Other than the techs making minor new highs each day (only NDX today), the rest of the indexes are struggling just to hold onto recent gains. The bulls haven't done anything wrong yet but there are plenty of signs that they're weakening. This year's rally is looking like it's on wobbly legs.
Today's Market Stats
The stock market's rally this year has been largely due to overnight rallies in the futures market. That has given us gap-up starts to the day and then a quick bout of short covering that has typically finished in less than 30 minutes. Generally speaking, there's been very little, if any, follow-through to the gap-induced rallies. The sideways consolidations and/or selling of rallies has it looking like an effort to distribute stock to the retail crowd, with the help of continued corporate buybacks.
What looks like an effort to distribute stock from smart money managers to the retail crowd, which includes most mutual fund managers, has been a slow and steady effort that hasn't prevented the indexes from working their way higher (except for the RUT). Corporations continue to sell record levels of corporate bonds, which they're using to help fund their corporate buybacks. The retail crowd has backed away from buying stock this year after their initial excitement following the November elections so it's been a struggle to keep the rally going.
This morning reversed what we've seen in the past week by starting with a gap down and quick selling. Once the selling completed in the first 10-15 minutes we saw the indexes bounce right back up. But the jam back up into a mid-morning high (a minor new high for NDX but not the others) was then followed by another choppy consolidation. It's as if someone doesn't want the market to sell off yet but doesn't have quite enough buying power (or desire) to push the market much higher. It was a mixed day with the indexes floundering around the flat line for most of the day.
Other than the gap moves and maybe an early-morning move like this morning's jam back up there's been very little for traders to do this month as we watch the indexes work their way higher (except for the RUT, which remains trapped in a 2-month sideways choppy mess). The bulls have been able to hang on and participate in the incremental moves to the upside while the bears continue to be bewildered about how the market can continue to hold on a push slowly higher while momentum dies on the vine.
The stock market is showing many signs of tiring and I think the slow choppy move higher is an ending pattern for the rally and that soon the bulls will be stopped out as the bears enter their short trades. The result will likely be a strong decline in the coming weeks and as I'll get into with the charts, we could be days, if not hours, away from a significant high. At least we have the setup for a significant high but as always, we wait to see if the market agrees with my assessment or not.
Other than the crude inventories report this morning, there were no significant economic reports to sway the market. As I'll discuss later, with the oil chart, the large buildup in crude inventories (+13.8M barrels, which follows +6.5M in the prior week) combined with a relatively high price for oil, is not a good combination for bulls. And when the price of oil drops sharply it's usually not a good time to be long equities either (it's that slowing-economy thing).
In addition to what I see as topping patterns for the stock market indexes, there are some fundamental reasons to be concerned about the stock market. Overvaluation is one and while there are several methods used to value stocks there is one generally accepted way of using earnings, which is the cyclically adjusted price-to-earnings (CAPE) ratio.
CAPE is similar to the P/E ratio except that it uses the past 10 years' worth of earnings instead of just the previous year. This helps smooth out big fluctuations year-to-year. At the moment the CAPE for the S&P 500 stocks is 28.4, which is 70% higher than its historical average of 16-17. To put this into perspective, it's now higher than at any time since the dot-com bubble in 2000.
Another valuation method is the price-to-sale (P/S) ratio, which is similar to P/E in that it uses just the previous year's sales and the current price. For the S&P 500 this ratio is currently 2.02, which is 40% above its historical average of 1.44. Again, this ratio is at its highest level since 2000. Both the CAPE and P/S are above where they stood in 2007 (the housing bubble).
We know that the stock market has been out of whack with what's going on with the economy (Main Street and Wall Street have been disconnected for a long time). Since 2009 the S&P 500 is up nearly +240%, making it one of the strongest bull markets in history. But at the same time the U.S. economy has grown only +2% per year, about +15% since 2009. If the S&P 500 grew by the same +15% we'd be looking at 767 instead of 2300. That's not chump change.
Fundamental measurements of the stock market have never been good for timing the market and the above information is only to give some perspective how overvalued it is. The more overvalued the market becomes the more bubble-like it becomes and that makes it more vulnerable to a downside disconnect. Assuming the market is ready for a reversal, which I believe it is, what we can't know is whether we'll get just a healthy (-10%) pullback before heading higher or if instead we are at a similar point as we were in 2000 and 2007. I believe it's the latter but obviously my crystal ball is no better than anyone else's. I just think it's not a good time to ride a correction down thinking "it always comes back."
On top of what I see as a vulnerable time for the stock market we have extreme bullish sentiment as measured by Investors Intelligence. The latest report shows bulls at 62% and bears at 16%. That's a very wide spread and 62% bulls is the highest it's been since 2005. Again, this can't be used as a timing signal but it simply shows more vulnerability. Other than corporate buybacks the market is simply going to run out of buyers when pretty much everyone is already in the pool.
