A morning gap up saw very little follow through and the indexes gave most, if not all, of the morning rally back. The bears have been effectively blocking attempts to rally and it's looking like we'll get lower prices before potentially heading higher.

Today's Market Stats

Thanks to an overnight rally in equity futures, which appeared to be designed to get indexes up and over some resistance levels, the market gapped up this morning (except for the Dow, which was dragged down by IBM) and bulls had an opportunity to reverse the downtrend we've been in since March 1st. But the bear's defense team blocked the attempt and the lack of follow through to the morning buying brought the bear's offensive team back onto the field.

There was very little in the way of economic reports or overnight news from overseas to help move the market and once the initial buying in the morning quickly petered out we saw the continuation of downward pressure. The bounce attempts have been consistently on lower volume while selling has been on higher volume. This is consistent with a downtrend and at the moment it appears the downtrend will continue to pressure the market.

The overall pattern of the pullback from March 1st is a choppy mess and it looks more like a correction to the rally than something more bearish. That could of course change in a hurry if we start to get a sharp strong decline that starts breaking some important support levels, but at the moment I think we're looking for a buying opportunity in the not-too-distant future. We might see the pullback continue the rest of this month and into early May before setting up a buying opportunity.

For now I see more opportunity for traders on the short side, based on the price and volume pattern. But the choppy price pattern is difficult to trade because of the whipsaws and reversals of reversals. Unless you're a fast day trader or one who can hang onto a trade in the face of sharp reversals in your face, this is a tough market to trade right now.

The current market condition will change but for now it requires caution and an opportunity to practice what I like to call the double-cheek trade -- stand up, firmly grab both butt cheeks and then sit down, trapping your hands and not allowing them to "accidentally" hit the buy/sell button. We are traders who like to trade and feel like we're wasting our time (and money-making opportunities) when not trading. But as Jesse Livermore told other traders, his success (when he had it) was based more on knowing when not to trade than what he traded.

The Dow was the worst performer today, thanks to IBM's big gap down and selling. The reaction to yesterday's after-hours earnings report was quite negative and the poor Dow never had a chance to get out of the red. The other indexes were doing well in the morning but then gave up most of the gains. SPX also dropped back into the red but the techs and RUT stayed in the green all day.

We often hear about how well corporate earnings are doing, how much they beat (if they beat) estimates, etc., but in fact corporate profit margins have been in decline since 2011. The stock market has been ignoring this fact by focusing on just earnings while forgetting about expenses. Expenses like higher dividend payouts, stock buybacks, interest on massive borrowing.

For a long time margins have been shrinking, which should affect valuations based on growth potential but the stock market has been whistling past the graveyard on this issue. Unless the decline shown on the chart below can get reversed we could find the market in serious trouble, even if that day of reckoning will be months from now. Manually matching those periods with declining profit margins will show you that the stock market did not do well during those periods.

Corporate Profit Margins, 1947-March 2017

The stock market has been pulling back since the March 1st highs and it's not looking yet like the pullback is complete. The pattern supports those who are looking to buy the dip but I think that opportunity could be another week or two or three away. The price patterns can be confusing at times like this but we have some key levels to watch to help guide the way.


S&P 500, SPX, Weekly chart

The choppy pullback from the March 1st high is looking more and more like a bullish consolidation pattern. There will likely be lower prices ahead but so far it's looking more like a bull flag type of pattern than something more bearish. An uptrend line from February-November 2016, currently near price-level support at 2275, could be the downside target for the pullback.

The bottom of a bull flag for the pullback is currently near 2300 so we have a 2275-2300 support zone to watch for. There is of course the potential for another rally leg to kick into gear at any time but so far the shorter-term pattern suggests lower prices before setting up the possibility for another rally leg. If the decline starts to accelerate I'll then start to think a little more bearishly but at the moment I'm thinking a larger choppy pullback this month before setting up another rally leg.


S&P 500, SPX, Daily chart

The daily chart below shows the possible down-channel and a projection to the bottom of the channel where it meets the uptrend line from February-November 2016 near 2293 May 9th. This is of course speculation on my part but a continuation of a choppy pullback to that time/price would be a very good setup to get long for the next rally.

If the bears take control of this market and drive SPX below the bottom of its down-channel, currently near 2304, it would then start to look more bearish. Because of the choppy pattern there are a myriad possibilities for price movement and the big caution right now is that this is not a good time for traders -- there are simply too many whipsaws and lack of follow through. And bulls need to exercise caution since there are no indications yet that the next rally leg is ready to start.

