With the Fed mostly out of the QE picture (for now) all eyes and ears are on the ECB to see how much QE they'll launch. A leak of information this morning about what the ECB will do may have been a test of the market's reaction.
Wednesday's Market Stats
Equity futures had declined during the overnight session and the cash market gapped down to start the trading day. And then 5 minutes after the open there was a "leak" of information that supposedly came from two ECB officials that outlined some of the ECB's purchase program. The reaction from the market was immediate, blasting SPX 17 points higher in the next 5 minutes before pulling back and then continuing higher later in the morning. Was the leak intentional to gauge the reaction of the market? Will the somewhat subdued reaction give the ECB a reason to make the program bigger and better (to juice the market higher)?
There were many questions following the leaked information and one was "why so small?" Expectations have been for the ECB to launch a "shock and awe" program to purchase at least 1.0-1.2 trillion Euros in the coming year. This would mean about 100 billion per month but the leaked information was half that -- about 50 billion per month. Many traders are already feeling the actions of the central banks are not doing enough and if the ECB does in fact announce a program that buys "only" 50 billion Euros a month we could see a sell-the-news reaction. But if the ECB got the information they were looking from this morning's subdued response perhaps they'll bump up that number in their announcement (just a guess on my part).
In addition to the quantity of purchases by the ECB there is great interest to hear what kinds of purchases will be made. Many expect the ECB to announce their intention to start buying sovereign debt so if they instead announce an intention to continue buying only corporate bonds and asset-backed securities (ABS) the market would likely react negatively. The market wants (needs) to hear 100 billion Euros per month for at least a year and that the program will include purchasing sovereign debt as well.
As I'll review with the charts, it's looking like the market is set up to react positively to tomorrow morning's ECB announcement but that it will not hold and the spike up could be quickly followed by a strong selloff.
We only had a couple of economic reports this morning, which included Housing Starts and Building Permits. The numbers were mixed, showing strength in the number of homes that were started but weakness in the number of new building permits, especially for multi-family units. Home builders are not feeling as confident about the future and that's been reflected in the stock prices of the builders. The report from the Mortgage Bankers Association showed applications for mortgages declined by 3% last week but that follows a +24% increase in the week before that.
One negative that the housing market is fighting is household formations. Between lower earnings and higher debt there are many people, especially young college grads, who have not been able to qualify for loans. Household formation is currently running about 500K per year, which is about half the number of homes being built. That's a recipe for excess inventory so the number of new building permits as we head into the spring will be an important metric to watch. In order to show a healthy and sustainable housing market, to help the broader economy, we need to see closer to 1 million household formations per year.
Overall it was a relatively quiet day as the market continues to consolidate. Prices have been more volatile this month but the price swings have been dampening out as the market traded essentially sideways since November. On the first trading day of November SPX was trading near 2020 and today it closed at 2032. It's been a wild ride from then to now but all it's done is churn traders' accounts. I think once we get through the ECB announcement we should get a move out of the recent trading range.
Starting tonight's chart review with a look at the SPX weekly chart, there is the potential for a bullish breakout following the whippy sideways consolidation since the December 5th high. The upside target in that case would be the top of its parallel up-channel from October 2011, which will be near 2130 by mid-February. If we get a euphoric reaction to the ECB announcement that gets some follow through it would push this bullish possibility to the top of the list. But at the moment I see a lower probability for the bullish scenario. The consolidation also fits as topping action, something we've seen many times before at important highs (even if only trading highs). This can be seen at the previous highs on the chart. A drop below last Friday's low near 1988 could usher in stronger selling.
S&P 500, SPX, Weekly chart
There is one bullish pattern that suggests a breakdown below last Friday's low near 1988 could be a bear trap. The daily chart below shows a possible descending wedge pattern off the December 29th high and it only needs one more leg down to complete it. To turn SPX more bearing I think we need to see a drop below the 200-dma, near 1968, to confirm the decline is real. Otherwise we could stay trapped for a little longer in a choppy and whippy consolidation pattern. The bulls need to see a rally above the 20- and 50-dma's, at 2045-2046, which would be confirmed bullish above 2072. Mind the chop inside the triangle/wedge.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2072
- bearish below 1963
Supporting the idea that SPX would be more bullish above 2045 is a rising wedge pattern off last Friday's low, as shown on the 30-min chart below. This pattern assumes we will get a positive reaction to the ECB announcement but then disappointment will follow. The rising wedge pattern needs another push higher to complete the 5-wave move up from last Friday and 2045-2050 is the upside target, which surrounds the 20- and 50-dma's on the daily chart. If this bearish pattern is the correct interpretation we're going to see a fast retracement back down to last Friday's low (1988), bounce and then continue lower (unless the bullish descending wedge on the daily chart is the overriding pattern). What these multiple patterns tell me is that Thursday's move (if not Thursday morning's move) could be a head fake and therefore a review of the charts Thursday night is going to be very important.