OK, with all of that as "background," let's see what the charts are telling us, starting off with the NDX weekly chart since this has been the stronger index.
Nasdaq-100, NDX, Weekly chart
At the January 26-27 highs NDX ran into the trend line along the highs from April-September 2016, which fits as the top of a rising wedge for the rally from February 2016. The wave count has us in the 5th wave of the rally, which is the leg up from November 4th. Following a quick pullback from the January 27th high NDX has again pushed up to the top of its rising wedge and until we see a clean breakout from this wedge I think it's important to watch for a possible top.
Nasdaq-100, NDX, Daily chart
The NDX daily chart shows the price action around the top of its rising wedge (the trend line along the highs from April-September 2016) and how it stopped yesterday's and today's rally (it closed on the line today). All it needs now is a gap-up over resistance to bring in the buyers. I say that tongue-in-cheek but it is the way this market deals with resistance.
A trend line along the highs from November 10 - January 27, at 5230-5250 depending on how long it takes to reach it, is the next upside target zone if it breaks above 5210 and holds above 5200. Otherwise, with an extended rally leg since December 30th and now showing bearish divergence against the January 27th high, I think it's a risky bet on the long side. A break of the uptrend line form December 30th, currently near 5174, confirmed with a drop below this morning's low at 5169, would be the first sign of a top being in place.
Key Levels for NDX:
- bullish above 5210
- bearish below 5086
Nasdaq-100, NDX, 60-min chart
There are two price projections for the 5th wave of the leg up from December 30th, with both coinciding closely at roughly 5205-5207. If we see a quick pop up to that level Thursday morning and then a drop below this morning's low near 5169 it would provide all the proof I'd need to see to declare a top in place. The bearish divergence vs. the January 27th high helps confirm we're into the final 5th wave. But if it rallies above 5207 and then uses the April-September trend line, currently near 5202, for support it will keep the pattern at least short-term bullish.
Powershares QQQ Trust, QQQ, Daily chart
The QQQ is of course the ETF that can be used as a trading vehicle for NDX and it's good to look at for volume. On its daily chart below I also have the Bollinger Band and you can see how it's been pushing up the top of the envelope since December. But while QQQ has been pushing higher it's been doing so on declining volume since November's rally started.
Declining volume is another indication that the rally is running out of buyers and in a rally that is pushing up against resistance it's reason enough to at least pull your stops up tighter. Note the bearish divergence on the Money Flow Index (MFI) at today's high vs. the highs at the end of January. This bearish divergence fits with what we see on the NDX charts above.
Semiconductor index, SOX, Daily chart
Helping the techs has been the semiconductor stocks and as long as they remain strong it's actually a good sign about the economy (semiconductors are so many different products that they're a good reflection of production). But the SOX is in an ending pattern and showing bearish divergence since the end of November. The wave pattern calls the rally from January 6th the final 5th of the 5th wave in the rally from February, which means the rally could reverse at any time.
The SOX has been following the trend line along the highs since last March and is approaching a trend line along the highs from July 2014 - June 2015, currently about 14 points higher near 986. I'm not sure if it will make it much higher, if at all but at the moment there's no reversal signal, just a warning sign that it could top out here.
S&P 500, SPX, Daily chart
Since the January 31st low I've been thinking SPX has a good shot at reaching the 2320 area where it would hit its trend line along the highs from August-December 2016 by the end of this week. There are some cycle studies that point to February 8-10 as a turn window. As an example, a 50-day cycle off the February 2016 low has today as a turn date, +/- 1-2 days. An important number on the Gann Square of 9 chart is 2321 since it aligns with the date March 6, which is the date of the 2009 low. There's also a full moon and lunar eclipse (and a comet flyby) this Friday night/Saturday morning.
So we have a lot coming together this week for what could be a very important high and frankly I thought we'd see SPX do better than it's done this week. Has it simply run out of steam? As Scotty would say to Captain Kirk, "I'm giving you all I got!" The choppy consolidation off last Friday's high could lead to one more leg up but like NDX, if it drops below this morning's low at 2285 I think the fat lady would be singing the blues for the bulls. That would not be confirmed until we see a drop below the January 31st low at 2267.
Key Levels for SPX:
- more bullish above 2325
- bearish below 2267
Dow Industrials, INDU, Daily chart
On January 31st the Dow broke its uptrend line from November 4 - January 19 and on February 3rd and again on Tuesday it back-tested the broken uptrend line. Today's decline leaves a bearish kiss goodbye following the back-test, which leaves it vulnerable to further selling. But we've seen the Dow in particular nuzzle up underneath broken uptrend lines before finally letting go. That remains a possibility but would become less likely if it closes below this morning's low at 20015.
