshort.com

We're also seeing investors piling back into stocks again, convinced this is now a bull market worth investing in. Unfortunately for these late-comers, they'll very likely, again, catch the top of the rally. When everyone jumps in it leaves few to continue pushing the market higher (and when combined with lower usage of margin it significantly reduces the demand for stock). It's really just a Ponzi scheme that's not been outlawed. We've got a stock market that has continued to further disconnect from what's happening on Main Street and the yawning difference will soon be corrected and I highly doubt it will be Main Street catching on fire to join the stock market.

About $100B has been plowed into equity mutual funds and ETFs by individual investors in the past year. June saw almost $10B in positive flow and 8 of the past 10 months has seen a positive flow of cash into the stock market by individual investors. The low volatility and slow but steady progress to new highs has lulled investors into a false sense of security. Low volatility leads to high volatility and usually a lot faster than investors are ready for. Professional money managers start to get worried when they see individual investors arriving en masse to the stock market. These investors do this when they see only the rewards of higher prices and forget about the risks. It's very often a sign of the end of the trend when most everyone finally recognizes it. This is what makes the above charts so compelling right now -- it's a dangerous time to be complacent about the upside.

But as always, price is king and that's why we evaluate chart patterns. These patterns reflect the aggregate trader mood and we can often get a heads up through technical analysis when things start to change. At the moment there are only hints of change but the longer-term trend is still up (depending on the index). Starting with a week view of SPX you can see the month-long consolidation near the highs. A consolidation following a rally is typically a bullish continuation pattern and that potential clearly exists here. It could result in another big run higher, potentially above 2100. That's hard to see at the moment and I'm thinking instead we're seeing an ending pattern.

SPX has been stalled at the price projection near 1990 for the past month and MACD has crossed down out of overbought. It's not hard to see this as potentially bearish even though the consolidation looks bullish. Keep in mind that if a bullish continuation pattern fails, as the bearish interpretation here suggests could happen, it tends to fail hard as too many traders get caught leaning the wrong way and suddenly start to bail out together. This is why the charts above are potentially important.

S&P 500, SPX, Weekly chart

The daily chart below shows the potential for at least a little higher to the 2000 area, an upside target I've been mentioning for more than a month. For a 5-wave ending diagonal starting from the July 10th low I see this as a good possibility. Today's price action put a dent in that expectation but the bulls aren't done yet. There's been a break of the uptrend line from April-May, near 1974 Thursday (about a point below its broken 20-dma near 1975), and if that's not recovered quickly it will be an indication that a breakdown has started.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1985
- bearish below 1955

As can be seen on the 60-min chart below, the decline from last week is so far just a 3-wave correction to the rally. As long as SPX stays above its July 17th low near 1955 it stays potentially bullish. At the moment it's potentially bearish because of the break of the April-May uptrend line and the back-test this afternoon. The bearish wave count calls for a strong decline on Thursday in a small-degree 3rd of a 3rd wave down, something that would likely drop SPX quickly to the next support level near 1940 (uptrend line from February-April). The bulls need to step on the gas quickly Thursday morning to prevent this from turning bearish.

S&P 500, SPX, 60-min chart

The dominant pattern for the DOW is its rising wedge from April. The wave count for this pattern actually starts from the February low and it had the requisite 5-wave move up that consists of corrective wave structures. Yesterday's break below the bottom of the wedge, near 16970, followed by only a back-test of the bottom this morning, is a bearish sign. It broke its 50-dma on an intraday basis but was rescued this afternoon to close just above it near 16874. A further break is likely if the top is in place but I see the potential for a higher bounce for another back-test of both the broken uptrend line and 20-dma, near 17K.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 17,060
- bearish below 16,760

One way to play the DOW from here is to watch for a bounce that gets RSI up for a back-test of its broken uptrend line (a confirming indication the trend is ending or will end after only one more new high). Many times a back-test and lower high will occur with a new price high and that's usually a high-odds setup for a reversal that you can play (short in this case). Price might break down from here instead but it's something to watch for if the RSI back-test happens.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4000
- bearish below 3866

I like the RUT's weekly chart to show a clean wave count that strongly suggests THE high is in place. If you don't care much for EW (Elliott Wave) stuff you can skip over this part. The RUT's bounce off the 2009 low is a big 3-wave move up that and each of the 2 legs up is itself a 3-wave move. The 2nd leg up is the one shown on the weekly chart below and starts from the October 2011 low. The first leg of the 3-wave move up from October 2011 is a 3-wave move and is labeled wave-A. The pullback into the June 2012 low is wave-B. Based on this interpretation I've been expecting wave-C, the move up from June 2012 to end much earlier than it has. It's been stretched in time and price by "support" for the market.

Regardless of how long the c-wave has taken it still fits the pattern for it -- a 5-wave move up that stayed inside a parallel up-channel. The 5th wave, which is the leg up from May, is equal to the 1st wave at 1221.28 (shown on the chart) and the high on July 1st was 1213.55, which was essentially a test of the 3rd wave high on March 4th. The 5th wave stopped at the mid-line of the up-channel, which is common, and it shows bearish divergence against the 3rd wave, which is very common. It could rally higher and extend the 5th wave, which is not common when the 3rd wave extends, as this one did, and therefore the expectation here is for a continuation lower after putting in THE high on July 1st. This chart has SELL! written all over it.

