The stock market has been working hard to hold onto its gains from the rally off the February low but today's loss, while relatively small, showed signs of cracking in the support levels. Bulls can still save it here but with such an overbought market up against strong resistance it's looking like it could be time for at least a rest period for the bulls.

Today's Market Stats

The market has been working hard this week to hold onto the gains made since the February 11th low. By not giving up much it remains potentially bullish since it's easy to interpret this week's minor pullback as just a small correction within the larger rally pattern. But the problem for the bulls right now is an extremely overbought market, by several measures, and very high bullish sentiment. Both measures are at levels that marked trouble for bulls in the past. Price hasn't confirmed we've started a reversal back down but that's the risk for those holding onto long positions.

It was a quiet morning for economic reports and the only important one was new home sales, which at 512K was as expected. That was an improvement over January's 502K (revised upward from the originally reported 494K), but the bigger picture for housing is showing some signs of aging. For the past year new-home sales have essentially leveled off but as can be seen in the lower chart below, price appreciation has been slowing since 2013 and the latest report shows the 3-month average has dipped into negative territory (prices are declining). Despite historically low mortgage rates and banks easing their lending standards (there are many signs the banks are starting the same sub-prime lending that got them into so much trouble last time), making it easier and cheaper to get a mortgage, a lack of demand for houses has resulted in slowing price appreciation.

Exacerbating the declining demand for new houses is the decline in homeownership rate, which has now declined to a rate (near 63%) that hasn't been seen since the mid-1960s when records started. That's a near 50-year low and represents a strong headwind for new home sales. Part of the explanation is the loss of the middle class standard of living, which represents a whole slew of economic problems but that discussion could take pages of digital ink. Hint: it's one reason why Trump has become popular, much to the dismay of the establishment and those who don't understand the plight of the disappearing middle class.

New Home Sales and Prices

So much of our economy is dependent on the housing market and at the moment it's not looking as good as we'd like to see it. The stock market has done an outstanding job holding up in the face of deteriorating economic conditions and corporate earnings decline. The mountain of debt facing our country and businesses is a potential ticking time bomb (much worse than the situation prior to the 2008 collapse) but the stock market has held up despite all that. In spite of all the doom and gloom possibilities we've had a strong stock market and that's been bullish if only because the market hasn't declined. It hasn't gone anywhere since the Dow reached its current level in November 2014 but the bulls are happy it hasn't declined (and the bears have been frustrated to no end).

Consolidating sideways following a strong rally is actually bullish and that has to be respected by the bears. As I've been showing with the Dow's weekly chart (and updated below), we have a big sideways triangle pattern that says the bulls will be rewarded with a big rally in a few months. But at the same time, the deteriorating economic and corporate conditions, as well as the extreme debt levels, is a warning sign that should not be ignored by the bulls. All big moves start off small and what we need to try to figure out is what small pattern will provide clues for the larger pattern.

The market's price/time patterns rarely repeat exactly but the patterns do tend to be fractals. Just as you see repeating patterns in nature (such as Fibonacci ratios) so too do they repeat in the stock market. The reason we trade price patterns is because they tend to repeat. Think bearish rising and bullish descending wedges, triangles, flags, etc. There is currently an interesting price pattern that has played out like we saw from the August 2015 low into the November 2015 high. As this pattern has played out it has pushed indexes into potentially strong resistance. And while the price pattern has repeated we also have bullish sentiment repeating in lock step with price.

Jim alluded to this as well in his wrap last night. The Dow's pattern is a good example with its double bottom in August-September 2015 with the higher low in September. The rally from September into the November 3rd closing high was 25 trading days. The January-February 2016 double bottom, with a higher low in February, led to Monday's closing high (so far), which was 26 trading days from the February 11th low. BTW, March 21st was also the spring equinox, a date that is often seen accompanying market turns. Tuesday the Dow made a new intraday high and came within spitting distance of its downtrend line from May-November 2015, which considering how overbought the market is, should be strong resistance at least to the first attempt to get through it.

At the November 2015 high the Dow had retraced 93.5% of its May-August decline. At Tuesday's high the Dow was within 13 points of retracing the same 93.5% of its November-January decline. While the market doesn't necessarily repeat exactly, that's about as exact as you can get, in both time and price. While it doesn't mean the rally will top out right here, it does mean bulls need to be cautious about pressing for more; you need to ask yourself if you would initiate a new long position here and if the answer is "no" then the next question to ask if it's worth holding on for more. Is the profit:loss ratio in your favor? If not then get your stop up tight.

As mentioned above, the sentiment picture is also repeating. The CNN Fear&Greed index is a great indicator since it combines several sentiment measures into one indicator and as you can see on the chart below, it climbed above the level where it was last November. A turn back down from the high usually precedes a turn down in price (the market simply runs out of buyers as bullishness begins to wane) and as you can see on the chart, it has started a turn back down from near 80, a level that has always meant danger for bulls.

