The stock market has been rallying, or holding up, into this week with the expectation it will receive good news about the employment picture and more QE from the ECB. Today there was some nervousness about those expectations.

Today's Market Stats

The stock market's rally in the past week was hardly inspiring (except for the relative strength in the small caps), especially after the strong rally off the November 16th lows, but there's been a clear expectation for some help from the ECB and positive employment data. But today's selling showed investors getting a little nervous in front of Thursday's ECB announcement. The market is also a little uncertain about what the reaction will be to Friday's nonfarm payrolls (NFP) report. There are a lot of mixed economic signals for the Fed to contemplate and their upcoming decision on a rate hike is at best only a 50/50 guess for the market.

Today's decline completely reversed yesterday's gains and the week is slightly negative after today but it's the next two days that could significantly move the market. Bullish sentiment is very high, which means we have a lot of traders who are not going to be scared off by a decline, at least not initially. Dip buying, including today's, is probably on the mind of most traders. But various measures of trader sentiment show a reason for caution as we head into the end of the week.

There are many ways to gauge market sentiment and we have plenty of surveys that tell us what percentage of traders are bullish, neutral or bearish and these are typically played from a contrarian perspective. When too many become bullish, as is the current situation, the market can simply run out of buyers to keep propelling the market higher. Another "sentiment" gauge comes from watching how traders are using the Rydex funds, which have a selection of bullish and bearish funds, straight and leveraged. One fund, the Nova fund, is for traders who feel bullish about the market and it seeks to leverage the gains in the S&P 500 by 150%. As always, the leverage can work against a trader, which is why using leverage is a sign of bullish enthusiasm.

Looking at the Rydex Nova fund assets, shown on the chart below, you can see that it has now pushed above where it was at the November 3rd market high. A lower price high is met with higher total assets in the leveraged bullish fund and that should be a warning flag for over-eager bulls. In a market decline, even if it's to be just a pullback, the leveraged fund will feel the pain to a greater degree. Note also on the chart that RSI for Nova has reached a level (above 70) where previous market highs have been found. This begs the question about whether or not the market has priced in expectations for what the ECB and Fed will do with their monetary policies. Buy the rumor, sell the news? That's certainly one possibility here.

Rydex Nova fund vs. SPX, Weekly chart

There are plenty of ways to look at the underlying strength of the market and I've shown several recently to point out the disparity between what the indexes are doing (rallying) vs. what most of the stocks are doing (underperforming). When the market's indexes are rallying but the number of participating stocks is dwindling it's usually a good signal the bull run is coming to an end. The chart below shows the NYSE Summation index (NYSI), which is essentially a running total of the McClellan Oscillator, which measures advancing issues minus declining issues. Like other oscillators, you look for divergences between the peaks and valleys of each and we're currently seeing divergences at two different peaks.

You can see the deterioration in the NYSI since the market in March, which led to the strong breakdown in the market in August. The rally back up into the year's trading range (prior to the August decline) has been met with a lower high in the NYSI. And now the rally from November 16th, which has SPX knocking on the door to new highs, the NYSI is showing significant bearish divergence. SPX has rallied back up on the backs of fewer stocks, which is a strong indication it's a counter-trend rally and not the start of something more bullish.

NYSE Summation index vs. SPX, Daily chart

Interestingly, as bullish sentiment about the stock market hits extreme levels and the stock market shows weakening participation in the rally, there's another sentiment indicator that comes from the bond market. Back in 2007, as the stock market was searching for a high (with the same weakening signals as shown above), I was watching the TED spread, especially since there were so many concerns about the sub-prime mortgage problem (well, Bernanke wasn't worried about it since the problem would be "contained"). The TED spread measures the difference between the perceived safety of 3-month U.S. Treasuries and Eurodollars futures, which reflects concerns about the credit ratings of corporate borrowers.

We know corporations have been binge borrowing for the past several years, thanks to the uber-cheap borrowing rates. They've been using the money to buy back stocks and enable more M&A activity but now they're starting to struggle to make payments. With corporate earnings in decline it has put the squeeze on the companies' ability to service their debt. This is especially true in the energy-related fields and many of the miners. The worry over their ability to repay their loans is causing the TED spread to start widening again, as can be seen on the chart below. The rise has been starting to accelerate higher and is now higher than it's been since late-2011 following the market scare that year. This rate rise should be of great concern to the market.

