Last week the market rallied hard and it was pretty much straight up into last Friday morning's high. Since then we've had a pullback and some large price swings while the market figures out what to do next. The waning momentum (bearish divergence) and price pattern suggest we could see at least a larger pullback correction before heading higher (maybe).

Today's Market Stats

There was a fair amount of trading volume today, which is what bulls want to see for a positive day and the market internals supported the green we saw in the indexes but we're seeing signs of weakening in the rally. Since the June 27th low, even as prices marched strongly higher, I watched the market internals weaken as the week progressed which created short-term bearish divergences. It provided a warning sign that we could be in the process of getting at least a larger pullback before heading higher, or we could be in the early part of what will become a more significant decline. Part of the issue with this week's volatility might be the market simply waiting now to get through Friday's NFP report before deciding what to do next.

Brexit worries resurfaced last night and drove our equity futures lower, which had us starting the day with a gap down. Shortly after the morning low the indexes shot back up and the Dow rallied a little more 200 points into the high just before the close. The turnaround might have had something to do with the Fed's record-setting reverse repo (flipping the expiring bonds) with $83.4B (hat tip to Vincent for that info). The operation completed at 13:15, which is when the market had a little swoon before chopping its way higher for the rest of the afternoon. Without that Fed operation it's anyone's guess what today would have been like.

There was very little news to move the markets, other than the Brexit worries, and the net result after today's price action is a pattern that is difficult to decipher as far as pointing in one direction or the other. All we can do is wait to see if last week's rally will get some follow through or if instead it was a 1-week wonder rally. I'll start tonight's review with the NDX weekly chart.


Nasdaq-100, NDX, Weekly chart

Last week NDX made it back up to three broken uptrend lines, all of had been broken with the decline into the June 16th low. The trend lines were the uptrend line from March 2009 - August 2015, the bottom of an up-channel from 2010 and a short-term uptrend line from February 8 - May 19. Following the June 16th low NDX bounced the next week and back-tested these trend lines before dropping lower into the June 27th low. The strong rally last week brought NDX to within spitting distance of the broken trend lines again and another test from here would be near 4490, which is also the location of the downtrend line from December 2015 - April 2016. If NDX gets above 4490 it will look more bullish, especially if it gets above its June 6th high near 4537. That would be the signal for a potentially strong rally to follow. Notice how MACD is holding above the zero line and a "reset" here followed by a turn back up would be a buy signal (although the last one in late May failed with a lower price high on June 6th). But if the bounce attempt fails and NDX drops below its June 27th low near 4179 I'd look for a drop to the bottom of a possible sideways triangle, which is the uptrend line from August 2015 - February 2016, near 4000.


Nasdaq-100, NDX, Daily chart

On the weekly chart above you can see the effort to hold onto the 50-week MA, near 4408. The daily chart below shows the confluence of the 20-, 50- and 200-dma's at 4404, 4404 and 4416, respectively. That's a lot of moving average S/R and the price volatility in the past two weeks has seen a struggle around these averages. Today it closed above all of them and remains potentially bullish above 4404 (closing basis). Notice too that price-level support at 4375 was tested today and held (this morning's low was 4375.72). At the moment it's not clear what kind of price pattern is playing out and until NDX drops below price-level support at 4282 it remains potentially bullish but be careful about the possibility for a lot of choppy price action between 4200 and 4500. While the weekly chart shows a potentially bullish setup on MACD (rounding back up from the zero line), the daily chart is showing the opposite as it starts to round over from the zero line. Watching to see which one wins...

Key Levels for NDX:
- bullish above 4500
- bearish below 4179


S&P 500, SPX, Daily chart

SPX bounced off support at its 50-dma, near 2077 (with a low at 2074), and ran back up to within a couple of points from closing yesterday's gap down, which is at 2103 (today's high was 2100.72). What for the possibility we'll get a gap close and then back down. I think we'll see at least one more leg down for its pullback from Monday, which is based on a small impulsive move down into this morning's low. That called for a bounce correction and then another leg down, possibly more. Two equal legs down from Monday's high (measured from this afternoon's high) points to 2066 so be careful chasing a decline to that level since it could reverse right back up again. Below 2066 would have it looking a little more bearish.

Key Levels for SPX:
- bullish above 2113
- bearish below 2025


Dow Industrials, INDU, Daily chart

Like SPX, the Dow bounced off support at its 50-dma and made it back up to a downtrend line from April through the June 8th high. So at the moment it's trapped between support and resistance and I'm watching to see which one will break first. It could be bullish above 18000 (more bullish above 18130) and bearish below 17638 (two equal legs down from Monday).