Russell-2000, RUT, Weekly chart

The daily chart shows the wave count for how the 5th wave finished (a nice 5-wave count for the move up from May) and that was followed by an impulsive decline to the July 17th low. The impulsive decline says the trend has changed to the downside. The choppy bounce pattern following the July 17th low suggests another stronger decline once the bounce correction completes. At the moment I can argue for a higher bounce, perhaps up to the 1165 area but so far the leg up from Monday is very choppy and it looks like it will complete with a lower high. That in turn would set the pattern up for a stronger decline in a small-degree 3rd of a 3rd wave down, something that would likely drop the RUT quickly to its uptrend line form October 2011 - November 2012, currently near 1100. This says the recent relative strength in the RUT is a head fake so be careful chasing it higher.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1185
- bearish below 1120

Many of the sector indexes look similar to the broader averages. One that is a little difference, and weaker, is the homebuilder index (DJUSHB). As can be seen on its weekly chart below, price has now dropped marginally below support near 460. It's only minor and could easily recover. The weekly closing price will be important. The longer-term price pattern calls for another leg down to at least test, and probably break, its 2008 low at 130. The slowdown in the housing market is something I've been suggesting will happen for a long time now and I believe this index will soon reflect the disappointment in the homebuilding stocks.

DJ Home Construction index, DJUSBH, Weekly chart

Another index that suggests the top could already be in place is the TRAN. The 5th wave of its rally from November 2012 is the leg up from April and its 5th wave is the leg up from June 12th. Yesterday the TRAN dropped below the up-channel for this final 5th of the 5th wave and that suggests the whole thing is now complete. Today's bounce was a back-test of the bottom of its broken up-channel and almost reached back up to its broken 20-dma, at 8319. It would turn more bearish with a close below its 50-dma, near 8195 on Thursday. The decline from July 23rd looks impulsive while the bounce off yesterday's low looks corrective and that keeps things bearish for now, even if we get a higher bounce before heading lower.

Transportation Index, TRAN, Daily chart

The U.S. Dollar and the metals have continued to chop sideways in their month's-long consolidation and until they break out and we see something worth looking at more closely I'll keep using their weekly charts to show the bigger pictures for them. The dollar has rallied strong the past month and has now made it up to the top of its sideways trading range that it's been since its October 2013 low. There was a minor intraday break above resistance at 81.50 but that's where it closed. It's overbought as it tests the top of its range and I'd say there's a good chance we'll see a pullback. If it's just a minor pullback that lasts only about a week I see the potential for a run up to at least 81.90 where the rally off the May low would have two equal legs up. I show a lot more potential for a strong rally this year, up to the 87 area but one step at a time to see how the bulls hold up here.

U.S. Dollar contract, DX, Daily Weekly

The big sideways triangle for gold is still in play and my expectation is for higher prices for the triangle to finish near 1360 later this summer before starting back down toward 1000. The triangle is currently about 1260-1360 and what happens inside that 100-point range doesn't mean a hill of bean to the larger pattern. We have to wait for the break before knowing what will happen next. I lean short gold but see the potential for a rally to 1360 before trading that way.

Gold continuous contract, GC, Weekly chart

I see oil in an ending diagonal pattern (shallow rising wedge shown on its weekly chart below) and that calls for one more rally up to the115-116 area before collapsing back down. If oil drops below 96 first (maybe peace will break out all over the world), it would then turn bearish earlier than I'm projecting.

Oil continuous contract, CL, Weekly chart

Tomorrow's economic reports include unemployment data and more importantly the Chicago PMI (shortly after the market opens). The PMI is expected to drop a little from June's reading but as long as it hits close to its expected 61.8 there should not be much of a reaction. Friday's economic numbers will be market moving so be careful about what positions you're holding over Thursday night.

Economic reports and Summary

The stock market has been waiting for something for well over a month now and it's difficult to tell which direction it will break out of the consolidation. I suspect a breakout to the north would be short-lived and turn into one giant head fake, especially if SPX tags 2000+ and then fails to hold it. But I've seen too many important market tops get put in with what looked like bullish continuation patterns. They're instead little rolling tops and when price chops its way higher, especially in rising wedges like we're seeing, it's most often a warning sign that the rally is ending.

We've got a plethora of signals that show the higher index prices are not being met with stronger market internals. Quite the opposite actually. One indication of market strength has been discussed recently by Mark Cook, who was profiled in Jack Schwager's book "Stock Market Wizards." When someone like him talks we should definitely be listening. At the moment he is also very cautious about the upside. His proprietary indicator that he developed in 1986, the "Cook Cumulative Tick," has reliably warned him about previous major highs and lows.

Cook's indicator alerted him to the 1987, 2000 and 2007 market highs and the following crashes and his indicator is now warning him of another one coming. He was also able to identify the 2009 low with his indicator. If ever there was a good crystal ball this sounds like a good one. Basically the indicator is showing him the higher index prices are not being supported by stronger tick readings. His analogy is a dam with minor cracks that look harmless but the weakening of the structure that you don't see is the unseen problem and it's a warning that the dam could suddenly and catastrophically burst.

As Cook says, "It's like being in the Twilight Zone. Imagine going outside when it's raining and getting sunburned. That's the environment we're in right now. Some people might say it's 'different this time,' but it never is. Could the market go higher? Yes, it could, but the extension of time will create an even greater divergence that has to be snapped back together."

Respect the upside but don't get complacent about it. And stay aware that when the dam breaks there will likely be a flood of water (sell orders) and this market has already proven it can't handle too many sell orders at once (bids disappear). Be careful out there...

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