Following a quick pop up this morning the indexes spiked down as strong sell programs hit the tape. But as is usual for this market, the selling stopped after the first 30 minutes and the dipsters arrived to mop up. Buying the dip continues to work but there is growing risk it might not soon.

Today's Market Stats

The market got hit with some strong sell programs right after a small gap up started the day. But the selling stopped after the first 30 minutes and the dipsters arrived on cue to start their buying again. The indexes recovered a good portion of the morning selling and they closed with only marginal loses. Interestingly, the techs look vulnerable to a reversal back down while the RUT looks like it could start a bigger bounce, which would reverse the pattern we've seen between the two.

The morning selloff was blamed on some economic numbers but those pre-market reports saw very little reaction in the futures. It wasn't until the cash market opened that the selling hit. Was it a shot across the bow of the USS Bullship or just a quick shot of selling to clear some weak longs before resuming the rally? Answer that question correctly and you'll be able to position yourself for the next move.

One of the issues we're soon going to be dealing with is higher volatility from big trades going off in the ETFs, which now account for over $2T worth of U.S. stocks. And more than a quarter of these funds are traded by the quant hedge funds, otherwise known for their computerized algorithm trading. There's little to no concern about individual stocks and they're trading only on technical/algo signals

The computer program trading is pretty much on autopilot where a human is not even involved and the buying and selling can quickly get out of control. The programs are designed to stop trading if things get out of whack and that could then cause the problem with lack of liquidity in the market. That's when flash crashes have occurred in the past.

Because everyone is "investing" in the same ETFs, especially the big ones like SPY to essentially be invested in the S&P 500 index, we could see huge price swings if everyone starts to react the same way and panic in and out of funds en masse. Selling will quickly get out of control since fear is a stronger emotion than greed and when everyone wants out there could be times when there are virtually no buyers. The computers will have shut down trading after initially joining in the selling to clear their inventory.

Many are now investing in ETFs to avoid fees with mutual funds, who are also heavily investing in ETFs rather than individual stocks since the fund manager feels safer that way instead of being responsible for picking the wrong stocks. Hedge funds have much higher fees and haven't had stellar performance, which is driving more investors into passive investing through ETFs. This makes for a very different market than we had not many years ago. I think it makes it a much riskier market, especially when the selling begins. And that makes the question about this morning's selling even more relevant.

Before getting to my regular charts I wanted to show some comparative charts as a way to highlight the weakness under the surface of this market. At the moment we're seeing all dips bought and a constant underlying bid to the market. That has many thinking we must be in a new paradigm with a constant stream of new money coming into the market. Whether it's out-of-thin-air Fed money, overseas money, Mom and Pop money through ETFs, corporate buybacks, you name it, there seems to be an endless stream of money into the market. The cumulative advance-decline line continues to show good liquidity coming into the market. So it's not unreasonable to think this market has much higher to go.

What we can't know is what will cause the money spigot that's pouring money into the market to turn off. Usually it's an event that jolts players awake and ask the question, "Is my money safe in the stock market?" When enough people become concerned about the market we'll see a reversal but not before. A hint of investors becoming concerned start to show up in some of the market breadth numbers and comparative (relative strength) charts.

The first group of charts below shows market breadth with new 52-week highs in the middle and the number of advancing less declining stocks in the bottom chart. SPX is at the top. Notice the negative divergence between the new highs for SPX but declining highs for the number of stocks hitting their own 52-week highs and the slight deterioration of the number of advancing stocks. In other words the rally in the broader averages is happening on the backs of fewer and fewer stocks.


S&P 500 vs. New 52-week highs and Advancing-Declining stocks, Daily charts

Some of the explanation for the deterioration in the market breadth numbers above could be the fact that more investors are simply going with the passive investment approach by simply investing in ETFs, such as SPY for SPX, instead of picking individual stocks. Picking individual stocks is what mutual funds used to do but even they now do a lot of passive investing.

Buying just the SPY as an example creates buying in just the 500 stocks in the S&P 500, whether or not each stock in the S&P 500 deserves to be bought. The rest of the stocks outside the S&P 500 essentially get ignored. It's only speculation as to whether or not this is the primary cause of the deterioration in the market internals but with a strong bearish divergence on the daily and weekly charts for SPX I'd say it's still providing us fair warning.

