We got the typical bullish move last week in front of Memorial Day weekend but the market has gone sideways for the past week. There is still more upside potential but there's enough evidence of topping to warn bulls to be more defensive.

Today's Market Stats

The market has been holding onto last week's gains since last Wednesday and the indexes put in new highs on Tuesday before dropping back down. The tech indexes and RUT have been stronger (although NDX finished in the red today), especially the RUT, and that's been bullish. But with the completion of end-of-month and today's new-month money we could see the market start to struggle more as waning bullish momentum warns us of a tiring rally.

Today's economic reports included the ISM index, which came in a little better than expected, at 51.3 vs. 50.4 expected and an improvement from April's 50.8. But Construction Spending for April was weaker at -1.8% vs. expectations for +0.5% and a drop from +1.5% in March. Auto and Truck sales were essentially the same as April so it was a neutral day for reports. Tomorrow's important report will be the ADP Employment and then Friday will be a big day with the nonfarm Payrolls, hourly earnings, unemployment rate, Factory Orders and ISM Services.

While this week's economic reports were somewhat neutral, we have had more negative than positive and that has been an indication that our economy continues to slow. Yet, in spite of the plethora of worsening economic and earnings news the stock market continues to ignore it all and is again challenging its 2015 highs. Pretty amazing and rallying on bad news is actually bullish so the bulls have to be given their due, even if it doesn't make much sense logically for how the stock market should be behaving. A logical stock market is of course an oxymoron, which is why we try to at least discern what's going on with the use of charts.

What has been reported by many is the huge bullish influence of share buybacks. There's a lot of data showing company buybacks have provided most, if not all, of the support that has driven the market indexes back up since 2009. Companies have borrowed huge amounts of money, made cheap by the Fed's policies, and they used the money to buy back shares and increase dividends. It's been a poor use of the money since it has been totally non-productive (vs. putting it into capital equipment and other revenue-enhancing investments) and that has only created a larger debt burden for companies to deal with. All in an effort to boost stock prices through higher "earnings."

The earnings "improvement" has of course been a sham since it only improves earnings per share but not actual earnings. The SEC is in fact close to changing the requirements for earnings reporting to be more in line with GAAP (Generally Accepted Accounting Principles) and that will force companies to report closer to actual earnings instead of make-it-what-you-want earnings. Earnings have been in decline for a few quarters and all signs are now pointing toward a recession (we've probably already entered one but we have to wait for numbers to confirm the fact in hindsight). This presents a real problem for the stock market if it's not able to attract new money from somewhere else. Stock buybacks have been in significant decline this year and earnings have also been in decline. Companies are buying back fewer shares (less support for the stock market) and earnings per share are deteriorating (especially after the SEC requires more GAAP requirements), which of course creates less support for high valuations. The combination of these factors should be knocking the stock market back down. Again, that's the logical conclusion but we know logic does not apply (yet).

Stock buybacks have amounted to trillions of dollars of support for the stock market since 2009 (far more than the money the Fed has created). But those buybacks have slowed significantly as described in a recent article in Bloomberg:

" After snapping up trillions of dollars of their own stock in a five-year shopping binge that dwarfed every other buyer, U.S. companies from Apple to IBM just put on the brakes. Announced repurchases dropped 38% to $244 billion in the last four months, the biggest decline since 2009, data compiled by Birinyi Associates and Bloomberg show."

As noted in the Bloomberg article, the number of companies they have been cutting their dividends has also increased to the highest level since 2009. And yet here we are with indexes testing all-time highs. Go figure.

My concern is that the market is once again whistling past the graveyard, just as I was warning back in 2007, and it's going to take a shock (be it a black swan or something less) to start the selling. I strongly suspect the selling will beget more selling and after a big down day leads to another we'll have many scratching their heads wondering why the market is suddenly selling off (probably on good news). Many bulls are waiting for a signal to get out but oftentimes the signal comes too late for them to get out near the top and then they're afraid to take a "loss" (of profits) so they hang on for an expected bounce back up that never comes. It's how bulls get trapped so my recommendation is to set your stops and then honor them, which might mean manually stopping yourself out if a limit stop order was not triggered after a big gap down.

The charts are showing upside potential but I'm looking at them with a wary eye. I see upside potential but I don't see it as worth the downside risk. In other words, I think the downside risk dwarfs upside potential so that has me feeling cautious about the market at the moment and trading very short term (selling weekly credit spreads and making small directional trades that have a lifespan of days, not weeks. Tonight I'll start the chart review with the SPX weekly chart.


S&P 500, SPX, Weekly chart

I'm not sure a downtrend line from July 2015 through the April high is an important one but SPX is now approaching it near 2105 (yesterday's high was 2103 and today was near 2101). All highs since May 2015 have been lower highs, even if only marginally, and so far the bounce off the May 19th low remains below the April 20th high at 2111, which is why the downtrend line is potentially important. You can see the bearish divergence on MACD at the moment against the April high, which is true on the daily and intraday charts as well. In other words the rally looks to be running out of steam as it approaches this line of resistance. If the bulls can break above 2105 and then 2111 they'll have to then deal with the November 2015 high near 2116 before finally tackling the May 2015 high near 2135. That's a lot of resistance to fight through and I don't think it's a good risk vs. reward trade on the long side here. Watching for a rollover from resistance to short could be the better bet.