TED Spread

Another way to look at concerns about risk is to look at the LIBOR (London Interbank Offered Rate) rate, which is basically the interest charged on money lent between banks. There was little concern about risk after recovering from the 2008-2009 market crash until this past year, which is when the rate started to rise. It's another indication banks are getting nervous about lending money even to other banks and are starting to demand a higher rate of return for what they feel are higher risks. Whether they're failing corporate loans, student loans or sub-prime auto loans (worse today than the sub-prime mortgage fiasco back in 2006-2007), there's a lot of debt out there that's not going to get paid back. The big question of course is what the banks are seeing amongst themselves that warrants increasing concern. These rates have a long way to go before they're even close to where they were back in 2005-2006 but it's the relative change (about 50% higher in the past year) and the accelerating rise, especially in the longer-dated maturities, that's worth watching.

LIBOR rates, 2012 - November 2015

The above charts are not meant to be trading signals but instead they tell you whether or not you can relax about the long side here or should instead be vigilant about controlling risk. The use of leverage is inadvisable in this current climate and liquidating some inventory and going to cash is, in my opinion, highly advisable. Selecting some shorting candidates (e.g., in relatively weak sectors but nearer their highs than lows) as a hedge, if not for speculation, would be a good exercise to go through.

As always, timing is everything in the stock market and your trading horizon will determine when you decide to get in and out of trade positions. The month of December is typically bullish, though it has its ups and downs, so one could easily argue it's too early to be thinking short. The chart below shows the average December and while the 2nd week is typically weak, it usually sets up the Santa Claus rally. This is of course not guaranteed and as I'll cover in tonight's charts, I could argue that this December will not be bullish. Or if we do get a Santa Claus rally it will start from much lower and lead only to a lower high. Notice too the relative strength in the RUT -- this is likely one reason why the RUT has seen relative strength in the past week. Traders are front-running the normally bullish month. But as with the rally into what could be significant news this week, have traders gotten ahead of themselves?

December trading pattern

I came across a good interview with Milton Berg, the CEO of MB Advisors, who did a good job summarizing the issues facing us in the stock market. He talks about some of the things mentioned above and I like the way he pulled some fundamental and technical analysis together: Milton Berg on Bloomberg

Moving on to the regular charts, the SPX weekly chart shows it has stalled for nearly six weeks now at trendline resistance, which includes the broken uptrend line from October 2011 - October 2014 and the top of a parallel up-channel for the rally from 2009, both of which cross near 2098. The big question is whether it's been consolidating beneath resistance as it tries to gather some strength to bust out to the upside, in which case I can see the potential for a rally up to the 2170 area before year-end. That would likely be a blow-off move with lots of bearish divergences as a result of a reaction to the Fed perhaps. But it's vulnerable here and a turn back down, which would likely be strong and fast, is clearly a risk that must be respected by the bulls.

S&P 500, SPX, Weekly chart

The daily chart below shows the cycling around the broken uptrend line from 2011-2014 in late October and into the November 3rd high and how it's been resistance since coming back up to it on November 20th. I show a projection on the chart at 2145.86, which is where the 5th wave of the move up from August would achieve equality with the 1st wave. This bullish wave count calls the November 16th low the start of the 5th wave. The bearish wave count says the November 16th high was the completion of a 3-wave bounce correction resulting in a lower high relative to the July high. The bounce off the November 16th low is to another lower high and a drop below 2065 would be a strong clue that no more new highs are coming.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 2117
- bearish below 2060

The choppy price action since November 20th could be a correction to the rally from November 16th, with today's sharp decline finishing the correction, and the bullish interpretation is that it will be followed by a strong rally, presumably in reaction to a bullish reaction to the ECB and maybe Friday's NFP report. A rally above this morning's high near 2104 would be a bullish move and short-term traders should abandon the short side if that happens. But if we get just a bounce correction to today's decline that's then followed by a drop below whatever low is found following today's decline, I would abandon the long side since the bearish interpretation of the pattern calls for a strong decline to follow, one that could quickly take SPX back down to at least the August low (1867) before the end of the month.