Key Levels for DOW:
- bullish above 18,130
- bearish below 17,140


Dow Industrials, INDU, 60-min chart

A little closer view of the Dow's daily chart can be seen on the 60-min chart below. The move down from Monday is a small impulsive (5-wave) move and that suggests today's bounce should not make a new high and instead turn back down to give us at least an a-b-c pullback from Monday. The projection shown at 17638 is for two equal legs in the pullback and a drop below that level would start to suggest something more bearish, such as a larger 5-wave move down from Monday. We can't know which pattern is more likely (or something entirely different) but this gives us something to watch as a way to see what price tells us (confirms or not).


Russell-2000, RUT, Daily chart

The RUT also held its 50-dma today, breaking it intraday in the morning, like yesterday, and that keeps things potentially bullish. A back-test followed by a rally above its June 23rd high near 1172 and its broken uptrend line from February-May, currently near 1164, would confirm the bulls remain in control. The first sign of bearish strength would be a drop below its 200-dma, near 1114, and then confirmed bearish below 1087. Watch out for the possibility of a lot of chop between the key levels.

Key Levels for RUT:
- bullish above 1173
- bearish below 1087


10-year Yield, TNX, Weekly chart

Last week I showed the TNX daily chart to point out a downside projection near 1.39%, which matched the July 2012 low at 1.394%. Yesterday is closed below 1.394, marking a new all-time low, and this morning it gapped down to open at 1.336. It then immediately bounced back to a high at 1.395 before consolidating and closing at 1.385, leaving a back-test of price-level S/R at 1.394. If it consolidates for a week or two we can expect lower but it's important to recognize this could be a strong support level to launch at least a higher bounce (with selling in bonds).

In addition to the relative weakness of bond yields vs. what we're seeing in the stock market (bearish non-confirmation for the stock market), there are other comparisons to track as a way of identifying additional signs of whether or not the stock market's strength is supported by other market sectors. The first comparison below is a set of three weekly charts with SPX at the top and then in the middle is a chart that shows the relative strength of the Consumer Discretionary sector (XLP) vs. Consumer Staples (XLY). The bottom chart is the relative strength of the banks vs. SPX.


SPX vs. XLP/XLY and BKX/SPX, Weekly charts

The idea here is that in strong economic times people will spend more money on discretionary items (depending on how much discretionary income is left over after paying the bills) whereas in a weaker economy (incomes not keeping up) people will still need the staples (toothpaste, toilet paper, etc.) but will cut back on discretionary spending. That's a sign of trouble for the economy and in turn the stock market. And in a strong market you want to see the banks leading the way, which has not been true since 2010. The relative strength of BKX to SPX is once again testing support from 2011, a break of which would likely indicate the banks are going to drag us lower.

Before leaving the banks, it's important to know what's happening in Europe, even in strong Germany. The banks are crashing and a large part of the blame goes directly to the ECB and their idiotic policies (same with the Fed). Banks can't make money in a NIRP environment and while the banks are being encouraged to lend even more money (or else park it with the central bank and get charged for doing so) they're already dealing with a climbing default rate on current loans. Many banks in the U.S. have even gone back to what got them into so much trouble before 2007 -- sub-prime loans to people who can't afford the loans (it's already being done with auto loans and student loans).

The Italian banks are in serious trouble, which might not be surprising considering it's not much better off than Greece. But Germany's largest bank, Deutsche Bank, is also in serious trouble and this is in the strongest country in the EU! Most of the big banks, including the U.S. banks, have derivatives exposure in the multiples of trillions of dollars. This is a ticking time bomb that the stock market has been ignoring for a long time. Banks stocks have been shunned by investors but U.S. bank stock prices are still closer to the top than the bottom (2009) and yet they're in far worse shape than they were back then. If you want to stay invested in the stock market you should at least be hedged by shorting the banking sector. They'll very likely be one of the leaders to the downside. Keep an eye on the relative strength vs. SPX.

The next comparison is the relative strength of the Transportation stocks vs. Utility stocks and then the RUT's relative strength vs. SPX.


SPX vs. TRAN/UTY and RUT/SPX, Weekly charts

When the economy is contracting there will be fewer shipments of products but people still need to keep paying their utility bills. Investors like the Utes for their relative safety and dividends. When the transports underperform utilities it's a sign the economy is slowing and the stock market will decline. That hasn't happened yet as the market fights to hold onto the highs of the past two years but the message is clear here -- bulls are skating on thin ice. The RUT is likewise underperforming SPX and that's another sign that traders are moving out of the riskier stocks into the relative safety of the big caps. There is always a move to safety by smart money before the stock market starts a serious decline. The amazing thing to me is how long this process is taking but it does support my opinion that the next decline will be far stronger than anything we've seen so far. When it's done most investors will want nothing to do with the stock market (especially since most will be wiped out).