Note also that with Tuesday's high the Dow came very close to the top of an expanding triangle off its December 13th high. This is a bearish topping pattern and can be viewed as the left half of a possible diamond top pattern.
Key Levels for DOW:
- bullish above 20,200
- bearish below 19,785
Russell-2000, RUT, Daily chart
The RUT has been banished to the desert for 40 days and now maybe it's finally ready to make a move. Since its December 9th high today is the 40th trading day inside a choppy sideways/down consolidation. Too bad we don't have any clues as to which way it's going to break. I've been viewing the pattern as a bull flag pattern but this has gone on so long that I can also now view it as a rolling top pattern.
We'll just have to wait for a breakout or breakdown from this pattern, with a rally above 1385 or a decline below 1333, before we'll know which way this is going to go. One caution is to watch carefully for a head-fake break that's then followed by a reversal back inside the pattern. That would be a good signal for a sustained reversal (e.g., if it does a quick drop below the bottom of the pattern but then reverses and closes back inside the pattern it would be a bullish buy signal).
Key Levels for RUT:
- bullish above 1385
- bearish below 1333
10-year Yield, TNX, Weekly chart
There was more buying in the Treasury market today, which didn't help the stock market as money could be rotating out of stocks and back into bonds. This is dropping the yields and TNX is back down to its broken downtrend line from 2007-2013, which it had broken above on December 1st. I thought the bounce off the line on January 18th would lead to a rally up to 2.687% where it would achieve a Fib projection for an a-b-c bounce correction off the January 2015 low. While that projection is still in play, it's starting to look like it's vulnerable to the downside from here.
A drop below its January 17th low at 2.313 would be bearish since it would leave behind a failed breakout above its longer-term downtrend line. We might get just a larger pullback to its 200-week MA, near 2.24, before heading back up but that can only be guessed right here. We'll have to see where it goes in the coming week to see whether or not support is going to hold. If the stock market is setting up a reversal to the downside I think TNX will be leading to the downside (as money pours into the relative safety of bonds).
High Yield Corporate bonds ETF, HYG, Weekly chart
While on the subject of bonds, the high yield corporate bond fund, HYG, is showing some vulnerability here as well. The decline off the October 2016 high found support at the 50-week MA and the November 14th low has been followed by a bounce back up to the October 2016 high at 87.56 (with a high at 87.69 on January 27th). HYG could continue up to at least its 200-week MA, currently at 89, but the daily chart says it could be trouble here.
The bounce off the November 14th low fits as an a-b-c bounce correction and achieved two equal legs up at 87.66 (only 3 cents higher on January 27th). The daily chart looks like a rolling top is developing since the end of December and you can see the bearish divergence on the weekly chart. If it drops back below price-level S/R near 86.30 it would be a good sell signal. As a measure of desired risk, a sell signal for junk bonds would be a warning sign for the stock market.
Transportation Index, TRAN, Daily chart
The transports look like they're in trouble as well. At its January 26th high the TRAN tested its December 9th high but then rolled back over, leaving a double top with significant bearish divergence. Each attempt, in December and again in January, it got above its November 2014 high at 9310 but was unable to hold above, which left two head-fake breaks.
The TRAN is currently trying to hold onto its 20- and 50-dma's, near 9238 and 9190, resp. Today's close near 9246 is marginally above both MAs and if it can get back above 9310 and hold above it for more than a day it could have a fighting chance to make a new high. But at the moment it's not something I'd bet on happening.
U.S. Dollar contract, DX, Daily chart
Last week I had mentioned I thought the US$ was ready for a bounce correction before continuing lower. The bounce started after a quick new low on February 2nd but has more upside potential before heading back down. However, it hasn't been able to bust through its declining 20-dma, currently near 100.40, and it's possible the dollar will drop further before setting up a bigger bounce correction.
Gold continuous contract, GC, Daily chart
With the dollar in decline it has given a boost to gold and while it's currently struggling to get past its October 2016 low at 1243.20 it's looking like it has at least a little more upside potential. Two equal legs up from December 15th points to 1273 but it has already met its minimum projections at 1237, where the 2nd leg of an a-b-c bounce is 62% of the 1st leg up. So it's possible gold will roll back over at any time but for now, between the projection near 1273 and its 200-dma at 1266 we'll see if gold can make it at least a little higher before rolling back over. Above 1274 would be more bullish for gold.