S&P 500, SPX, 30-min chart
It's no different for the DOW, which remains inside a possible descending triangle, having bounced off the bottom of it last week, near 17260. The top of the triangle, which is the downtrend line from December 26th, will be near 17800 Thursday morning. It could remain a choppy whippy mess inside this pattern so traders might do better by waiting for a break. The one caution about the upside is that we could get a head-fake break that finishes a flat a-b-c correction off the January 6th low with a test of the January 13th high at 17923 and then a strong decline to follow that. I think a breakdown would have a better chance of follow through for a trader to participate in.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 18,000
- bearish below 17,000
On the NDX chart below I'm showing the same descending triangle as the DOW's. We have consistent patterns across many of the indexes and as the consolidation patterns tighten we can expect a strong move out of them. These triangle consolidation patterns that follow a rally are typically bullish so bears need to watch this carefully for any signs of bullishness. You don't want to be on the short side if this is getting ready to blow out the top. The flip side of the coin is that the consolidation pattern also fits as a topping pattern and a breakdown could catch a lot of traders leaning to the long side. That's a reason why a failed bullish pattern tends to fail hard and that's the outcome I expect to see here. Just keep control of risk management either way.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4230
- bearish below 4089
The RUT was the weaker index today and one of the few to close in the red. It could be in the same kind of descending triangle as the others but it's a bit sloppier. Multiple 3-wave moves since December make it difficult to figure out the next higher-probability move. I don't see the RUT leading in either direction yet but when these consolidation patterns break I suspect the RUT will be out in front of the next move.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1217
- bearish below 1150
Last week I showed the VIX chart to point out the rally up to its downtrend line from October-December 2014. I thought it could turn back down from resistance and help warn the bears to back off on the short side. Sure enough, the VIX has pulled back as the stock market bounced but now it's approaching its uptrend line from December, which crosses its 20-dma near 18.20 on Thursday. This trend line held on the pullback into the January 9th low (bounce high for the stock market) and now it's a warning sign for bulls while we wait to see if the VIX holds support here.
Volatility index, VIX, Daily chart
The banking index, BKX, could soon provide an important clue if the bounce off last Friday's low is followed by another new low. As shown on its daily chart below, a new low would give us a clean impulsive 5-wave move down from December 29th. The small bounce off last Friday's low looks corrective and fits as the 4th wave, which should be followed by another new low for the 5th wave. A good downside projection for it is the trend line along the lows from May-October 2014, which will be near 64.25 by the end of the month. At that point it would be a good setup for at least a larger bounce correction, maybe something more. If the 5-wave move down is a larger-degree 1st wave in what will become a much larger decline, we'll get just a 2nd wave bounce correction in February and then strongly down after that. But if the 5-wave decline is the completion of a larger a-b-c pullback from September (as an expanded flat correction with the higher high in December) then we'll get a stronger rally to follow the new low. How the bounce plays out (assuming of course we'll get one after a new low) will provide further clues as to what the larger pattern will likely be.
KBW Bank index, BKX, Daily chart
This week's new high for the U.S. dollar is showing some bearish divergence against the highs earlier in the month, hinting of at least a pullback coming. I continue to like the reversal setup for the dollar after it hit the top of its parallel up-channel from 2008-2011, near 93.30 (with last Friday's brief high at 93.56 and Tuesday's closing high at 93.38). The dollar would be more bullish above 94, with 97 as an upside target, but at the moment I think there's a good chance we'll see the dollar start at least a multi-month pullback/correction before pressing higher.
