The psychological level for SPX, at 2000, was defended on Tuesday with a last-minute bump back up to close at 2000.02. Today's little bump back up into the green at the close added a dime to that and closed at 2000.12. Don't go and spend all that extra profit in one place!

Wednesday's Market Stats

The overnight trading range was very narrow (ES traded in a 2.50-point range until opening it dropped a point lower in the pre-market session) and the day mirrored the overnight session. SPX traded in about a 5-point range before it dropped a point lower in the late afternoon before getting the save into the close. Trading volume was practically non-existent. And the volume will likely decline further as we near the holiday weekend.

There were no geopolitical events to move the market and there were no important economic or central bank reports to move them either. In other words there's not much to report on as far as what might have served as a catalyst for a market move. Consequently the market didn't move.

Before jumping into tonight's charts I wanted to talk a little bit about sentiment. As usual, as the indexes have made new highs we've heard many market pundits come out of the woodwork to proclaim how bullish the market is and how the bull market will continue for another 5 years and why SPX 2500 is practically a foregone conclusion before the end of the year (or whatever number they're arguing about). We heard none of these forecasts when the stock market tanked in July. Looking at the market from an EW (Elliott Wave) perspective it's a little easier to understand this sentiment shift.

As you know, I use EW patterns to help judge where we are in a move. Like all other technical tools it's subject to interpretation but one thing I like about it is that I know when an expected move gets negated and that actually further clarifies the picture. It's nice when price follows an expected pattern, especially when in a trade that's making money because the market is moving as expected, but when the wave count transitions from one wave count to another it's just as helpful. The use of other technical tools, such as trend lines/channels, oscillators and Fibs can help support or call into question wave counts and that's an important part of the analysis. What you see on my charts are always my best guesses at the time but obviously price is king and I have to respond to it and not what I think it should do instead.

One important component of wave analysis is the use of sentiment. Each wave has its own "personality." I'll use a rally as an example. At the conclusion of a decline, the rally starts with the 1st wave (duh) and it's a wave that most traders don't believe in. The decline has most traders believing in a down trend and the 1st wave is thought to be just a correction to the decline. Bears eagerly short it and longs are not buying it because they're sure more lows are coming.

Once the 1st wave completes we get a 2nd wave pullback, which is typically a sharp pullback correction, and the trend followers jump on the decline with full expectation that new lows are coming. The 2nd wave is the one that captures many traders going the wrong way and then when it completes, at a higher low, we'll see the start of the 3rd wave up. Bears keep thinking it's just another bounce correction and they keep shorting it. Longs are fearful of a further decline and they use bounces to exit positions.

When the 2nd wave pullback finishes and the 3rd wave starts back up, especially when we get into the middle of the 3rd wave, traders begin to recognize that the trend has in fact changed. Shorts start aggressively covering and longs start getting back in and the combination produces a strong move (the 3rd wave is typically the strongest of a 5-wave move). The 3rd wave is the most profitable wave to trade and the key is to identify when it's setting up.

At the completion of the 3rd wave we get a 4th wave correction, which is typically a slow choppy sideways pullback, the opposite of a sharp 2nd wave pullback (and is referred to as the "rule of alternation" between 2nd and 4th waves). The 4th wave chop is where a lot of traders give back profits made during the 3rd wave. You want to avoid trading a 4th wave and obviously the key is to identify when it should start and finish.

Finally the 4th wave finishes and we get the 5th wave up to a new high. This is the wave of complacency. This is when trend followers are fully on board -- shorts are out and longs are all in. Market pundits are out in force projecting the continuation of the uptrend forever and much higher. Bullish sentiment goes to new highs while technical indicators show the move to new highs is accompanied by weaker market breadth and waning momentum. Just at a time when everyone believes in the trend they should instead be getting ready for a significant reversal. Care to guess which wave we're currently in? And we've got 5th waves at multiple degrees of the trend, which indicates we've got more than a significant reversal coming. Starting with the SPX weekly chart I'll show you what I mean.

Off to the left of the SPX weekly chart below is the start of a 5-wave rally from October 2011. The chart picks up this wave count with the wave-2 low in June 2012 and the start of the 3rd wave, which itself will be a 5-wave move. The 5-wave move up to December 2013 completed the 3rd wave and that was then followed by the 4th wave pullback into February. From February is the 5th wave, which again needs to be a 5-wave move, and once complete it will complete the larger-degree 5th wave.