Key Levels for SPX:
- bullish above 2379
- bearish below 2322


S&P 500, SPX, 60-min chart

The 60-min chart shows a short-term down-channel within the down-channel from March 1st. The bounce attempts have been 3-wave moves and on weaker volume, which shows them as corrections to the decline. The likelihood is that the decline will continue and has the potential to accelerate lower in the coming days. A drop below the bottom of both down-channels and a break of price-level S/R near 2300 would be potentially worrisome for the bullish expectations following the pullback but the more important level for the bears to break is near 2275.

There will be plenty of time to evaluate the decline, assuming we'll see more to the downside, to see if it will continue to support the longer-term expectation for another rally leg.


Dow Industrials, INDU, Daily chart

The negative reaction to IBM's after-hours earnings release yesterday (today it finished down -8.36, -4.9%) hurt the Dow today. Chevron and Exxon were also weak with the oil sector today and they helped pull the Dow lower. The net result was the Dow did not gap up with the other indexes this morning and led to the downside but still lost only -0.6%. It is the first major index to drop below its March 27th low (20,412) and further supports the idea that we're going to see a move down to at least the bottom of a down-channel for the pullback from March 1st.

The bottom of its down-channel is currently near 20160 and crosses price-level S/R near 20K on May 5th, which is close to the same day as the May 9th date mentioned for SPX. Two equal legs down from March 1st points to 20131 and based on all this I think a good downside target/support zone is 20,000-20,130. Below 20K would be more bearish.

Key Levels for DOW:
- bullish above 20,888
- bearish below 20,412


Nasdaq-100, NDX, Daily chart

Yesterday NDX ran up to resistance at its broken 20-dma and its broken uptrend line from December, both near 5399. Thanks to an overnight rally in equity futures that resistance was easily taken care of with this morning's gap up. It then promptly ran into the trend line along the highs from April-August 2016 and turned back down. Notice how this trend line (purple) acted as support for most of the time since mid-February until it was broken again on April 11th.

It's now back up for a back-test and the bearish pattern says we'll get another leg down. A drop below its 50-dma, which held as support last Thursday, currently near 5366, would be a bearish heads up and then a drop to the bottom of its megaphone pattern, near

Key Levels for NDX:
- bullish above 5443
- bearish below 5275


Russell-2000, RUT, Daily chart

The RUT was again the stronger index today and that's typically a bullish sign. But the RUT's early gains fizzled with the rest of the market and even though it finished in the green with its +0.4% gain it showed weakness following this morning's rally attempt. Like the NDX, it gapped up this morning and jumped over resistance at its broken 20-dma near 1363 and then made it back above its broken uptrend line from November 4 - March 27.

Unfortunately for the bulls there was stronger resistance waiting to pound the RUT back down. At this morning's high at 1376.69 it was only pennies above its broken 50-dma and its downtrend line from March 1st. The decline from the morning high dropped the RUT back down to its uptrend line from November, currently near 1367. Intraday it looks like a pullback to support and ready to spring higher but on the daily chart, with the shooting star at resistance, it looks like a failure to recapture the broken uptrend line. We'll know better on Thursday which support and resistance line is stronger.

Key Levels for RUT:
- bullish above 1390
- bearish below 1345


10-year Yield, TNX, Daily chart

Treasuries have kept rallying this weak and that's putting downward pressure on stocks as money rotates out of stock and into bonds. This has resulted in a continuation of the pullback in yields, which is an indication that there's less fear of an expanding economy and resulting higher inflation. Recent data does in fact show a reversal of inflation that was ticking higher in the past several months.

As can be seen on the TNX daily chart below, it has broken important support at the bottom of its trading range since the end of November as well as dropping back below its downtrend line from 2007-2013. This follows the double top in December and March and the width of the trading range suggests a downside price objective at 2.00%. This has been considered a pivotal yield level for the 10-year and what happens after that will be very important to the longer-term picture.


KBW Bank index, BKX, Daily chart

The banks have been weaker than the broader market since December and was especially weak at the March 1st high (note the bearish divergence in March relative to December). There is the possibility we have a H&S top (left shoulder in December, head in March and the right shoulder into April. The height of the head projected down from the H&S neckline points to about 76 for a downside target. It doesn't guarantee it will get there, or stop there, but it provides a sense of downside risk.

Prior to 76 there is support at the H&S neckline, near 87.25, the bottom of a down-channel from March 1st, near 83.75, its 200-dma, near 82.20 and then its July 2015 high at 80.87. In other words the bears will have a lot of work to do before they can hope to achieve the downside objective near 76. Note today's failure at the trend line along the highs from April 2010 - July 2015, which acted as support until it was broken last week. Today it was resistance on a back-test.


Transportation Index, TRAN, Daily chart

The TRAN has also formed a possible H&S top, which includes bearish divergence at its March 1st high relative to its previous highs in December and January. The downside objective out of the H&S top is down near 7925. Again, there are plenty of support levels between here and there but it shows the downside risk. The first sign of bullishness would be a rally above the April 10th high at 9218. This morning's high at 9043 was a back-test of its broken 20-dma at 9040.


