Portfolio rebalancing efforts have been evident in the market as rallies have been sold into as fund managers sell stock and move money into bonds. It's been just a small effort so far but today we saw some winners for the year getting sold harder as money managers take profits off the table into year-end.

Today's Market Stats

Between tax strategies and year-end portfolio rebalancing efforts, it's been a struggle for the market in the past week and today's selling looks to have caught some Santa Claus bulls by surprise. Today's selling was not severe although after the run we've seen since November 4th a 100-point decline for the Dow feels severe. While moves this week (with the low volume and not having everyone present) might not be telling us the real story behind what the market will do in January there are some things we need to watch carefully in order to get some clues for what to expect in the coming weeks.

The only economic report this morning was Pending Home sales for November, which declined -2.5% vs. +0.1% in October. Last week's report on New Home sales showed a +5.2% increase in November so the report was largely ignored. Today's selling was likely related more to end-of-year preparations than anything else.

As we head into the end of the year there is of course much speculation about what the new year will bring us. There's certainly plenty to worry about, especially all the financial difficulties so many countries are facing and the huge debt burdens that are becoming a greater drag on productivity growth. But there are plenty of opportunities to find growth areas and participate in the stocks in those areas.

It seems a majority of analysts have come to expect a pullback correction in January and from a contrarian perspective I have to wonder if too many are expecting a market decline in the beginning of the year. Might the market rally in the beginning of the year, get everyone bullish again and then start a bigger decline? One can only guess but it's something to think about.

Even if the stock market does suffer a big correction in January, maybe something worse than a correction, there are always niche markets that do well. The challenge of course is finding those stocks, especially knowing that the majority of stocks follow the broader market's moves. Think broader market, sector and then individual stock and you'll be able to keep yourself more aligned with a trend.

As we head into the new year we need to be able to identify when the current uptrend might be over and whether or not a new downtrend has started or instead if it will be just a correction within the existing uptrend. Identifying this for the broader indexes and then sectors of interest will then help you identify stock candidates for both long and short plays. I suspect 2017 is going to be a year for traders and not for those who prescribe to buy-and-hold. Once the Trump presidency moves into the "real" work of getting things done rather than just stating what could be done, the current rally could run into trouble.

I want to start off tonight's chart review with a top-down look at the Nasdaq as a way to provide a big-picture look at the techs (and in turn the broader market) and then show what to watch for in the short-term charts.

I'll start with a monthly view to show why I think it's very important here to recognize the downside risk in the coming year(s). I say risk but I also think it's important to recognize the huge money-making opportunity in front of us. I believe 2017 will be a return of the Bear but there's huge profit potential for traders. Bear market declines happen much faster than bull market rallies and that provides us with the potential for huge profits in a much shorter period of time.

Whether you short stocks, buy puts, buy inverse ETFs or any number of ways to play the short side, you will make more money in a shorter period of time than in a bull market. I believe you have a once-in-a-lifetime money making opportunity in the coming year(s). If you're a dyed-in-the-wool(hide?) bull and do not like playing the short side you'll at least want to know where your stops should be so that you don't ride the next bear market (if that's what's coming) all the way down only to have to wait for it to make it back up to where we are currently. But again, playing the short side in the coming year will be an amazing opportunity for traders.


Nasdaq Composite index, COMPQ, Monthly chart

Following the 2000-2002 decline the Nasdaq has fully recovered and finally climbed above its March 2000 high at 5132.52 with a monthly close at 5162 in July. Other than a dip back below that level in September and then a little deeper dip into the November 4th low (5034), it's been able to hold above 5132, which is obviously bullish.

The problem is that the new high above the 2015 high is showing bearish divergence against that high, and really since the end of 2013, and it's likely near the completion of the leg up from 2009. This is potentially important because the move up from 2002 is a 3-wave move and from a bearish perspective (I believe we're still inside a secular bear market) we could be close to the completion of an A-B-C bounce correction, albeit a big one, off the 2002 low. The secular bear says we are still due one more leg down for a larger (a)-(b)-(c) pullback from the 2000 high before we'll be ready for the start of the next secular bull.