S&P 500, SPX, Weekly chart

At the same time SPX looks to be completing the 5th of the 5th wave it's again tagging the trend line along the highs from April 2010 - May 2011, currently near 2002 (today's high). For the wave count on the weekly chart, the completion of the rally from August 7th will be the completion of the rally from October 2011, which in turn will complete the rally from March 2009. It will be an important high and it's occurring just when the most traders and market pundits are turning uber-bullish. Most are turning more bullish at a time when the rally is actually quite weak (see the bearish divergence on MACD and RSI) and this helps interpret the wave count as the 5th wave (both the comparative weakness and the uber-bullishness).

The daily chart below looks closer at the 5-wave move up from February. Again, like the weekly chart, the 1st wave of this move is off the left side of the chart and we pick it up with the 2nd wave pullback in April. The little squiggles in April-May and then again in June-July make it difficult to count but at the time of the July high it was looking good for the final high, especially with the impulsive decline into the August 7th low. But this was another example of a 4th wave "gotcha" and the 4th wave turned out to be a larger correction that started off the July 3rd high and the sharp decline from July 24th was actually the conclusion to the 4th wave.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 2007
- bearish below 1960

We've been in the 5th wave since the August 7th low and while the straight-up rally looks very bullish it's actually showing less strength by many internal breadth measures. If it rolls over near here we're also going to see confirming bearish divergence against the July highs (which is typical for a 5th wave compared to the stronger 3rd wave). As you can see more clearly on the daily chart, price has stalled at the trend line from April 2010 - May 2011 with yesterday's small shooting star and today's little doji. I consider it very high risk at this point to be long while recognizing there's a little more upside potential into early next week, as shown on the 60-min chart below.

The 60-min chart below focuses on the 5th of the 5th of the 5th wave. We've got a larger-degree 5th wave up from February (weekly chart), which needs to be a 5-wave move. The 5th wave of the rally from February is the leg up from August 7th, which also needs to be a 5-wave move. Once the final 5th wave finishes we'll then have a completed rally. Simple, no? If only, but it does identify where and when to expect the completion of the rally and even if it does something different from what's expected it actually helps clarify a better wave count.

As I've labeled the move up from August 7th, we should be ready for the final 5th wave. There's a way to consider Tuesday's high the final high but I'm waiting for price to tell me rather than just guess. One early signal from SPX that the final high is already in place would be a drop below 1989 and a break below its parallel up-channel shown on the chart. We could see SPX drop a little lower Thursday morning before heading up or just start up immediately Thursday morning since this week's consolidation continues to support the idea that we'll get another rally leg.

S&P 500, SPX, 60-min chart

If this afternoon's low completed the pullback correction off Tuesday morning's high, the upside projections for the 5th wave are 2021 (62% of the 1st wave) and then 2036 (equal to 1st wave). The higher projection crosses the top of the up-channel at the end of the day September 3rd. If SPX drops to about 1991 Thursday morning and then heads higher in the 5th wave we'll have upside projections near 2016 and 2031. We've now entered an important turn window based on cycle turn dates, the end of which is September 4th but from a time perspective we could see an important high at any time in the coming week. One other price level to keep an eye on, if reached, is 2015, which is the 127% Fib extension of the previous decline and is commonly associated with reversals.

The reason I have the key level to the upside as 2007 on the daily chart has to do with the Gann Square of Nine chart. The chart below shows the middle vertical section of this chart in order to highlight, in yellow, the important price levels. As noted at the top, the October 2002 low at 768, the April 2012 high at 1422 and the October 2007 high were on the same red vector, which shows prices that vibrate off each other (in Gann's language). Gann believed in a strong relationship between time and price, giving time more importance than price. Not seen off the left of the Gann Sof9 chart is the red vector that's 90 degrees to the one through the above price levels -- it points to the dates for the October 2002 low, October 2007 high, October 2011 low and October 2012 high.

Gann Square of Nine chart

Now 180 degrees to the above prices is the highlighted 1998 at the bottom, which I thought had a good chance of being a final high. But since 1998 was exceeded (although only one day on a closing basis so far -- yesterday's) the next highlighted level at 2007 is another possibility. It's 180 degrees from the March 2009 low at 666, which makes it particularly interesting since the 2009-2014 bull market could be capped on both ends on the same vector on the Gann Sof9 chart.