We have a very different market than even what we had at the start of this century. All the program trading and ETF trading, many will argue, leave us extremely vulnerable to large volatile moves as all 500 stocks in the S&P 500 get bought and sold together, en masse. Panic moves, in either direction, could cause massive price swings and that would result in even fewer investors desiring to be in the stock market. This would be especially true for the baby boomer group who are now more interested in protecting their capital.

Needless to say, it's going to be interesting moving forward when the market finally starts to correct in a bigger way.

Back to the comparative charts, the relative strength (RS) of the Transports (TRAN) vs. Utilities (UTY) is shown in green and the RS of Consumer Discretionary (XLY) vs. Consumer Staples (XLP) is shown in red. SPX is again in the top chart. The bottom chart shows the RS each of BKX and RUT vs. SPX.

I like to watch the Transports as a sign of strength (or weakness) of the economy while the Utilities is more of a defensive sector (where money goes for safer dividends rather than growth). When TRAN starts to underperform UTY it's a sign of a move into more of a defensive posture, which does not support an ongoing bull market. Note that the RS of TRAN/UTY is threatening to break a support level that it has held since March 24th.

Consumer discretionary (XLY) spending will show a stronger RS vs. consumer staples (XLP) when consumers are feeling better about their financial position and the economy. When XLY starts to underperform XLP it shows consumers are becoming more cautious but still obviously buy toothpaste, toilet paper, etc. They forego big TVs and other toys. Up until the high on May 2nd the RS line has pulled back and is now threatening to break its uptrend line from March 21st. We're on the cusp with both RS lines of knowing whether or not the present bull market will be in more trouble.

S&P 500 vs. Relative Strength of Transports vs. Utilities and Consumer Discretionary vs. Consumer Staples, Daily charts

Now onto the regular charts, I'll start with the Nasdaq again since the techs have been stronger than the other indexes. When they reverse back down we'll have a stronger signal to pay attention to. Until then, with their outperformance to the upside, the bulls remain in control. However, there are some early signs that the bulls should be very careful here.


Nasdaq Composite index, COMPQ, Weekly chart

The Nasdaq has worked its way up toward a price projection at 6263 (it's still 40 points away with this morning's high at 6222), which is where an extended 5th wave in the rally from February 2016 would equal the 1st through 3rd waves (one of the common relationships when the 5th wave extends). This projection crosses the trend line along the highs from April 2016 - March 1, 2017 next week.

The 2016-2017 trend line is currently near 6240 and was last tested with last Thursday's high and remains the upside target for now (if the bulls can keep up their buying pressure). But as I'll show on the other two Nasdaq charts further below, now's a good time for bulls to play more defense rather than hope for more highs.


Nasdaq Composite index, COMPQ, Daily chart

The 2016-2017 trend line is the purple line on the daily chart below. It was tested on May 16th and again on May 25th. This morning's quick gap up to 6222 was another test and was quickly followed by a strong spike down. The bearish divergences on MACD and RSI suggest the rally will likely complete sooner rather than later. The 5th wave of the move up from November is showing bearish divergence against the 3rd wave (the March 1st high).

The 5th wave of the leg up from March 27th is also showing bearish divergence against the 3rd wave (the May 16th high), which is more easily seen on RSI. This all helps confirm the wave count and it suggests this rally is now running on fumes and might have topped with this morning's quick high. Today's hanging man doji at resistance is reason for caution as well. There's a little more upside potential but the wave count, with the 5th of the 5th wave in the rally from November completing, suggests upside potential is now dwarfed by downside risk.

Key Levels for NDX:
- bullish above 6240
- bearish below 5996


Nasdaq Composite index, COMPQ, 30-min chart

Moving in closer to look at the final little 5th wave, which is the leg up from May 18th, the rally made it up to the 127% extension of the previous decline (May 16-18), at 6217, which is a common reversal Fib to watch. This morning's high came within about 4 points of its trend line along the highs from March 21 - May 1 and then spiked down.

Notice the bottom on May 18th -- a gap down was quickly followed by a strong spike back up. The spike up completed in the first hour and then pulled back before continuing higher. This morning's gap up was followed by a spike back down and then a bounce. As below, so above? The bounce off this morning's low is currently a 3-wave move and could therefore be just an a-b-c correction to this morning's decline. Any further selling Thursday morning would turn the short-term pattern further bearish and more strongly suggest the rally from November has completed.

Another reason why the techs might be topping here is because I see the potential loss of support from the semiconductors. The SOX has now achieved a price target and is up against trendline resistance.


Semiconductor index, SOX, Weekly chart

The SOX has now made it up to a price projection zone at 1092-1106. The higher level is the 78.6% retracement of its 2000-2002 decline and the lower number is where the 5th wave of the leg up from February 2016 equals the 1st wave. This morning's high was 1101.76, about 5 points shy of the higher target.

A trend line along the highs from March-October 2016 was tagged with this morning's high and it's slightly above its broken uptrend line from June-November 2016, currently near this morning's low at 1086. The bulls need to push above this morning's high whereas the bears want to see this morning's low broken. Where the SOX goes from here will likely lead the tech indexes.


S&P 500, SPX, Daily chart

SPX pulled back to support this morning near its March 1st high at 2401 and its May 9th high near 2404. This level was resistance in May until the gap up over it last Thursday. That gap was closed with this morning's drop down to 2403.59 and with support holding it's looking like SPX will press higher. But like the Nasdaq, the bounce off this morning's quick low is just a 3-wave bounce so far and nearly accomplished two equal legs up at 2412.43 with this afternoon's high at 2412.31.

A drop back down Thursday morning would be potentially bearish, especially if the 2401-2404 support level breaks. However, as long as support holds there remains upside potential to the price projection at 2434, which is where the move up from March 27th would achieve two equal legs up (to complete an A-B-C move for the 5th wave of the rally from January/February 2016, which is a rising wedge pattern).

Key Levels for SPX:
- bullish above 2406
- bearish below 2352


Dow Industrials, INDU, Daily chart

The Dow's spike down this morning had it breaking back down below its downtrend line from March 1 - April 26 but then recovered back to the line for the close. Whew, almost lost it there. This is the trend line the Dow gapped up over last Thursday so it's important for bulls to hold the line. However, today's decline has the Dow back below its uptrend line from November 4 - April 19, now nearing this morning's high at 21051. This morning's low found support at the 20-dma, at 20937, and that's probably a more important level for the bulls to defend.

There's upside potential to 21211 where it would achieve two equal legs up from March 27th and then much higher potential if the bulls can break above that level. But with the waning momentum it's looking doubtful that the bulls can accomplish much, if anything, more to the upside.

Key Levels for DOW:
- bullish above 21,047
- bearish below 20,553


Russell-2000, RUT, Daily chart

The RUT had one of the stronger bounces off this morning's low, which is a bit of a change in character for the index that's been running weak compared to the others. With this morning's low near 1355 the RUT tested its uptrend line from March 22 - May 18 and almost made it down to its uptrend line from February-November 2016, currently near 1353.

The resulting candlestick today is a bullish hammer on support and if it rallies on Thursday we'd have at least a short-term bullish reversal candlestick pattern. The challenge for the bulls will be its broken 20- and 50-dma's, currently near 1382 and 1378, resp. Just above those is its downtrend line from April 26 - May 25, currently near 1385. That gives the bears a 1378-1385 zone of resistance to defend.

Key Levels for RUT:
- bullish above 1392
- bearish below 1347


10-year Yield, TNX, Daily chart

On May 17th TNX broke support at its uptrend line from July-September 2016, tried to recover last week but then sold off from last Wednesday's high, leaving a back-test and bearish kiss goodbye. It's now about to test price-level support at 2.19, which is the bottom of its gap up on November 14, 2016 and then back-tested twice on April 18th and May 18th.

Normally I'd say the chances of another back-tested holding is slim but with the 200-dma coming up to the same level, currently near 2.17, there's likely to be at least a bounce off 2.17-2.19 support. It would obviously be more bearish below 2.17.