U.S. Dollar contract, DX, Daily chart

The US$ is potentially inside a bullish descending wedge off its January 3rd high but it's missing the kind of bullish divergence I would expect to see to help validate the pattern. It's also possible the 3-wave pullback into the March 27th low is all the pullback correction we'll see before heading higher and a rally above the April 10th high at 101.26 would point to that possibility. But the bearish wave count calls for an acceleration of the selling from here and a drop below the bottom of the wedge, currently near 98.40, would likely be followed by strong selling.


Gold continuous contract, GC, Daily chart

The short-term pattern for gold would look best with one more minor new high to complete the leg up from March 10th. Two equal legs up from March 10th points to 1307.60, which is slightly above its downtrend line from September 2011 - July 2016. This is an important longer-term trend line, currently near 1304, and a strong break of it would be a strong bullish statement. But with a 3-wave move up from December 15th to a potentially strong line of resistance and with the dominant trend still to the downside, gold traders can look to get short near the trend line, using a stop just above 1308.

The next upside target above that level is 1335.10, which is where the rally from December 15th would achieve two equal legs up. Above 1336 would be especially bullish but for now I think buying a minor new high, if we get it, could lead to disappointment. We could have much better prices ahead for us to pick up the shiny metal for long-term holdings.


Silver continuous contract, SI, Monthly chart

I always like to see what silver is doing since it has less of a currency-like demand as does gold. It's more of an industrial metal and it's therefore more of a reflection of the economy than is gold (although gold also is an industrial metal, especially in the semiconductor industry). At any rate, I like to see gold and silver in sync to help with confidence in determining the larger trend.

The monthly chart of silver is shown below to show the dominant trend had been down since it peaked in April 2011. Just as the dominant trend for gold is down, until the downtrend line from 2011-2016 is broken, there's a parallel down-channel for the decline, the top of which is a downtrend line from April 2011 - July 2016.

Sunday's overnight high at 18.65 tested the top of silver's down-channel. Near the same level, currently at 18.14 and where silver closed today, is the 50-month MA. The bulls need to see a continuation of the rally in order to break through these two important lines of resistance. Until resistance is broken this is a place to short silver with a relatively tight stop (no higher than 19).


Oil continuous contract, CL, Weekly chart

Oil dropped sharply today and that had the energy sector suffering. Oil's decline follows a back-test of double trendline resistance and looks bearish as the weekly RSI rolls over from its own back-test of the broken uptrend line from 2015. MACD has barely been able to lift off the zero line and a rollover from here would create a MACD sell signal.

Since the low in August 2015 there is a potential inverse H&S pattern for oil, with the head at its January/February 2016 double bottom and the right shoulder at the August 2016 low. The neckline (bold blue line) is currently near 53.30 and was back-tested last week. There's a downtrend line from May 2015 that could be the neckline of a larger inverse H&S pattern and it too was back-tested with last week's high at 53.76.

The setup looks good for oil bears to take a shot at getting short black gold (and maybe soon the real gold as well) with a tight stop just above 53.80. A rally above price-level S/R near 58.50 would be a bullish move, in which case the H&S objective near 80 would be the upside target (if it can get through its 200-week MA, currently at 66.35.


Economic reports

Tomorrow's economic reports include the Philly Fed index, which is expected to drop sharply to 24 from 32.8 in March. Leading indicators is also expected to show a slowdown. The only report of consequence on Friday will be existing home sales, which are expected to show continued growth (the rally to new highs in the home builders is a good sign for the housing market, although I do see evidence of them putting in a top soon).


Conclusion

The overall pattern of the pullback from March 1st continues to suggest we're getting just a correction to the longer-term rally. A choppy move counter to the dominant trend is typically just a correction to that trend and it will be followed by a resumption of the trend. After more than six weeks of a choppy pattern it's hard to argue that it's bearish. We could see the choppy pullback continue for another week or two but unless it starts spiking to the downside and taking out some key support levels (could happen) we'll be looking to be buyers of the correction. But I don't see a setup for buyers yet.

Using SPX as a market proxy, I see the potential for a continuation lower to a support zone at 2275-2300, about another 1.6%-2.7% lower. A choppy pattern such as we've had, and could continue to have, is not a good time for traders. From an EW perspective, the pattern fits a 4th wave correction (to be followed by one more rally to complete the 5th wave) and 4th waves have a reputation for sending brokers' children to expensive colleges while causing traders to go broke. You want to avoid trading inside 4th waves.

Assuming we'll see the market work its way lower over the next couple of weeks, we'll have time to evaluate the setup to get long. In the meantime exercise patience and if you need to be in the market I'd rather be short than long expect lots of whipsaws.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT