The stock market had been chugging higher this month but on much weaker volume and momentum. But it was looking like this opex week had the chance to be another bullish one, until the selling hit on Monday. Tuesday's selling continued today and some support levels were broken but the recovery off the morning low gives the bulls another chance to pull a rabbit out of the hat and save the week from being negative.

Today's Market Stats

The price pattern up until Tuesday's selloff was supporting the idea that we'd see the market hold up for at least a few more days before stronger selling might hit. But Tuesday's selling followed by the selling this morning had the bulls on the ropes and it wasn't looking good for them. Someone then stepped in to rescue the poor bulls and left Wednesday neutral, which in turn leaves the week looking like it could easily go either way. That's of course not very helpful for traders trying to pick a direction.

Until Tuesday's selloff we had the indexes in synch with rising wedge patterns for the leg up from August 2nd, which fit as the final leg for the rally from June 27th. But the rising wedge patterns did not finish and that leaves an unfinished pattern to the upside, which in turn leaves us guessing what kind of pullback we could get before proceeding higher. A more significant high could be in place but unfortunately that can only be guessed at this point without a supporting price pattern. The thing going for the bears, at least for the short term, is that short-term uptrend lines have broken and so far there's been no attempt to recover them.

Providing a little bit of volatility this afternoon was the release of the FOMC minutes from last month's meeting. In the minutes the Fed made reference to an improving economy but provided no hints or clues about when they might raise rates again. The market is left to wonder if September is still possible (highly unlikely) or if December will be the month (also not likely). The discussions that come out of the Jackson Hole meeting on August 26th might provide some more clues but probably not. I don't think the Fed has a clue about this economy and therefore when will be an appropriate time to raise rates. It's the lack of inflation that has the Fed flummoxed.

Making it more difficult for the Fed to even think about raising rates is that it would make the dollar stronger and hurt international trade. Most of the other central banks, including Japan, England and the ECB, are talking about further easing with more money, lower (negative) rates and more asset purchases. It's a little hard for the Fed to try to raise rates in that environment.

There's a big question about what there is left to drive this market higher. There's of course central bank money and government investments but with the European crisis hitting a lull (it will be back) and Brexit fears subsiding, the need to prop up the market has gone away (for now). Earning's expectations have helped some bullish sentiment but it turns out it wasn't a great earnings season.

With the earnings season winding down it could be difficult for the market to make more headway to the upside. Already it's been a slow grind higher on very low volume in the past week (lowest we've seen since 2007) and even though most companies "beat" earnings expectations, those expectations have been carefully managed by companies to ensure the stock analysts will provide numbers that the companies can beat. But those expectations have been consistently lowered and they're now struggling to keep them positive even while using all kinds of accounting tricks to do so. Companies are back to playing the games we saw at market tops in 2000 and 2007 (non-GAAP reporting).

Corporate buybacks have supported the stock market since 2009, adding well over $2T (that's a 'T') buying power to the market, which dwarfs anything the Fed has tried to do. Most of the corporate profits over the years have gone into stock buybacks, which prompts the question "what happens when corporate profits dry up?" Companies have also been on a debt binge, with rates so low, and then using the borrowed money to buy back more of their own stock. Investments in capital equipment and business expansion have been nil because the companies didn't see the demand out there. We've had a very slow recovery since 2009, the slowest since WWII.

At some point, especially with profits drying up, servicing all of the debt used to buy back stocks will become more difficult and lower profits, higher debt payments and fewer loans (bond issuance) will result in fewer stock buybacks. Lower profits also increases the P/E ratio since the 'E' is declining, which gives us a stock market that is becoming more overvalued that's been held up primarily through the support of corporate buybacks. When the music will stop is anyone's guess but with the profit decline now falling into negative territory I don't think the market has much more wiggle room higher.

The chart below shows corporate profits since 1965 (it's hard to read the top of the chart but the values include inventory and capital consumption adjustments). The main point of the chart is that whenever the corporate profits have dropped into negative territory, as it now has, it's been followed by a stock market correction (if not a crash). Will this time be different? That's a dangerous bet but obviously possible in this world of central bank money and government involvement.

Corporate Profits, 1965-2016, chart courtesy fred.stlouisfed.org

The larger point out of all of this is that there are fundamental reasons why the stock market should not be rallying. But the stock market has continued to rally in the face of all the weakness and that's an important message. Price is king and that's all that matters. It's like news -- it doesn't matter; the only thing that matters is how the market reacts to the news. Where is price going? And that's why we use charts and even though the charts have been showing us plenty of reasons to doubt the rally, and therefore not particularly helpful, it's the best tool we have. It's like Winston Churchill telling people that democracy is a lousy form of government, until you compare it to all the rest. So let's start with the SPX weekly chart and work down.