This interpretation of the secular cycle calls the 2002-2007 and 2009-2016 rallies cyclical bull markets within the larger secular bear. The significance of this is that the next leg down to complete the secular bear will likely be more severe than the 2002-2202 decline and very likely will drop the Nasdaq to a new low below the 2002 low at 1108. Even a drop down to test that low would be an 80% decline from here and I don't think there are many of us who would like to hold through that decline just because "the market always comes back."


Nasdaq Composite index, COMPQ, Weekly chart

There are two points to make about the parallel up-channel for the move up from the May 2011 high, which is shown a little closer with the weekly chart below. First, the parallel channel helps identify the wave count and the EW technique is to draw a trend line from the top of wave-1 (May 2011 high) to the wave-3 high (July 2015). A parallel line is then attached to the wave-2 low (October 2011) and this line is where you watch to see if the 4th wave will find support there, which it did with its low in February 2016.

The second point is that the 5th wave, which is the rally from February, often stays in the lower section of the up-channel and as you can see it has not been able to climb above the midline (dotted line) of the channel since dropping below the line in January. It is currently testing the midline again for the 3rd time since the February low. A "3 drives to a high," which we have seen since February, is usually an ending pattern because it's the completion of a 5-wave move. This and the bearish divergences against the 2015 high and the August/September highs is what helps us confirm we're seeing the 5th wave of the move up from February, which in turn will complete the 5th wave of the move up from 2009. Once a 5-wave move completes we'll see at least a correction to the move (the rally from 2009) but the more bearish interpretation, as mentioned for the monthly chart, is that we could be looking for the beginning of the next leg down to complete the secular bear.


Nasdaq Composite index, COMPQ, Daily chart

The daily chart of the Naz shows a rising wedge pattern for the rally from February and the small bearish divergence since July, which again helps confirm we're probably seeing the 5th wave of the move up from February. The 5th wave, which is the leg up from November 3rd, might not be finished yet and as depicted on the chart below, we could get another rally to complete the move. An upside target is 5600-5625 to complete a small rising wedge for the rally from November.

A rising wedge to complete a larger rising wedge would be a very bearish setup in January if it completes as depicted. But one interpretation of the pattern suggests this week's high is the completion of the rally and therefore trying a long play from here is risky. Having said that, a long play with a stop just below the 20-dma, near 5410, is not a bad risk vs. reward play. Just be sure to honor your stop. A break of its uptrend line from November 3rd, currently near 5447 (log price scale), which was done with today's low close at 5438, and then the 20-dma would more strongly suggest a top is already in place. That makes it important for the bulls on Thursday to recover from today's decline.

Key Levels for COMPQ:
- bullish above 5625
- bearish below 5232


Semiconductor index, SOX, Daily chart

One sector negatively affecting the tech indexes today was the semiconductor sector. The SOX left a bearish engulfing candlestick for an outside down day (gapped up, made a new high, closed below yesterday's close). It almost engulfed last Friday's candle as well. Tuesday the SOX had closed above the top of a rising wedge for its rally from February but today it closed back below the line, currently near 928. That leaves a throw-over finish and now puts it on a sell signal and the only way to negate the signal is with a rally above this morning's high at 944.23. If the SOX has topped out it's going to make it more difficult for the techs and broader market to rally since a rally without the banks and semis is typically a warning sign. Later we'll see how the banks are looking.


S&P 500, SPX, Daily chart

SPX had been forming what looked like a sideways triangle consolidation pattern off its December 13th high but that was negated with today's decline. We either have an important high already in place or else today's decline was the completion of a simpler a-b-c pullback correction off the December 13th high. Two equal legs down for that kind of move is near 2245, only slightly lower than today's low at 2249. Its 20-dma will be near 2246 on Thursday so we have potential support at 2245-2246 to then launch another rally leg, which is what I'm depicting.