S&P 500, SPX, 60-min chart

The DOW has the same pattern as SPX and therefore the same setup -- bullish above this morning's high at 17901 (more bullish above its November 3rd high at 17978) and bearish below a projection near 17525 (below which I would have a difficult time interpreting the pullback pattern as bullish). It has been struggling with its broken uptrend line from October 2011 - October 2014 and its downtrend line from May-November, both of which cross today near 17900 and today's high. It could literally go either way from here and it's very likely going to be this week's news events that propel the move. Be careful of the whipsaws in between the key levels but follow the break of one of them.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 17,978
- bearish below 17,525

The techs were the stronger indexes this morning but the selling brought them back down and into the red and although the candles are small on the Nasdaq daily chart, one could argue the two bearish engulfing candlesticks this week (Monday and today) are telling us rallies are being used to sell into. The bearish divergences evident on the oscillators as the November 3rd highs are tested provide another warning. I see upside potential for the Nasdaq to the 5300 area but only if the market gets a strong positive reaction to this week's news. A drop below its November 24th low at 5050 would be a strong sign the top is already in place.

Nasdaq Composite, COMPQ, Daily chart

Key Levels for COMPQ:
- bullish above 5163
- bearish below 5050

The RUT has been the more bullish index since the November 16th low (after languishing for much of the bounce off the August low) and as mentioned earlier, it appears traders were front-running the expected December rally (playing the seasonal pattern). But like its big brothers, it has been struggling with its broken uptrend line from October 2011 - October 2014. In fact its struggle the past four trading days is its 3rd attempt since September to get through the trend line. One could argue we now have a topping pattern referred to as a 3-drives-to-a-high pattern (September, November and now). If it can break through resistance, which includes today's high at 1205 and then price-level S/R near 1213 and its 200-dma at 1214, we'd have a bullish breakout. But at the moment it's a bearish setup for a topping pattern that would be confirmed with a drop below its November 16th low near 1150. Watch the whipsaws in between.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1215
- bearish below 1150

Watching the Treasury market, in an attempt to learn what the bond market thinks central banks will or will not do and what that could mean to buying/selling in Treasuries. This whole year has really been nothing more than a big, but contracting, sideways consolidation and that might not change for another month or two. The TNX (10-year yield) daily chart below shows the possibility for a continuation into January in a sideways triangle before heading lower early next year. This sideways triangle is within a longer-term downtrend and therefore fits as a continuation pattern. If TNX drops below 2% I'll turn more bearish sooner whereas a rally above its November 9th high at 2.377% would turn me bullish. At the moment it has found support at its 50- and 200-dma's, at 2.15% and 2.16% resp., but I think it will head down to the bottom of its triangle, which is the uptrend line from January-August and is currently near 2.04%.

10-year Yield, TNX, Daily chart

Following up on last week's update on the TRAN, I had mentioned the high on November 20th was a good fit for the completion of an ascending triangle for the bounce correction off its August low. The little throw-over above the top of the triangle, followed by a close inside the triangle, produced a sell signal. That signal would be confirmed with a drop below the bottom of the triangle, which is the uptrend line from August 24th and today it poked below it but closed above it, currently near today's closing price at 8030. Trendline support will probably be good for at least a bounce and then watch for what follows. Another rally above the November 20th high at 8358 would be a bullish breakout but a bounce and then drop below today's low at 7994 would be bearish, confirmed with a break below its November 16th low at 7921. It has been weaker than the DOW for a long time and it could be the canary index if it continues lower.

Transportation Index, TRAN, Daily chart

The U.S. dollar popped up this morning and made another new high, coming very close to its March high at 100.78 with a high at 100.54. I have a price projection for the 3-wave move up from August at 100.48, which is where the 2nd leg up is 162% of the 1st leg. That projection was achieved today and the rally since November 12th has been very choppy, forming a small rising wedge as shown on the daily chart below. This is typically an ending pattern and with the achievement of the price target followed by a strong intraday reversal I think there's a good chance the dollar is now ready to reverse back down. The intermediate pattern calls for a decline back down to its August low as part of a larger sideways consolidation pattern into 2016 (before heading higher). The more immediate bullish pattern calls for a multi-week choppy consolidation before pressing higher in January. Both patterns suggest a pullback but depending on which larger pattern is playing out we're looking for either a choppy consolidation or something a little stronger to the downside. Each suggests the dollar is not going to rally following either the ECB announcement tomorrow or expected Fed action, which suggests the market has either already priced in an ECB QE increase or the ECB will disappoint. The euro is heavily shorted right now and it could be ready for a short squeeze.