S&P 500, SPX, Weekly chart

The SPX weekly chart has the appearance of topping as MACD and RSI start to roll over. But on a weekly basis there's no bearish divergence to suggest this could be an important top and since MACD has not crossed down yet (even on my faster 8,13,5 setting) there remains the potential for the rally to continue higher as MACD and RSI flatten out in overbought. The price projection at 2223 is the 127% extension of the May 2015 - February 2016 pullback, a common Fib target/resistance level. It doesn't mean SPX will get there but it's a level of interest if reached. In the meantime it's looking vulnerable to at least a larger pullback and maybe something more bearish.


S&P 500, SPX, Daily chart

Monday's high for SPX was a test of the trend line along the highs from April-July and today's pullback was another test of its 20-dma, near 2175. I show another push higher to the trend line again, perhaps up to 2200 by mid-week next week. Above 2200 would be more bullish, in which case I'd look for 2223 mentioned on the weekly chart above. The big strike against the bulls is the significant bearish divergence on MACD. This can of course be negated with another rally but it's showing the weak momentum for the rally from August 2nd, which fits as the 5th wave of the rally from June 27th. If the 5th wave completed on Monday we'll get at least a larger pullback (test the May 2015 high near 2135?) and maybe something more bearish.

Key Levels for SPX:
- bullish above 2200
- bearish below 2147


S&P 500, SPX, 30-min chart

I'm trying to make sense of the shorter-term wave pattern since that's usually a good way to see a setup for a reversal. Unfortunately all we're getting are corrective moves in both directions. That typically means it's an ending pattern and the setup going into Tuesday was for a pullback and then one more leg up to finish a rising wedge pattern. The completion of a rising wedge would have been a great setup for a reversal to trade but that setup got blown out of the water with the Tuesday-Wednesday decline. But that decline turned into just another 3-wave move (labeled a-b-c on the chart), which means it could head higher from here or it could be part of a larger pullback before heading back up. The bottom line though is that without a clean ending pattern to the upside the odds are we'll get another push higher from here or after a larger pullback. Short-term trading in this corrective price environment is the best (and most difficult) way to trade -- get in and out quickly before the market reverses again.


Dow Industrials, INDU, Daily chart

The Dow's daily chart is similar to SPX with just a little more upside potential than SPX to reach its trend line along the highs from April July, which was not tested with Monday's high like SPX did. I have two price projections based on its pattern that correlate closely -- on at 18778 and the other at 18828, so basically a 50-point spread from about 18780 to 18830. The trend line along the highs crosses these projections on tomorrow and August 26th. It doesn't mean the Dow will get up to that target zone, or stop there, but watch closely for a possible high if reached (if a high is not already in place).

Key Levels for DOW:
- bullish above 18,830
- bearish below 18,247


Nasdaq-100, NDX, Daily chart

The biggest negative I see for the NDX is its breakout failure. Last week it struggled to get above its March 2000 high at 4816.35 but then did so with Monday morning's gap up and close at 4827. The problem for the bulls was Monday's volume was the lowest seen since 2007 so it was hardly a bullish breakout. And then on Tuesday it dropped back below 4816 and dropped further today before recovering back into the green, but still below 4816. This leaves a failed breakout attempt as traders take profits after having achieved the short-term victory with a new all-time high. Now there's the risk for profit taking to turn into a more significant decline as more trader stops are hit. Between its 20-dma, near 4750 on Thursday, and its December 2015 high, near 4740, there should be good support if reached. A drop below 4740 would signal something potentially a lot more bearish happening. However, like the blue chips, the pullback from Monday is a 3-wave pullback and it could lead to another push higher directly from here or possibly after a little larger corrective pullback.

Key Levels for NDX:
- bullish above 4820
- bearish below 4689


Russell-2000, RUT, Daily chart

The RUT is in the same pattern as the others and it's the 3-wave move up from August 3rd that has me wondering if maybe we're see a larger rising wedge pattern for the rally to hold up into the end of the month, which I depict in green on its chart. This would be a very frustrating pattern for traders on both sides but I think especially for bears who are already extremely frustrated in this market's ability to simply float higher (albeit slowly) in the face of deteriorating economics and earnings. To bears the question is what kind of catalyst is it going to take to knock this market down. If the RUT drops below price-level S/R near 1215 it's going to look more bearish and as with the others, a drop below the August lows would tell us the top is in place. Whether that top will be just temporary or something more significant would have to be figured out later but for now, the bulls maintain control as long as the pullbacks remain corrective.