Another leg up would be the 5th wave of the move up from November 4th and an upside target for it would be near 2300. This is the kind of rally that would have many believing we won't get a decline in January but in fact it would give us an outstanding opportunity to play the short side. Now all the bulls need to do is prevent SPX from dropping below 2244 (on a closing basis) since that would point to the possibility that an important high is already in place.

I've recently discussed the importance of 2271-2273 on the Gann Square of 9 chart (aligned or square with the March 2009 low for price and date) and it's important to note how that resistance zone has held on a closing basis since first tested on December 13th. Based on this Gann relationship I'm very tempted to call a top already in place but I'll let the market determine that from here. Again, the bulls need to do something on Thursday to at least give them the chance for one more new high.

Key Levels for SPX:
- bullish above 2278
- bearish below 2244


S&P 500, SPX, 60-min chart

The 60-min chart below shows a parallel down-channel for the pullback from December 13th, the bottom of which is currently near the downside projection at 2244.93 for two equal legs down from the 13th. It's a bull flag until proven otherwise (with a breakdown below 2244). That makes it a decent play on the long side if support holds since you can keep your stop tight (near 2244 on a closing basis).


Dow Industrials, INDU, Daily chart

While SPX had been trading sideways in what looked like a pennant until today, the Dow had been trading in more of a rising wedge pattern and that had it looking more like an ending pattern. But the bottom of a parallel channel for its consolidation which is up-sloping as compared to the down-sloping channel for SPX, is currently near 19817, only 10 points below today's low. A drop below the bottom of its channel and more importantly a drop below its December 14th low at 19748 would signify the bulls are losing the battle and that could embolden the bears. The risk this week is that the week could simply be more volatile than usual because of the lower trading volume. As with the other indexes, there is still the potential for another rally leg, one which should leave a bearish divergence against the December 13th high.

Key Levels for DOW:
- bullish above 19,981
- bearish below 19,748


Russell-2000, RUT, Daily chart

The RUT also dropped below the bottom of a sideways triangle that it had been forming since its December 9th high. Currently near 1365, watch to see if it acts as resistance on a back-test on Thursday since that would obviously be bearish. But at the moment the drop below the bottom of the triangle can be considered just a throw-under completion to the triangle, which will now be followed by the next rally leg. As depicted on its chart, I see the potential for a rally to its trend line along the highs from 2007-2015 (the top of its big megaphone pattern that I've shown in the recent past on its weekly chart). Today the RUT held at its 20-dma, practically to the penny on a closing basis at 1360.82 and that makes it especially important for the buyers to return to the table on Thursday. A drop below the bottom of its sideways triangle and its 20-dma would be a bearish development.

Key Levels for RUT:
- bullish above 1405
- bearish below 1347


20+ Year Treasury ETF, TLT, Weekly chart

So far TLT is holding support at its uptrend line from 2011-2013, which was tested the week before last. The bounce pattern is not that impressive and has me wondering if we'll see another leg down to test its June 2015 low at 114.88 before setting up at least a stronger bounce. But if the bounce can get back above its 200-week MA, currently at 120.19, it would be a signal that an important low is in place. A rally in TLT would likely coincide with a decline in the stock market so it's an important symbol to watch. If we do get another rally leg out of the stock market into mid-January I suspect we'll see TLT drop lower and potentially to the 114.88 support level.


KBW Bank index, BKX, Daily chart

Like the SOX, the banks were relatively weak today as well and that certainly didn't help the bulls try to recover from today's selling. BKX also left a small bearish engulfing candlestick today and engulfed the previous 5 trading days (which were just small-bodied candles as BKX traded sideways in a tight range). From this perspective it looks like the bears could take over from here but a better result for the bears would be a break below its 20-dma, which will be near 92 on Thursday. A drop below that level would also be a drop below the bottom of a possible ascending triangle for its consolidation off the December 8th high so that would be more bearish. In the meantime, if BKX can hold above 92 there is still the potential for BKX to rally to at least the trend line along the highs from last March-April, which will be near 95.50 by mid-January. Above 96 would be even more bullish.