I won't take up more space showing the above charts back in 2007 but I think it's very important to note that the two sets of charts above, into the October 2007 high, looked just like they do now. The bearish divergences have been ignored a long time and could continue to be ignored for much longer. We know the central banks and governments are buying the bond and stock markets (in addition to manipulating currencies) and that's helping (distorting) the stock market but it's also making it much more vulnerable to a downside disconnect (crash). Being long the market right now is much riskier and should be done with the understanding that you could wake up to a very nasty surprise one morning, especially since there's a lot of margin being used at the moment.


Margin Debt vs. SPX, Monthly chart

The chart below shows the amount of margin debt (blue vertical bars) being used to hold stock and you can see how its peaks and troughs coincide closely with the stock market. What's more important to note is that at stock market tops we see less margin being used (the bearish divergences are shown with the black lines). The stock market tops often because it simply runs out of buyers. The officially sanctioned Ponzi scheme, known as the stock market, constantly needs new buyers willing to pay higher prices to those who are selling and when those buyers fail to show up we'll see the sellers start to overwhelm the buyers. Many times there's a catalyst for strong selling but tops are usually associated with waning upside momentum and the drop in margin debt since the peak in 2015 is a big warning sign here -- there are fewer buyers willing to risk margin to buy more. Match this up with the sets of charts above and it doesn't take a rocket scientist to recognize the danger signs for bulls. They're currently ignoring the "Thin Ice" signs and are merrily skating across the pond.


U.S. Dollar contract, DX, Weekly chart

The US$ is consolidating beneath its 50-week MA, near 96.50, but should work its way back up toward 100 over the next couple of months. If it drops below its June 23rd low at 93.02 I'd start thinking a little more bearishly about the dollar but so far it continues to follow my longer-term expectation for a large sideways consolidation before breaking out of the 92-100 range in another rally leg next year.


Gold continuous contract, GC, Weekly chart

Gold appears to be in a mini-blowoff move higher -- higher prices with weakening momentum is typically what happens to the precious metals when the late-to-the-party traders scramble to get aboard the rally (when mainstream publications recognize the trend and urge their readers to buy). If gold rallies much above 1418 I'll be impressed but two equal legs up from its December 2015 low points to 1417.50 and that projection crosses its downtrend line from September 2011 - October 2012 in another couple of weeks. That makes for a great upside target and then a reversal back down for at least a pullback correction before rallying higher. There is still the risk that the 3-wave rally off the December low is just a correction to the longer-term downtrend and once complete we'll see gold head for a new low, possibly below 1000.


Oil continuous contract, CL, Daily chart

For the past several weeks I've shown the oil weekly chart to point out resistance near 51 (price projections, October 2015 high and the broken uptrend line from 1998-2008) and how oil has been consolidating/topping near this resistance. Topping is still a distinct possibility and the choppy pattern off the June 9th high suggests we'll see a fast breakdown if it loses support near 45.80 (today's low was another test of support). But there's a descending wedge that has formed off the June 9th high and that's a bullish continuation pattern. Most times a triangle pattern points to one more leg to complete the larger move, which is up in this case. If the bullish pattern is correct we're going to see a rally up to at least price-level S/R near 58.50 and maybe the May 2015 high at 62.58. This pattern says you don't want to be short oil right here and instead look for a pullback Thursday as a buying opportunity (stop just below 45.80). But if support near 45.80 breaks we could see a very strong decline, in which case you're not going to want to be long.


Economic reports

Tomorrow morning we'll get the ADP Employment report, which is expected to show +152K jobs, a drop from +173K in May. The NFP report on Friday is expected to show +180K, a big improvement from the +38K in May. The actual number may or may not have much of an impact since the Fed has essentially been removed from the equation for the rest of the year.


Conclusion

The stock market continues to hold up in the face of deteriorating fundamentals and as shown on the charts above, in the face of deteriorating technical as well. This can continue for longer than we think possible, especially since central banks have now made it their mission to prevent a stock market selloff. But the market is bigger than the CBs and that's one of the reasons why I think it's so vulnerable now -- faith in the CBs' ability to prop the market up could be quickly dashed in a decline that gets away from everyone. Just as there is only the "good faith of the U.S. government" supporting our dollar, faith in the Fed is waning quickly and the consequences could be severe.

On top of weakening fundamentals and technicals, the worst time for the stock market has historically (since 1950) been between July 17th (July 15th is opex Friday this year) and September 27th. If the stock market holds up into opex next week I'm thinking of stuffing a few put options into my portfolio. I already have some but I want to see how the market performs between now and the 15th before adding to my short position (full disclosure, I am net short the stock market).

Good luck in the coming week 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

 

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