Key Levels for RUT:
- bullish above 1244
- bearish below 1198

I mentioned the possibility for the RUT (and the broader market) to push higher into the end of the month and this is supported by relationships between important dates on the Gann Square of Nine chart. Projections from important dates, starting from the 1929 crash, are aligning in the first week of September. The March 2000 high was followed by a September 1, 2000 high and that led to a strong decline into September 2001. Looking at Fibonacci and Gann projections sees additional pointers to the 1st week of September this year so the price projection shown on the RUT's chart would meet both a time projection and price pattern for completion of the rally. For now it's just something I'm watching for while staying aware of the possibility the high is now already in place.


KBW Bank index, BKX, Daily chart

How the banks are doing is usually a good indicator for the broader stock market and at the moment BKX is threatening to break its downtrend line from July-December 2015, near 70 (today it closed at 70.05. Following its failed attempt to break its downtrend line on August 8th it will either be successful here or form a double top at an important downtrend line. A drop below last Friday's low at 68.57 would be a bearish heads up.


Transportation Index, TRAN, Daily chart

A downtrend line from August-November 2015 is where the TRAN was stopped in April and again in July. Currently near 7966, it's only a little higher than where it's currently trading (today's close was 7882). But short term, the TRAN broken its uptrend line from June 27th today and then bounced back up to it by the close. That leaves a potential back-test and bearish kiss goodbye if it sells off on Thursday. Otherwise watch for another test of its downtrend line.


U.S. Dollar contract, DX, Weekly chart

The US$ has pulled back from its July 25th high is what is so far a 3-wave correction to the rally from May. Two equal legs down for the pullback points to 93.82 (yesterday's low was 94.38) so there's a little more downside room for just a normal pullback but at the moment it's holding the bottom of a parallel up-channel from May, currently near 94.75. On the weekly chart you can see the top of its parallel up-channel from 2008 (bold blue line) and the top of the up-channel from May 2011, near 94.27 and 93.57, respectively. Yesterday's low nearly tagged the higher level while the projection for two equal legs down is closer to the lower level. Therefore I wouldn't consider the dollar more bearish until it drops below 93.50 but even then it should still stay range bound if it stays above the May 2nd high at 91.88.


Gold continuous contract, GC, Weekly chart

Gold is showing bearish divergence on its daily and weekly charts since March and a steeper divergence since July) so it's questionable whether or not we'll see another high for gold. But it still like the pattern that supports one more new high to a 1417.50 price projection or at least to its downtrend line from September 2011 - October 2012, currently near 1405. A drop below price support at 1308 and then its uptrend line from December 2015, near 1285 (which is also the 38% retracement of its 2001-2011 rally), would be an indication the top is in place. Whether that top will be just one of many in a new bull market or instead the top of a bounce correction that will lead to a lower price (the way I'm currently leaning) will have to be figured out after the pullback/decline gets started.


Oil continuous contract, CL, Daily chart

Last week oil broke out of its down-channel that it had been in since the June 8th high. It's been in a strong rally since the breakout and on Tuesday it broke back above its 50-dma at 45.70, which has it looking more bullish. There are only a couple more things the oil bulls need to do to prove we have more than just a bounce correction off the August 3rd low. First is to rally above the 62% retracement of its decline from June, which is at 46.90 (today's high was 46.95 but it closed at 46.84). The second thing oil needs to do is break its downtrend line from June 2014 - June 2016, currently near 47.90. And with those two things done it will have broken its downtrend line on MACD, which it's currently testing. But the bearish setup here is for the 3-wave bounce off the August 3rd low to lead to the next leg down so it's going to be important what oil does from here. A continued rally in oil could add support for the stock market.


Economic reports

Tomorrow we'll get the unemployment numbers, the Philly Fed index and Leading Indicators. Other than the Philly Fed index, if it surprises one way or the other, these won't be market moving. There are no major economic reports on Friday.


Conclusion

The pullback from Monday's high has the potential to lead to something stronger to the downside but with the decent bounce off today's low there is an equal chance the market will simply continue marching higher from here. The price pattern remains corrective and that keeps both sides guessing which way this market will head from here. We could get a larger pullback pattern before heading higher or of course it could continue to drop lower.

The recent buying has been on very weak volume and declining momentum so it's hard to bet on the upside. But this rally has defied both fundamental and technical reasons why the rally should have failed long ago and it could continue to defy those reasons. As mentioned earlier, there are some timing reasons why the rally could continue into the first week of September and while the rally might be a laboring choppy affair, it would still frustrate the hell out of the bears. Without seeing an impulsive decline I'm inclined to think the top of this rally is not in yet.

Having said that, I think downside risk dwarfs upside potential and because of that and the potential choppy move higher I'd be reluctant to trade big in either direction for now. Trade small and trade quick while we wait to see how the rest of the month plays out.

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