S&P 500, SPX, Daily chart

The daily chart below is messy as I'm trying to show additional reasons for potential trouble for the bulls. If the rally from January is a 5-wave move and the 5th wave is the leg up from May 19th it will equal 62% of the 1st wave at 2109, which is between the downtrend line from July 2015 and the November 2015 high. It would obviously be more bullish above multiple levels of resistance between here and 2116 and if the bulls can drive SPX above 2117 it would open the door to 2135. Above that they'd then have their sights set on 2160, which is where the 5th wave would equal the 1st wave in the rally from January. The upside potential needs to be respected by the bears but I'll believe it if and when SPX is able to rally above 2135, which I think could be very difficult to reach. But I also know we're dealing with something other than fundamentals driving the buying in this market.

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


S&P 500, SPX, 60-min chart

On the daily chart I talk about the 5-wave move up from January and the leg up from May 19th is the 5th wave. That 5th wave is shown in more detail on the 60-min chart below, which is itself now a 5-wave move up into yesterday's high and that suggests the rally from January could now be complete. But it's possible this morning's low is the start of the 5th wave of the move up from May 19th and upside projections for it are 2105 (to equal 62% of the 1st wave) and then 2117 (to equal the 1st wave). The 2105 projection matches the downtrend line from July 2015 and the 2117 projection matches the November 2015 high, so either is possible from here. But it's also possible the rally is already complete and it's the reason why I think betting on the upside is a poor risk vs. reward trade. A drop below this morning's low at 2085 would be a stronger indication that the top is in place. But for the larger pattern we still don't know yet if we'll get just a pullback correction to the rally from May 19th, and then proceed higher, or a larger pullback correction to the rally from January, and then proceed higher, or more bearishly, the start the next major decline. It's a risky spot to be long and I think it's a good time to get defensive and perhaps nibble on some short positions. Once we get a little larger pullback (assuming we'll get one) we can then look for evidence to see if we should be looking for just a pullback or something more bearish.


Dow Industrials, INDU, Daily chart

The Dow has been weaker than SPX as it has only been able to challenge its May 10th high at 17934, with yesterday's high at 17899, and is not yet close to challenging its April 20th high at 18167. It's bullish though above its 20- and 50-dmas, at 17683 and 17744, and the top of its broken down-channel from April, which was back-tested with this morning's low at 17664. The next support level is its uptrend line from February through its May 19th low, which is an untested uptrend line, currently near 17580. Therefore the bulls are theoretically in good shape above 17580 since there's a lot support between here and there. If the bulls can keep it up there's upside potential to 18350-18400 where the Dow would test its May 2015 high (18351) and then where the 5th wave of the move up from January would equal the 1st wave (18391). But before those levels could be achieved it would have to get through the top of a shallow up-channel from August 2015 (bold blue line), which is where the April rally stopped and is currently near 18100.

Key Levels for DOW:
- bullish above 18,100
- bearish below 17,330


Nasdaq-100, NDX, Daily chart

Yesterday NDX rallied up to resistance near 4525 where it met its downtrend line from December 2015 - April 2016 and the shelf of support to the island that was created in April between the gap up on April 13th and the gap down on April 22nd. Today it made a minor new high but it's still struggling near the 4525 resistance level and closed right on the downtrend line. The bulls need to do what they always do at resistance -- create a gap up to get over it and that would open the door for a possible run up to its April 19th high at 4574 and price-level S/R near 4600. But a decline from here would leave a bearish kiss goodbye against resistance and while that would give us a bearish heads up, the bears would not be in better shape until NDX drops below its May 11th high near 4408 and its 200-dma near 4401.

Key Levels for NDX:
- bullish above 4525
- bearish below 4400


Russell-2000, RUT, Daily chart

The RUT has been acting stronger the past several days and that's always a good sign for the bulls and as long as the RUT is leading to the upside it should keep the bears back on their heels. But today's high at 1163 is only marginally above price-level S/R near 1160. Considering the short-term bearish divergence since last week's highs, such as seen on its 60-min chart, it's a warning sign for the bulls to be careful here. A turn back down from resistance and a drop below this morning's low at 1148 would be the first bearish heads up. But if the bulls keep going we could see a rally to the 1200 area.

Key Levels for RUT:
- bullish above 1160
- bearish below 1094


10-Year Yield, TNX, Daily chart

Yesterday TNX tagged its downtrend line from March-April and then dropped back down. Today it dropped lower and tested its 20- and 50-dma's at 1.80 and 1.81, and only slightly lower is the uptrend line from July 2012 - January 2015, which TNX has been oscillating around since February. There's a sideways triangle pattern playing out since March and it continues to look like a bearish continuation pattern, which means TNX should drop lower out of it. This pattern, if we see downside follow through, suggests the Fed will not be raising rates in June and probably not in July (or the rest of this year).