Many see an improving economy as a reason to expect the stock market to continue rallying but in fact we've been getting a lot of misinformation from the government and Fed in hopes of keeping consumers and investors happy and spending. For example, the +288K jobs that were added in June -- that's a strong number and sounds great. Too bad the number came only from a net gain of part-time jobs. Full-time jobs were cut by 523K while part-time jobs increased by 800K. The net result are more jobs but lower paying, which lowers the discretionary spending by consumers, which in turn is a drag on our economy.

And the effort to keep investors bullish is working -- Jim mentioned in last Saturday's market wrap that there's been a huge influx of money into equity funds and into high-yield (junk) bonds (the largest inflow for 2014 so far). Risk-on is back in style, which is backed by the latest AAII Investor Survey, showing 46.1% of retail investors are bullish, the highest level of the year. Keep in mind what I said about sentiment in 5th waves. And it's all coming together with an EW count that suggests trouble directly ahead.

The DOW has been struggling with its July high at 17151 (broken marginally on Tuesday but so far it has been able to close above its July 16th closing high at 17138) and its trend line along the highs from May-November 2013. The DOW played around this trend line for about 6 weeks in June-July but finally broke hard below it in late July. It's now back up to it for what could be a bearish back-test to be followed by a kiss goodbye. That's the potential I show on the chart but if it rallies with SPX into early next week we could see the DOW up to the 17300 area before it tops out (to leave a head-fake break above its July high).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 17,150
- bearish below 16,985

NDX has been trying to get above two intersecting trend lines since early last week and while marginally above them I'd say the price pattern in the past week looks more like an ending pattern than something more bullish. One trend line is along the highs from March-July and is currently near 4065.50. The other is a broken uptrend line from June 2013 - February 2014 and both intersect on Thursday near 4068. Bullishly, the lines are currently acting as support so if we get another rally leg into early next week we'll surely see NDX do the same.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4075
- bearish below 3985

The RUT has been the laggard in this month's rally and it even got a head start by bottoming on August 1st. But so far it's only been able to retrace a little over 62% of its July decline and in fact closed on it today (1172.97, with a closing price at 1172.71). The RUT has seen a few major reversals around the 1st of the month, including the February low, March high, July high and August low. The timing is good for setting up another major reversal on or around September 1st (September 2nd is the first trading day of the month).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1173
- bearish below 1148

Bond yields continue to fall and not just in the U.S. as many of the European bond prices continue to rise in anticipation of more stimulus (bond purchases) by the ECB. Most feel that Mario Draghi will soon be forced to either eat or back up his words to do "whatever it takes." Europe is a stone's throw away from entering a deflationary cycle and while Central Banks think they can stop the process, and Draghi will certainly try, they're just along for the ride as well. The German 10-year bund fell to a record-low 0.909% today while Spain's 10-year yield dropped to 2.083%. There are certainly no worries about inflation.

The U.S. 10-year yield (TNX) remains relatively strong by comparison (less demand for the bonds, some of which is the Fed's reduced purchases) but it remains below resistance near 2.46%. The potential is for a sharp move lower that breaks down below its parallel down-channel from December 2013, the bottom of which is currently near 2.26% but I suspect once fears of deflation in the U.S., which I believe is coming, starts to become more of a concern we'll see the same interest in bonds, especially if the stock market starts to take a more significant tumble.

10-year Yield, TNX, Weekly chart

What's interesting about the current declining yields is that it's keeping investors feeling bullish about the stock market. Most bear markets have started after yields have been rising in response to an overheating economy. The declining yield scenario is therefore keeping investors complacent about what's happening this time. No matter how hard the Fed and other central banks have tried, they have not been able to stimulate the economy enough to get inflation going. This time, for the first time since WWII, we're facing a deflationary event and that has yields dropping. Deflation is bad for stocks but the stock market doesn't believe in deflation yet because the Fed keeps assuring us that everything is under control (cough).

The current deflationary period has been brought to us by far too much credit expansion and debt. The destruction of debt (paying it down or through bankruptcy), which has been happening in fits and starts since 2000, is deflationary. Interestingly, the Fed is on course to stop their QE stimulus program just at a time when they should be ramping up stimulus. But once again they'll prove to us that they really don't have a clue about what's happening in the real world, which is far different than what their books tell them.