Another sentiment reading comes from Tom McClellan, as shown on the chart below. The difference between bulls and bears, as reported by Investors Intelligence, is at a spread that's now wider than where it was at the November-December highs. It is well above the top of a trading band and more extended above the top of the band than at any time prior to 2014. With price lower than the November-December highs we have investors feeling even more bullish than back then, which is usually not a healthy combination.

Investors Intelligence Bulls-Bears, chart courtesy mcosillator.com

Here's another sentiment measure, which uses the VIX. We all know VIX reflects sentiment through the price of SPX options. It is most often a direct inverse picture of SPX and therefore it's not exactly predictive (any more than the SPX indicators). But when you create a ratio with VXV, which is the 3-month average of VIX, you get some interesting signals, as can be seen on the chart below (the middle chart). I've highlighted those highs and lows (above 1.0 and below 0.8, resp.) that at the very least warned traders that the move had extended into reversal territory. The bottom chart is of the VIX and its Bollinger Band. Notice how few sell signals are offered vs. the VIX/VXV, especially compared to the number of buy signals (green circles). Due to higher emotions in a decline it's more common for the VIX to spike above the top of its BB rather than buying causing a spike below the bottom with a stock market rally. It takes a little time to study the chart below to identify where the signals work and just as important, where they don't work. Look for corresponding signals to get a better idea for where it paid to take the signal.

SPX vs. VIX/VXV vs. VIX, Daily chart

The top chart above shows how many market highs did not have a corresponding low VIX/VXV (below 0.8) and a VIX reading that was not down to the bottom of its BB. Some SPX lows did not have a corresponding high VIX/VXV reading (above 1.0) but most important price lows did have an accompanying VIX high above the top of its BB. But a combination of a signal from VIX/VXV and VIX gave reliable reversal signals and we currently have one that's strongly warning of an important price high here. Bulls ignore this warning signal at their own risk.

With that let's move to the charts to see what price patterns I'm watching. The Dow's weekly chart


Dow Industrials, INDU, Weekly chart

With the Dow's high on Tuesday, near 17649, it stopped only about 16 points shy of its downtrend line from May-November 2015. Considering all the warning signals mentioned above it was a very good setup to get short (if you practice good money and risk management) since it's an obvious line of resistance to anyone who can draw a trend line on a chart. The pullback since Tuesday could easily get reversed but again, it's a low-risk spot to play a reversal. As for what's next, assuming we'll start at least a deeper pullback, we could see just a pullback before heading higher or we could see a drop back down to the bottom of a bullish sideways triangle that the Dow has been in since May 2015. Triangles are typically whippy and choppy and so far that's what we've seen. The bearish interpretation of the pattern is looking for a very strong decline in a 3rd of a 3rd wave down and a break below the triangle would be the recognition phase of the move (failed patterns tend to fail hard). But we have plenty of time to figure out what the next pullback/decline is telling us.


Dow Industrials, INDU, Daily chart

The daily chart shows what looks like a perfect tag of its downtrend line followed by the pullback into today. Today's low was a test of its uptrend line from February 11th, near today's close. Closing at support left both sides wondering what will follow and if the market is not done yet putting in a final high for the leg up from February we'll see a bounce off support and potentially a break above the downtrend line, now near 17665. But if the high is place then support will likely be broken with a gap down Thursday morning. That's the way this market deals with support and resistance and which way it gaps over resistance or below support provides a valuable clue as to which direction offers the least resistance.

Key Levels for DOW:
- bullish above 17,670
- bearish below 17,140


Dow Industrials, INDU, 60-min chart

The Dow's 60-min chart below shows the test of the uptrend line from February and now we wait to see what follows. If it continues to rally and breaks its downtrend line from May-November 2015 I'd look for a move up to the top of a parallel up-channel for the portion of the rally from the March 10th low, so perhaps up to about 18K.


S&P 500, SPX, Daily chart

Tuesday's high for SPX was a test of its downtrend line from November-December 2015 and the reversal from there looks a little more bearish than the Dow because it broke its uptrend line from February 11th, currently near 2050. Regardless of whether the longer-term pattern from here is bullish or bearish (yet to be figured out), the short-term pattern calls for at least a deeper pullback. This is why I think playing the short side is now the better trade. Once you can give the trade a little breathing room you can then follow the trade lower with your stop. If the pullback turns into a corrective form (e.g., overlapping highs and lows in a bull flag) then I'll look for a setup to get long for the next big rally leg. But if the pullback turns into an impulsive move (steep and strong) then I'll know to look for bounces as shorting opportunities with the expectation that the January-February lows will break.

Key Levels for SPX:
- bullish above 2057
- bearish below 2024


Nasdaq-100, NDX, Daily chart

On Monday and Tuesday NDX had closed above its 62% retracement of its December-February decline and its 200-dma, at 4415 and 4419, resp. But today it closed back below both, which leaves the potential for a head-fake break. However, like the Dow, NDX held its uptrend line from February 11th, closing on it at 4402. The bulls need to start buying immediately on Thursday in order to prevent a trendline break.

