The stock market has had a strong run for the past seven days, with the DOW rallying just over 1000 points from low to high. By any measure we now have an overbought market, which makes bets on the long side a bit risky.
Today's Market Stats
With the DOW rallying 1000 points in seven days (SPX 127 points) we have an overbought market but that didn't bother the bulls today. A gap up to start the day was followed by more buying in the first 45 minutes but then the sellers hit hard. The selling had the indexes back in the red but then the buying started again and it lifted the indexes back up to near their morning highs (the RUT made new daily highs this afternoon). It looked like a bullish day but we're starting to see weakening momentum at the time when the leg up from September 29th looks close to completion. What follows this rally leg will provide an important clue for what the rest of the year might be like.
There were no major economic reports today to move the market and the morning floundered a bit before finding its legs and climbed back up. Other than the usual concerns about China it's been quiet overseas. The market is ignoring news about Syria and other problems that are having more of a negative impact on Europe than the U.S., which left the bulls with little interference in moving the ball. The DOW has now had its best winning streak since July (SPX missed the same accomplishment with a minor down day on Tuesday). I think most would agree that we're now looking for at least a pullback correction before continuing higher. Unless of course we're at the beginning of a blow-off move to a final top this year. I don't see that happening but this market has fooled me a time or two before (wink).
On the SPX weekly chart below you can see the double bottom with the August and September lows, both near price-level support at 1885, and a turn up in the oscillators (with MACD crossing to the upside). From a bullish perspective there's a lot to like on this chart since a double bottom with bullish divergence (on RSI) is a good reason to buy the "dip" in an uptrend. But are we in an uptrend? The correct answer to that question determines whether we should be looking to buy the dip or sell the rip. In my opinion we've already seen the final high and the sharp decline from July will be followed by another one, which makes the price consolidation since August a bearish continuation pattern. The more immediate question is how high the bounce might get before turning back down. From a weekly perspective I see upside potential in the 2040-2060 area, which would be a back-test of price-level S/R near 2040, the bottom of the up-channel from October 2011, near 2055, and a test of the broken 50-week MA, currently near 2059. As for downside potential, two equal legs down from July, if it drops from here, points to 1733, which would also be a test of the February 2014 low and the uptrend line from March 2009 - October 2011 (arithmetic price scale).
S&P 500, SPX, Weekly chart
In addition to the upside targets mentioned with the weekly chart above, the daily chart below shows the 200-dma currently near 2062 but coming down, so the upper target mentioned above, at 2060, would likely be very strong resistance. But there are some lower targets that could mean SPX will not even come close to the 2040-2060 target zone. I'm looking at the bounce off the August low as an a-b-c bounce correction to the July-August decline, which will be followed by another leg down. Two equal legs up from August, counting the leg up into the August 28th high as the 1st leg, points to 1998, which was achieved today. SPX also back-tested its 50-dma today, near 1996, and the bearish setup is for the start of the next leg down from here. But there is one other higher target for the 2nd leg of the bounce off the August low -- if I look at the move up from August into the September 17th high as the 1st leg of the bounce then the 2nd leg up projects to almost 2026 for equality. That remains upside potential until and unless SPX first drops below Tuesday's low at 1972, which would indicate the bounce has likely finished. Keeping it simple, I'd say bullish above the 50-dma, near 1996, bearish below.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2000
- bearish below 1871
Assuming we're only looking for an a-b-c bounce correction off the August low, the c-wave is the move up from September 29th and it needs to be a 5-wave move. On the 60-min chart below I've labeled the moves and I'm counting the 5th wave as the leg up from Tuesday's low. It projects to 2027 where it would equal the 1st wave. Note the correlation with the projection near 2026 for two equal legs up from August. The one caution about the upside projection for the 5th wave is that it's untrustworthy because many times it truncates and finishes early. In other words the rally could complete at any time and trap bulls who are buying into the expectation that the rally is breaking out to the upside.
S&P 500, SPX, 60-min chart
The DOW has the same pattern as SPX and the comments for SPX apply to the DOW. The pattern for the a-b-c bounce off the August low can be considered complete at any time and therefore betting on further upside is risky. But there is some additional upside potential to make it at least short-term risky for bears as well. There's price-level S/R near 17050 (December 2014 low at 17067 and Feb 2015 low at 17037) and then the top of a parallel up-channel for the bounce from August, currently near 17320.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,100
- bearish below 15,942
NDX has been struggling just beneath its price-level S/R line near 4345, as well as its broken uptrend line from 2012-2013-2014, currently near 4325 (arithmetic price scale). Only slightly higher and coming down is its broken 50-dma, currently near 4350. Yesterday and today it bounced off its 20-dma, currently near 4278 and climbing. It's looking like it will be a battle between the 20- and 50-dma's before we see which direction will be chosen. However, as with the discussion about SPX, it's looking like we should expect at most one more small rally before turning back down. A rally above the 50-dma could make it up to its 200-dma, near 4385, but probably not much, if any, higher.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4345
- bearish below 4119
Unlike the other indexes, the RUT had made new lows into its September 29th low, which was a test of price-level S/R near 1080, and therefore two equal legs up for its bounce off the August low, which points to 1168, would have it stopping short of its September 17th high at 1194. Near the projection for two equal legs up is its broken 50-dma, now near 1166 but coming down, and its downtrend line from June, near 1167. It's bullish above 1152 but I wouldn't press my luck if it gets up near 1168.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1152
- bearish below 1080
Looking to the bigger stock index, the NYSE Composite index, it's relatively easy to see the 3-wave bounce off the August low. Two equal legs for the a-b-c bounce points to 10312, only 28 points above today's high. But as you can see on its chart below, it has now run into its broken 50-dma, near 10266 (probably down near 10260 tomorrow), and the bears could set up an attack here. Not much above the 10312 projection is price-level resistance at 10387 (the 2007 high) so there's some upside potential but this is a risky spot to try a long play. The bigger pattern calls for a strong decline to follow the completion of the a-b-c bounce.