Last week I showed the BKX index and pointed out the sideways triangle pattern that it's been in since its March high. I can view it as a bullish continuation pattern following the rally into it but I want to see BKX exceed its July 3rd high at 72.55 before turning at least short-term bullish the index. I had mentioned the 78.6% retracement and to watch for a small throw-over above it like it did into its July high. At the moment it's looking like we also might have had a brief throw-over above the top of the triangle (downtrend line from March-July) yesterday, which has been followed by a red candle today. If this is a failed breakout attempt and the bullish pattern is going to fail instead, it will likely fail hard and the bearish wave count suggests a very strong 3rd of a 3rd wave down will be next (the "recognition" wave). The next several days for BKX are going to be important.

KBW Bank index, BKX, Daily chart

At its August 21st high, the TRAN made it back up to its trend line along the highs from April 2010 - July 2011, which it had briefly climbed above when it made its high at 8515 on July 23rd. Its August 21st high, at 8482, was only slightly lower and so far fits as a retest of its July high (like the DOW) as well as its trend line along the highs. In the meantime the bearish divergence on the oscillators is glaring and the retest/back-test is a very good time to be thinking short. I see the potential for another pop up to the trend line, near 8530 early next week but I think resistance will hold.

Transportation Index, TRAN, Daily chart

The U.S. Dollar rallied strong while the Euro declined. Mario Draghi mentioned he'd like to see the Euro drop in value so that it will help the European economy. That kind of talk only inspires other countries to devalue their currency as well and it will again be a race for the bottom. Geopolitical (Russia and its satellite countries), economic and currency devaluations -- it's all eerily reminiscent of history (leading up to WWII). At any rate, the dollar spiked up after finally breaking free of the top of its trading range at 81.50 and hit a high of 82.75 last night before pulling back today. It could charge up to its downtrend line from June 2010, currently near 83.40, but if it does pull back we should see support now near 81.50.

U.S. Dollar contract, DX, Weekly chart

Following gold's strong decline last week it's been trying to get a bounce off support, which is its uptrend line from December 2013 - June 2014, currently near 1274. It's taking a while but I'm still looking for gold to bounce up to the top of its sideways triangle, near 1350 next month, before setting up a stronger decline into the end of the year.

Gold continuous contract, GC, Weekly chart

Following oil's steep decline last week it's been consolidating in a choppy sideways/up bounce, which is corrective and points lower once the correction completes. I suspect we'll see stronger support at 91-92 and maybe a bounce back up to its broken uptrend line from June 2012 for a back-test but for now oil looks more bearish than bullish and potentially strongly bearish if we've got a 3rd wave, as labeled on its weekly chart, ahead of us.

Oil continuous contract, CL, Weekly chart

Thursday will be a little busier for economic reports with the 2nd revision for GDP being one of the more influential reports. The number is not expected to change so there could be a jump in the futures if the number is a surprise. One thing helping GDP is inventory builds, which is not necessarily a good thing. China building an inventory of uninhabited cities might keep workers busy but eventually buyers are needed. I consider inventory builds one of the riskier parts of GDP because it can be stopped and reversed quickly if businesses get a whiff of trouble in the sales department.

After the opening bell we'll get Pending Home Sales, which are expected to improve from June's -1.1% to +0.5%. But if sales are down and confirm Monday's report of slowing new home sales there could be more trouble in paradise. New homes are being built almost twice as fast as they're being sold, which has increased inventory to a 6-month supply, the highest it's been since late-2011 (kind of like the inventory build that's considered a good thing for GDP). Build it and they will come might not be working so well right now.

Economic reports and Summary

From an EW perspective I'd like to see one more rally leg into early next week to do a nice job completing the wave count. SPX 2015-2030 would be the upside target zone, which I'll be able to zero in on a little closer as the 5th wave develops (assuming we'll get the final little 5th wave in the move up from August 7th). Look for an important high any time between now and September 4th.

There are some indicators, trend lines and price patterns for some of the indexes that suggest we could see a final high sooner rather than later and therefore I consider the risk to be on the upside. There's very little reward to the upside vs. huge downside risk. The marginal new highs this month vs. last month have actually done a better job in showing a cleaner wave pattern that now strongly suggests an endgame in sight. The trend is still up and therefore bears have to be extremely careful trying to catch rising knives. A conservative method to get short will be to wait for confirmation of a high, such as breaking uptrend lines/up-channels, and then short the subsequent bounce to lower highs. We'll have plenty of opportunities on the short side in the coming year and there's no need to rush entries. Both sides should be very careful in the coming week.

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