Key Levels for NDX:
- bullish above 4450
- bearish below 4356


Russell-2000, RUT, Daily chart

The RUT has created a double top against its trend line along the lows from October 2014 - September 2015 (a H&S neckline). The first attempt to get through resistance was March 7th and then again last Friday. It made a high at 1103.62 on Tuesday, stopping about a point away from retracing 62% of its December-February decline and now today's decline looks like it should see follow through. This week's high is leaving a bearish divergence against the March 7th high and MACD has crossed back down from a high not seen since November 2014.

Key Levels for RUT:
- bullish above 1105
- bearish below 1040


20+ Year Treasury ETF, TLT, Daily chart

The bonds rallied today and that had TLT breaking out of a bullish descending wedge pattern today. If MACD makes it back above zero and TLT holds above its 50-dma, currently near 129, it should rally fairly quickly and get above its February 11th high (wedges are typically retraced faster than it takes to build them). A strongly rallying bond market, if that's what's coming, would likely be the result of a run to safety into bonds and out of the stock market.


KBW Bank index, BKX, Weekly chart

BKX made it up to price-level S/R near 66.50 with Monday's high at 66.47 (close enough for government work) and while the reversal from there is only a small pullback so far, the odds say it will continue the reversal back down. It's holding above its 200-week MA at 65 (today's low was 65.19) and if that holds as support we could see resistance at 66.50 broken. But again, in an overbought market I think it's a risky bet on the long side here.


Transportation Index, TRAN, Daily chart

The TRAN is one of the few bullish patterns that I'm watching at the moment. It made a bullish break last Friday when it rallied above its downtrend line from March-November 2015, near 7980, and today it made it back down to the broken trend line, as well as its 78.6% retracement of the leg down from November 2015, near 7940. Monday's high, at 8114, stopped short of its 62% retracement of its decline from November 2014 into the January 2016 low, near 8200, and is not showing us any bearish divergence at Monday's high. If the back-test of its broken downtrend line holds it could lead to a bullish kiss goodbye and another rally leg, one which would probably make it up to its November 2015 high at 8358. But the current back-test must hold otherwise it will leave a failed breakout attempt and failed breakouts usually reverse hard as those who bought the breakout bail en masse.


U.S. Dollar contract, DX, Weekly chart

This week's bounce for the US$ has it back up against a broken uptrend line from August 2015 - February 2016, near 96. I think the dollar will work its way a little lower, perhaps down to the 93-94 area, before heading back up inside its large consolidation pattern.


Gold continuous contract, GC, Weekly chart

Gold has now rolled over from the top of a parallel down-channel for its decline from August 2013. There's no definitive pattern yet for its pullback from the March 11th high so it could still press higher following the current pullback. Looking at short-term price projections based on its pullback pattern, it would turn more bearish below 1210 so below that level I'd get more defensive if you're a gold trader (vs. a long-term holder of the shiny metal). We could see a drop down to the bottom of its down-channel and price-level S/R near 1000 in a few months. Gold traders became way too bullish on the rally and for a healthier rally it at least needs to shake out the weaker holders (those not committed yet to the longer-term bullish possibilities).


Oil continuous contract, CL, Weekly chart

Today's report showed crude inventories spiked up in the past week, up 9.4M barrels and that sparked some selling, which dropped the price of oil -3.5% today. Tuesday's high at 41.90 was at the top of a parallel down-channel for the decline following its June 2015 high and MACD has made it back up to the zero line. A rollover from both would be bearish and then it will be a matter of figuring out if we're looking at just a pullback or a more significant decline that will take oil to the bottom of its down-channel. At the moment, based on its larger wave pattern and until proven otherwise I'm looking for oil to drop to a new low, perhaps down to the $21 area before setting up a longer-term bottom.


Economic reports

Other than the weekly unemployment numbers tomorrow we'll get the Durable Goods orders, which are expected to be flat (ex-transports) to about -3% (total goods).


Conclusion

Time and price have come together to suggest at the very least that bulls need to be thinking defensively. That might mean selling to some and/or hedging with short positions to others. Bullish sentiment and overbought indications also suggest the bears should soon have a turn at the feeding trough. Trading is a game of probabilities and right now I think the higher probability is for at least a deep pullback before the market will be able to head higher. The more bearish price pattern says the two big bounces, into the November 2015 high and the current high, are merely a result of a big battle within a rolling top pattern and when it breaks down next time it's going to be a hard break and well below the January-February lows.

We can't know yet whether we'll get just a pullback before heading higher or instead something more bearish but considering the downside risk I think it's a very good opportunity to trade the short side, which of course means get defensive if you're holding long positions. At least protect your big gains. If while in a short position we see the market chop its way lower, such as in a bull flag pattern then turn less bearish and get ready to buy the pullback. But that won't become clearer for at least another week or three so in the meantime think short and watch out for those short-covering rallies.

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