Transportation Index, TRAN, Daily chart

The TRAN is also now on a sell signal after failing to hold its breakout attempt into the December 9th high. It had broken out above the tops of two parallel up-channels, from January and June, which cross near 9245, as well as above its November 2014 high at 9310. But it has now dropped back below all of those levels, including its 20-dma at 9211, and that leaves a failed breakout attempt. A rally back above 9310 would at least have it neutral but at the moment the TRAN is bearish.


U.S. Dollar contract, DX, Weekly chart

Like the stock market, the US$ has been consolidating since mid-December and it's not clear whether this consolidation will lead higher or if it is instead a topping pattern. The dollar has stalled at Fib resistance at 103.20-103.33 with a high so far at 103.62 on December 20th. That high was tested with today's high at 103.57 but the highest closing prices since mid-month were 103.26 on December 20th and 103.23 today. If it can close above 103.50 and stay above that level we could see the dollar stair-step higher into January. But at the moment the dollar is looking vulnerable to at least a larger pullback and possible back down to the bottom of a megaphone pattern following its March 2015 high.


Gold continuous contract, GC, Weekly chart

As the dollar has consolidated since December 15th so too has gold. At its 1124.30 low on December 15th it came within $3 of the price projection at 1121 where the 2nd leg of its decline is 162% of the 1st leg down. If gold continues to consolidate the rest of this week and maybe into next week, the more it will look like a 4th wave correction in the decline from July, which would more strongly suggest another leg down is coming, one which could reach down to its December 2015 low at 1045 before setting up at least a larger bounce. When the gold bugs give up on buying this "dip" (I'm still getting daily newsletters suggesting I'm an idiot if I don't buy gold here) it will be a better time to try your hand at buying some gold. But gold is oversold on a weekly basis so it's certainly not a good time to chase it lower.


Oil continuous contract, CL, Daily chart

Oil has been working its way up toward a price projection at 54.94, with a high so far at 54.51 on December 12th and today's high at 54.37, for two equal legs up from August. Coinciding with that projection is the 127% extension of the previous decline (June-August), at 55.06, which gives us a 54.94-55.06 target zone. This target zone crosses the top of a parallel up-channel from August early next week and the setup continues to look good for a top near 55. Oil would be more bullish above 55 but if it does top out near 55 it remains to be seen what kind of pullback/decline will follow. The larger pattern suggests the corrective bounce off the February low could be completely retraced, which would knock oil back down towards its February low near 26.


Economic reports

Other than the Chicago PMI on Friday there are no other major economic reports the rest of this week.


Conclusion

Between tax selling this week and rebalancing of portfolios (selling stock and buying bonds to bring ratios back in line with fund mandates) it could be tough on the bulls the rest of this week. And if the stock market doesn't recover Thursday and into Friday it could be tough on the bulls well into January. The bulls need a recovery on Thursday to keep the bullish pattern in play, which calls for a rally to new highs into next week and potentially into mid-January. Most analysts are expecting a January pullback, which perversely is why we could see a rally.

Follow the charts and take it a day at a time from here. While there is upside potential for one more rally leg, the longer-term pattern suggests now is not a good time to be aggressive on the long side. It's too early to tell whether or not you should join the bears but it could soon be time to thank the bulls for the ride and shift over to the bear's camp. If I have the longer-term pattern correct, 2017 should be an exciting year to be a trader. There's a lot of money to be made in a fast moving bear market but we'll let the charts tell us when it's time to play with the bears. For now, and unless we see a strong decline on Thursday, stick with the uptrend.

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


 

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