NYSE Composite index, NYA, Daily chart
Looking to the bond market for clues, it hasn't been much help lately. If the stock market is rallying I like to see the bond market selling (to help provide liquidity for the stock market). When the stock market sells off we often see that money rotating into the relative safety of bonds. The August 24th low for stocks was a high for bond prices, as can be seen on the TLT daily chart below. The September 17th high for stocks was a low for TLT. But since the September 29th low for stocks and the strong rally since then, TLT has essentially chopped sideways. In other words we're not seeing the typical support from a selloff in the bond market. In fact I think TLT has a good chance of continuing higher here after pulling back to its 50-dma for support yesterday and today. A continuation of the rally in bonds would likely put some pressure on the stock market, right at a time when I see the stock market bounce coming to an end.
20+ Year Treasury ETF, TLT, Daily chart
I usually show the weekly chart for the U.S. dollar since it gives a better longer-term perspective but tonight I'm using the daily chart to show the shorter-term picture and what to watch for. Since its March high I've been looking for the dollar to consolidate this year before heading higher next year. The large consolidation pattern looks like a shallow descending wedge, the top of which is currently near 97.30. There is a small rising wedge pattern for the bounce off the August 24th low, the top of which will cross the top of the descending wedge near 97.15 around October 20th. A rally up to that level and a reversal back down would be a good setup to see the dollar drop back down to the bottom of the descending wedge, near 91.75 in early December. That would then be a good setup for the start of a stronger rally in the dollar.
U.S. Dollar contract, DX, Daily chart
While the dollar has been consolidating in a shallow descending wedge, gold has also been working its way slowly lower, showing it doesn't trade counter to the dollar. Gold's decline has been reflecting the deflationary environment we've been in (and will continue to be in as the huge debt bubble is deflated) and I don't think we've seen the bottom for gold yet. We could see a larger bounce, perhaps up to 1195 for two equal legs up from the July 24th low, but at the moment gold is fighting its downtrend line from January, where it closed today at 1145. This is also only 3 points above price-level resistance near 1142. If it manages to push higher from here it will then run into resistance near 1180 where it would hit its 50-week MA and its longer-term downtrend line from October 2012. MACD has worked its way back up to the zero line from the low in July and a rollover from there would be a sell signal.
Gold continuous contract, GC, Weekly chart
Silver has been a little more bullish than gold this week and unlike gold it has popped above its August 21st high and made it up to its 50-week MA at 16.05 (today's high was 16.09 and it closed at 16.06). As can be seen on its daily chart below, it also reached its 200-dma at 15.97 and the trend line along the highs from September 3rd (it has formed an expanding triangle off its August 26th low). A price projection at 15.88, for two equal legs up from August, was also achieved. A downtrend line from July 2014 - May 2015 crosses the top of its expanding triangle pattern on Monday near 16.15 so it would be more bullish above that level but for now it's facing what could be stiff resistance to any further gains.
Silver continuous contract, SI, Daily chart
As with the dollar, I've been discussing the idea for a long sideways consolidation for oil before heading lower. A big sideways triangle is the pattern I'm thinking we'll see, which calls for 3-wave moves up and down for many months to come, but it's too early in the pattern to be sure how that will play out. For now it looks like oil should head higher following its month-long consolidation following its August 31st high. The triangle consolidation pattern fits well as the b-wave in an a-b-c move up from August 24th. Two equal legs up from that low points to 55.55 although it could run into trouble at its 200-dma, near 51, which would also be where the 2nd leg of its bounce would achieve 62% of the 1st leg up (a minimum expectation). It would turn more immediately bearish if it drops back below last Friday's low at 43.97.
Oil continuous contract, CL, Daily chart
Thursday and Friday continue the slow economic reports for this week. We'll get the FOMC minutes tomorrow afternoon but there should be no surprises for the market.
Economic reports and Summary
The price pattern got a little funky today but it's looking like we should expect only a little more upside before heading back down in a strong decline. I'm waiting for the completion of the 5th wave in the move up from September 29th, which would then complete an a-b-c bounce off the August low. That bounce fits best as a correction to the July-August decline and therefore should be setting up a very good opportunity to get short for another leg down. As mentioned for SPX, we could be looking at a 260-point drop, which would obviously be a nice trade. That's also the risk if you decide you want to hold onto a long position so be careful with your risk management.
Some cycle studies and comparisons of the price pattern since July to previous market crashes, including 1929 and 1987, suggest the market is vulnerable here. There's no guarantee of a strong decline to follow the bounce off the August low but I would say the odds favor the bears here and the coming decline, if we get it, could make the July-August decline look small. I mention this only to make you aware of the vulnerability. Upside potential is dwarfed by downside risk and I just don't see the value in holding long positions, such as in your 401(k). Go to cash, stay safe for the rest of the year or at least into November/December when we'll see if the coast is clear.
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