U.S. Dollar contract, DX, Weekly chart
Gold bounced back up to important Fibs yesterday and today -- shown on the daily chart below is the 50% retracement of its 2008-2011, at 1302.35. Not shown on the chart is the 38% retracement of its 2001-2011 rally, near 1287, and the 78.6% retracement of the previous decline from July, which is near 1300. Gold tends to trade well around its Fibs and with a Fib resistance zone at 1287-1302 it's tough resistance. This morning's brief high at 1307 was followed by a sharp (impulsive) decline, closing near 1293, and that left a shooting star for today's candle. If the gold bulls can push it a little higher there's a downtrend line from August 2013 near 1330.
Gold continuous contract, GC, Daily chart
Gold's rally off the January 2nd low has been strong and sharp, which fits well as the c-wave of an a-b-c bounce correction off the November low and while it has turned just about everyone bullish on gold I think it will be another bull trap (similar to the one following the "breakout" back in August 2012). If we get a multi-week consolidation and then another press higher I'll turn more bullish but right now this looks more like the completion of a bounce correction than something more bullish. I continue to believe gold will drop to the 1000 area before potentially putting in a longer-term bottom.
Gold's strong rally the past three days was likely in response to an expectation the ECB is going to join the crowd of central banks that are racing each other to the bottom by printing more and more money and seeing who can debase their currency the fastest. That's what makes gold more valuable. In fact when gold is priced in Euros it looks stronger than when priced in U.S. dollars. This morning's leak about what the ECB will do seems to have deflated the gold bugs' expectations and that could be hinting that both gold and the stock market might not be all that happy with the ECB's less-than-expected purchase program. That can only be guessed but that's the hint I see from the chart.
With this morning's brief high at 18.50, silver's bounce off the December 1st low came close to achieving two equal legs up at 18.71, to complete an a-b-c bounce correction off the December 1st low. The morning high was good enough to tag its 200-dma at 18.47 but it stopped 10 cents shy of price-level resistance at 18.60, a level I have been expecting silver to retest after it was broken in September 2014. As can be seen on its weekly chart below, 18.60 was a shelf of support since June 2013 and now it's back for a back-test and I'm waiting for the slap following a kiss goodbye. If the bulls can avoid getting slapped there's still upside potential to its downtrend line from April 2011, currently near 20.70, but the higher-odds setup here is for a reversal back down from support-turned-resistance.
Silver continuous contract, SI, Weekly chart
After hitting what I thought would be strong support near 44 oil has been trying to bounce but so far it's not very impressive. We could see a relatively small consolidation and then lower prices, in which case the January 2009 low at 33.20 would be the next downside target. But the bigger pattern calls for a multi-month choppy bounce/consolidation if we're to get a 4th wave correction in the decline from August 2013. The way the bounce has started (choppy overlapping highs and lows) it supports the larger corrective bounce idea, which is why I've been saying it's probably not a good trading environment other than maybe some sold puts below the lows (traders selling premium don't care if the market goes nowhere while the premium decays into their account).
Oil continuous contract, CL, Weekly chart
Thursday morning we'll get the usual unemployment claims data but nothing market moving. All eyes and ears will be on what the ECB announces in our pre-market session. The futures will be leading the way for the cash market. Whether the cash market will hold the initial direction is what's not clear.
Economic reports and Summary
"What's obvious in the market is obviously wrong." This is the quote that always bothers me when I see an "obvious" setup and right now that setup is a rising wedge pattern for the bounce off last Friday's low. It looks like a good setup for a new high for the bounce Thursday morning, where SPX will break its downtrend line from December and have it looking like a bullish breakout. But it will turn into a head-fake break (bull trap) that's then followed by a strong selloff (sell the news following the ECB announcement). This looks like an obvious setup to me and I'm looking at it as a good shorting opportunity. Now all I worry about is the setup being obviously wrong.
Trading is a game of probabilities, which is what differentiates traders from gamblers (although many traders are in fact gamblers). Put the probabilities in your favor, use appropriate risk management (stops and/or position sizing) and then let the market determine whether or not the trade will work. Most of us use charts for the trade setups and pick price levels that help define entries and exits and then let the trade either work or not. There is no right or wrong about the trade but the market is of course always right. We set up the trade, we execute and then let the market tell us when it's time to leave.
And the setup at the moment, for me, is to look for a morning bounce in the stock market and then short a rollover. Using the SPX setup as an example, the rising wedge and the 20- and 50-dma's coincide for a high in the 2045-2050 area, preferably at the lower end of that range. If the short trade works I'd ride it down to last Friday's low and then manage it closely from there. A review of Thursday's price action should help define how the next week will proceed.
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