The weakness in TNX (rallying in bonds) has been another warning sign for the stock market since lower yields reflects the bond market's concern about economic growth and slowing inflation. But it would obviously be a boost for the stock market if TNX can hold support and launch another rally. The oscillators are even hinting of the possibility.


KBW Bank index, BKX, Daily chart

The banks were particularly weak today, continuing their relative weakness vs. SPX since December. Today BKX dropped slightly back below its trend line along the highs from April 2010 - July 2015, currently near 88.90, but then managed to close on the line. It did the same in mid-April but then bounced to a lower high on May 4th vs. its March 1st high. It held the line on the next pullback into the May 17th low and is now again testing the line. Only slightly lower is the neckline of a possible H&S topping pattern (left shoulder in December, head on March 1st, right shoulder high on May 4th), currently near 86.80.

Between the trend line along the highs and the H&S neckline BKX has a 86.80-88.90 support zone, which should produce at least a bounce. But a drop below 86.80, and especially below its 200-dma (rising and currently at 85.67), would suggest a strong selloff to follow. The first downside target would be the H&S price projection near 75.25. Not until BKX can break its downtrend line from March 1st, currently near 91.40 (above its 20- and 50-dma's), would I start to think something bullish about the banks.


U.S. Dollar contract, DX, Daily chart

The US$ consolidated off its May 22nd low and now looks ready for another leg down, which could take the dollar down to the bottom of its parallel down-channel from January, currently near 96. I think it will work its way down to a price projection at 94.79 for the 3rd wave (or c-wave) in the decline from January, where it would equal 162% of the 1st wave down but not likely in a straight line.


Gold continuous contract, GC, Daily chart

With the dollar sinking lower it's helping gold bounce higher but gold is now approaching its downtrend line from September 2011 - July 2016, currently near 1280. This is an important trend line, which last stopped the rally into the April 17th high, so the bulls want to see gold above 1280. The bearish interpretation of the pattern says resistance will hold and we'll soon see another leg down for gold. We should get our answer soon.


Oil continuous contract, CL, Daily chart

Oil has been doing so much chopping up and down that I don't anyone has a strong clue about where oil is headed next. This morning's decline had oil dropping below its uptrend line from August-November 2016 but it then recovered with a spike back up off the midday low. It was also able to save itself from a close below its 20-dma at 48.57.

If oil rallies above last Thursday's high at 52 I think we could see a strong rally but first it would have to get through its downtrend line from February-April, near 52.40, and then its longer-term downtrend line from May 2015 - January 2017, near 53.40. But if the selling continues and oil drops below this morning's low at 47.73 it would be a break below multiple support lines and could lead to much stronger selling (down to 40 at a minimum).


Economic reports

Thursday morning is full of economic reports, the most important of which will be the ADP report, which is expected to be 180K and near what it was for April. Some additional labor numbers are not expected to change much either and as long as there are no nasty surprises it will keep the Fed on course to raise rates again in June.

In the morning we'll also get the results of construction spending and the ISM Index, neither of which is expected to have changed much from previous months. Friday morning in the pre-market session we'll get the NFP reports, which are expected to show a small decline from April.


Conclusion

The bull market rally is by no means dead yet and with a constant big under the market, along with the dip buyers, we could certainly see the market float higher for a long time. Some believe we need to see a melt-up, similar to the tail end of the rally into the 2000 high, before we should even think about looking for a top to this rally.

But from at least a short-term perspective I think we're close to, if not at, a market high. The pattern for the Nasdaq shows a wave count, price projections and trend lines that suggest it's very close to finishing the rally from November, which would mean at least a larger pullback correction. It's possible the techs put in their highs with this morning's quick pop higher but the blue chips support the idea for at least one more push higher. Even the RUT perked up a little today.

We have no confirming signals of a top and while there are plenty of warning signs, they aren't market timing signals. Stick with the bulls but only very carefully and with relatively tight stops. My concern is that we could see a big gap down to start the decline and many tight stops will be gapped over. Lightly positioned on the long side and mostly in cash is my recommendation for now.

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

Keene H. Little, CMT