Oil Commitment of Traders (COT) chart, July 2010 - February 2017, chart courtesy tradingster.com
Before getting to oil's chart I wanted to provide a little background that supports the bearish picture I see on its chart. Starting with the COT (Commitment of Traders) report, it's at an extreme not seen since June 2014. As shown on the COT chart below, commercial futures traders are now more net short than in June 2014 while speculators are more net long since then. This wide of a split between the two almost always resolves in favor of the commercials. Speculators are betting huge that the oil rally will continue but it's wise to bet against them now.
The last time there was a wide split between commercials and speculators, in June 2014, it was followed by oil's price getting cut by two thirds, from more than $100 to less than $30. It's anyone's guess whether or not something similar will happen again but that's the risk for anyone betting on the long side of oil (or any number of ETFs associated with oil).
At the same time that speculators are strongly net long and commercials net short, the oil supply is building. The oil rig count has nearly doubled from the low near 300 in the spring of 2016 to the current count of 583. This will only exacerbate an already building inventory (last week's inventory build was +13.8M barrels and +6.5M the week before). An inventory build is only going to add to the price pressure on oil.
If the price of oil does start to drop how long do you think it will take for the latest OPEC agreement to fall apart? If they start cheating on production to make up for lower prices it will further exacerbate the inventory overhang.
U.S. inventories of gasoline have also been rising for the past four weeks, rising nearly 21M barrels in January. The normal build in January in the past 10 years has been 12M barrels. This is an indication of an increase in production (nearly half of a barrel of crude goes to producing gasoline) or a decline in demand, or both. In either case it's not bullish for price.
As discussed earlier, these fundamental issues are not good timing signals for trading oil but they are a strong warning sign that the price of oil will likely not climb much higher, if at all, and could drop precipitously like they did after the June 2014 high.
Oil continuous contract, CL, Daily chart
The price pattern for oil argues the February 2nd high was the completion of a small rising wedge pattern for the leg up from January 10th. The small rising wedge fits as the 5th wave of the rally from November 14th, which in turn completes an A-B-C bounce pattern off the August 2016 low, which in turn completes a more complex bounce pattern off the February 2016 low.
This bearish bounce pattern suggests the next decline could drop oil below at least the August low at 39.19 and likely below the February 2016 low at 26.05.
Short term, yesterday's decline dropped the price of oil out the bottom of the small rising wedge, the bottom of which is currently near 53.40. If the bounce off Tuesday's after-hours low at 51.22 manages to make it back up to the bottom of the rising wedge, near 53.40, we'll see if does a back-test and then drops back down. A drop below Tuesday's low at 51.22 would give us stronger confirmation that a high is in place.
There are no significant economic reports on Thursday and then on Friday we'll only get export/import prices before the bell and the preliminary Michigan Sentiment report at 10:00. The market is on its own to respond to overseas news and what happens in the overnight sessions.
I spilled a lot of electronic ink above to explain why I believe the fundamentals and technical picture suggests bulls are probably going to be done in the next couple of days, if not already done. But in reality there's just one thing to know as we go forward. If you're holding stock you should be selling and if you like to play the short side you should also be selling (or buying puts and inverse ETFs). Why? Because the Patriots won the Super Bowl.
As Sam Stovall, the Chief Investment Strategist at CFRA, noted, since 1967 the winner of the Super Bowl has predicted with 80% accuracy what the stock market, as measured by the Dow, will do that year. When the AFC wins, as the Patriots did, the stock market has finished the year in negative territory. An 80% success rate is nothing to sneeze at, even if it makes no sense at all. To many of you my EW counts make no sense either (wink).
In all seriousness, I think the AFC win this year will add to the accuracy of this predictor since I believe the market is setting up for a major top, similar to the one in 2000 and 2007. Obviously we'll know in hindsight but that's the risk I currently see for anyone willing to hold onto long positions with the belief that the market "always comes back." It will come back but a severe decline into 2018-2020 could take the next 20 years to recover. Why not get into cash and be ready for a generational buying opportunity later? In the meantime trade the short side and put some more cash into your account.
As far as timing for a high, I had mentioned some cyclical studies point to a February 8-10 turn window, which we're now in. Many times important turn dates occur around full and new moons and this Friday night will be a full moon.
SPX MPTS daily chart
At the same time as the snow moon (the name given to the full moon in February) there will also be a lunar eclipse of it Friday night. And then we'll have the New Year comet reach its closest point to earth in its flyby Saturday morning.
And lastly, Friday/Saturday marks a 1-year anniversary of the rally off the February 2016 low, which presents the "opportunity" to make this last bull run exactly one year old.
So there you have it -- we have fundamental, technical and astrological reasons for a significant market high this week, ideally on Friday but +/- 2 days is well within the turn window. Be careful out there.
Good luck and I'll be back with you next Wednesday to see how this unfolds in the coming week.
Keene H. Little, CMT