KBW Bank index, BKX, Daily chart

BKX has now made it up near its downtrend line from July-December 2015, currently near 71.70 (last week's high was 71.53, yesterday's high was 71.46 and today's was 71.22). These highs are slightly higher than the late-April highs but showing bearish divergence and that suggests the downtrend line is going to hold as resistance. There is upside potential to its November 2015 high at 77.14 but until the downtrend line is broken I don't think that's a high-probability move. The weekly candle is currently a hanging man doji up against the downtrend line.


Transportation Index, TRAN, Daily chart

The TRAN has been fighting to break its downtrend line from March-November 2015 since March -- it has broken it twice but was unable to hold above it. Yesterday it closed marginally above the line and today it closed on the line, currently near 7770. Yesterday's high was a test of its broken 50-dma, currently at 7828, and near the same level is the 50% retracement of its November 2014 - January 2016 decline, at 7856. If the bulls can get back above 7860 it could be three time's a charm for the bulls, otherwise a rollover from here would indicate resistance will hold and the bears will get braver.


U.S. Dollar contract, DX, Weekly chart

Yesterday the US$ ran into the top of its down-channel from December 2015 and looks ready for a pullback but it should only be a pullback to a higher low before continuing higher within its sideways consolidation that it's been in since March 2015.


Gold continuous contract, GC, Weekly chart

Gold's decline last week had it dropping back inside its down-channel from 2013, leaving a failed breakout attempt in March and April. The new April price high left a bearish divergence against its March high and that was a warning that the rally probably wouldn't hold. But the larger pattern is still up for grabs and we'll have to wait for a few weeks before we'll get some better ideas. The longer-term pattern suggests (to me) that gold has not yet put in a longer-term bottom and that the May 2nd high will now be followed by a new low below the December 2015 low at 1045. The bottom of its down-channel crosses price-level S/R (from 2008-2009) near 1000 in August and that's a good target for now and until something in the pattern tells me to expect something different.


Silver continuous contract, SI, Daily chart

Silver has sold off hard since peaking May 2nd at the top of its down-channel from 2013 and the short-term shallow down-channel from the end of 2014. But silver is approaching its uptrend line from January, near 15.65 (today's low was 15.83) and that could produce at least a bounce. But as with gold, until I see something in the price pattern that tells me otherwise, the longer-term pattern continues to suggest lower prices for silver, potentially down to the $10 area.


Oil continuous contract, CL, Daily chart

In the recent weekly updates on oil I've shown an expectation for the completion of an A-B-C bounce pattern off the January low and a 5-wave move up from April 5th to complete the c-wave. Price projections for the wave count pointed to 50.21-50.95 for the completion of the rally, which would also have it testing its October 2015 high at 50.92. For the 5-wave move up from April 5th the 5th wave equals the 1st wave at 50.21 and last week's high was 50.21. Yesterday's high was 50.10 and then today it dropped further and broke its uptrend line from February, currently near 49.12. Notice too on the weekly chart below that in addition to the price projections at 50.21-5095 there is the broken uptrend line from 1998-2008, currently near 50, which was tested in January-March 2015, broken in July 2015, back-tested in September-October 2015 and now is being back-tested again. Oil would clearly be more bullish above 51 but with it being overbought (and showing bearish divergence on its daily chart since March) I don't give it high odds here for a breakout. We're more likely looking for at least a pullback if not a drop back down to the 20-25 area. And if oil turns down from here we could see the stock market follow it (or the other way around but regardless, the two have been following each other for a while now).


Economic reports

Tomorrow's economic reports include the ADP Employment Change report, which is expected to show a slight gain from April and the unemployment numbers. Unless the ADP report is really different from expectations there likely won't be much of a market response. The response is tough to guess anyway since it will be more from a guess how the Fed will treat the number in their rate decision.


Conclusion

There are plenty of reasons why the stock market should be selling off and yet it isn't. That alone tells us the market is more bullish than it might appear on the charts and the bears need to respect that. Don't short the market just because it shouldn't be rallying. Follow the charts and watch for breaks of support or play the rollover at resistance, both of which give you close stop levels and a way to tightly manage your risk. Getting short and staying short just because it will "eventually" roll over is not a good trading strategy. The market can, and will, remain irrational far longer than you can remain solvent fighting it.

The flip side is bulls cannot afford to get complacent here. The indexes are again testing the 2015-2016 highs but are vulnerable to a downside break because of the lack of fundamental support. I of course hesitate to use that word but the fact remains -- stock buybacks, which have provided the bulk (many say all) of the support for the stock market, are in a strong decline and the waning momentum to the upside is a warning sign. The rally can certainly continue higher, especially with short covering from frustrated bears, but I think we're a news event away from a nasty downside surprise.

From a percentage gain vs. percentage loss perspective I think the downside risk far outweighs the upside potential. Ask yourself if you would enter a new long position here and if the answer is "no" then pull your stop up tighter and get defensive. It might be early to get short but I would have some shorting ideas/candidates identified so that you're ready to go. Trade cautiously and stay safe.

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