U.S. Dollar contract, DX, Daily chart

The euro shows a high concentration of shorts while the U.S. dollar is just the opposite. If the dollar is ready for at least a pullback we should see the commodities finally bottom and start at least a bounce. That includes gold and as I've been saying for the past couple of weeks, while I'm bearish longer-term for gold I think it's setting up for a bounce before it heads lower. And the COT (Commitment of Traders) report shows it's likely ready for a bounce. The chart below was put together by Tom McClellan (he does a great job showing comparisons) and it clearly shows when you don't want to be trading against the big commercial gold traders. They are almost always on the other end of hedge funds and retail traders (which includes most fund managers).

Gold COT vs. gold price, Weekly chart courtesy mcoscillator.com

The chart shows how short the commercial traders have been during past rallies and I suspect we'll see the same thing again. But by the same token, they get less short (they're almost always hedged somewhat) when gold has been sold off, as it is currently. At the moment these traders at the least net short than they've been in the past two years. Gold looks ripe for a bounce (to another lower high is what I'm projecting). I show an expected rally on my weekly chart, perhaps up to price-level S/R near 1142 where it crosses the top of its down-channel in mid-January. We could see a little more downside, maybe 1140-1145, but I think betting on the downside in gold right now is a risky bet. I'd rather start looking to nibble on some long positions for the expected bounce. Trading the gold miners, or the GDX, could get an even better return.

Gold continuous contract, GC, Weekly chart

Oil continues to struggle to get off the $40 mat and it could drop down to test its November 20th low at 39 but with bullish divergence and an expectation for the dollar to start a pullback/decline I think there's a good chance oil will finally be able to get off the mat and rally up to the $52 area as part of a larger bearish consolidation pattern.

Oil continuous contract, CL, Daily chart

Today's ADP employment report showed +217K jobs added, vs the 185K the market expected and an improvement over November's 196K (revised higher from 182K). This has some speculating that Friday's NFP report will come in stronger than the expect 208K, which would be a decline from November's 271K. We still have a busy week ahead of us for economic reports but in reality the only two things the market is interested in are the ECB QE announcement on Thursday and the NFP report Friday morning. It could produce some wild swings in the market.

Economic reports

Conclusion

The stock market has been rallying recently in anticipation of more drug money from the ECB and Mario Draghi's promise to do more of "whatever it takes," whatever that means. We'll find out tomorrow and any further money printing from the ECB could ignite a continuation of the rally. The one thing to be careful about is the possibility that the anticipatory rally might have already been baked into the cake and now it's time to eat it. Buy the rumor, sell the news.

Friday's NFP report could have just as large an impact on the market but the problem there is trying to figure out how the Fed might react and then how the market might react to the Fed's reaction. It makes my head hurt so I'll simply lie low and react to the market's moves, take my little bit of cheese while avoiding the cat and then scurry back into my hole. And if there are too many cats running around I'll just stay in my hole and wait for it to quiet down. The beauty of what we do is that the market is always there and we're not forced to trade when we don't want to. Wait for the next bus with a prettier bus driver (or a hunkier one for you ladies) to come by and pick you up. It could get wild in the next couple of days so trade safe or stand aside and let the dust settle.

Be sure to take advantage of the end-of-year special for subscription renewals. I firmly believe we are going to have a wild year ahead of us and while I'm bearish for 2016, there will be plenty of trading opportunities in both directions. By the same token, being on the wrong side of a wild swing can make for a very bad day (e.g., bear market rallies can destroy your account if you're on the wrong side). One good trade, or a save from a significant loss, will more than cover the cost of a subscription and often it's just good to read opinions to help you form your own. That's the beauty of the educational effort made by the various OIN writers. We might not be right in our calls but hopefully we give you some things to think about. A second (third, fourth) set of eyeballs watching the market with you can be extremely valuable.

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Good luck in the coming days 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