Most of the market has been in a choppy consolidation this week while waiting to get through this afternoon's FOMC announcement. To no one's surprise the Fed raised rates 0.25% and the initial reaction was sell the news. But a late-day rally saved the indexes from a worse selloff.

Today's Market Stats

This morning started like previous mornings where we saw a small gap up that was then followed by immediate selling. Tuesday's gap up and immediate pullback was followed by another push back up but today's pullback was followed by mostly sideways consolidation. The pre-market economic reports caused some commotion in the dollar and metals, which then reversed themselves after the FOMC announcement. The net result was more chop and a negative day for the indexes, except the Dow as it continued to work its way higher to another new all-time high (it's working on a 4th straight week at new highs).

This morning's economic reports gave the stock index futures a little pop to the upside and that gave us the little gap up to start the day. The retail sales report, which was largely ignored again, showed further slowing. It will matter when it matters. Sales dropped -0.3% in May from +0.4% in April. Retail sales ex-auto was the same -- -0.3% in May vs. +0.4% in April. That's a significant drop and it points out the fact that the consumer is very likely maxed out on their credit cards (consumer debt is now higher than where it was back in 2007 before the crash into 2008).

The other pre-market report was CPI data, which also slowed and we're now facing possible deflation, er I mean, disinflation. CPI dropped -0.1% in May vs. +0.2% in April and it was lower than the expected 0.0%. Core CPI was higher, coming in at +0.1%, the same as April.

In the Fed's statement this afternoon they feel the slowing of inflation is, let's say it together, transitory. While inflation is running well below the Fed's target of 2%, The Fed feels the economy can handle another rate increase of 0.25%, making the Fed's policy rate now 1.00%-1.25%.

As for reducing its balance sheet, the Fed stated the roll-off of some maturing debt will start sometime this year but they were not specific about when it would start. They are of course data dependent on this, stating "The committee currently expects to begin implementing a balance sheet normalization process this year, provided the economy evolves broadly as anticipated."

The information about the roll-off stated there will be an initial cap of $6B for Treasuries and $4B for agency and mortgage debt, meaning only $10B per month will be allowed to expire without replacement. The remainder of expiring debt for the month will be reinvested. This is obviously a puny amount when you're talking about a balance sheet that has more than $4T of debt.

The Fed's current plan is to increase the cap by $6B per quarter for Treasuries and $4B per quarter for agency and mortgage debt until the cap reaches $30B and $20B per month, respectively. Considering the per quarter increase and max cap of $50B per month (which would be a significant drain of liquidity from the market) it would take about 6 years to get their balance sheet down to where it was prior to the huge expansion that started in 2009. This plan will of course change depending on the economy and it assumes no recession and/or financial catastrophe hits us.

No recession and no financial disaster in the next 10 years has about a zero percent chance of happening. I came across the chart below that shows we could be a lot closer to both than most are currently thinking. It's a chart that shows year-over-year changes in bank loans plus nonfinancial commercial paper. Interestingly, notice the deterioration that's been happening for a long time -- the peaks since 1973 have been lower during each recovery. Also, each low since 1981 has been lower.

Typically, each time loans have peaked and the year-over-year change turned down there's been a recession (vertical gray bars) and the last time (2008) led to extreme financial hardship for banks as all the bad debt had to be written off. Today we have a lot of bad debt in auto and student loans, much of which is already in default (and default rates are on the rise). With the recent turn down in bank loans we have to wonder if it will be different this time. I would not bet on that.

Declining Bank Loans, 1967-April 2017

I'll start tonight's chart review with the Dow since it's been the stronger index lately. It seems money might be rotating into the safety of the bluest of the blue chips, which many view as a defensive move. Money that must be invested in stocks (many funds require managers to be fully invested) will often be moved to the large cap stocks because it's much easier to get in and out of them without greatly affecting their prices.

With the significant expansion in the use of ETFs (passive investing), these are also used by fund managers to control their risk (so they think). One of the consequences of using ETFs is that individual stock picking has declined significantly. The large impact of the FAANG stocks is an example of how just a few stocks can greatly impact the index it's a part of. The tech indexes have suffered much worse than the Dow recently because of this. Helping the Dow has been the recent outperformance of the financials and energy (although energy took a hit today).

The RUT has been more volatile than the others because funds use the various small-cap ETFs (inverse, 2x, etc.) as their playground and it causes a lot more volatility than playing around in the larger-cap ETFs. But the overall result in the use of these ETFs is what we're seeing today -- a fractured market between the indexes as traders unselectively trade in and out of a multitude of stocks only because those stocks are a part of the same index as say the FAANG stocks.


Dow Industrials, INDU, Weekly chart

The weekly chart of the Dow is the one that has kept me more bullish than bearish but admittedly I was beginning to think it was in trouble at the end of April and beginning of May. That was when it was making a double top with its March 1st high and showing bearish divergence. But the pullback into the May 18th low looked more like a correction to the rally and not something more bearish and since then we of course have seen the Dow push to new highs.

Unfortunately for the bulls the bearish divergence has not been negated and it suggests the recent push to new highs might not hold. It doesn't prevent a continuation higher but it does suggest caution about the upside. I've been thinking we might see the Dow make it up to its trend line along the highs from May 2011 - December 2015, which is currently near 21590 and about 200 points above today's high.

An important point to keep in mind is that the rally from January 2016 now has the requisite 5-wave move and can be considered complete at any time. Betting on further upside is a risky bet since upside potential is significantly dwarfed by downside risk.


Dow Industrials, INDU, Daily chart

The rally from May 18th has formed a rising wedge pattern (better seen on the 60-min chart further below), which is another warning sign for bulls to pay attention to. The good thing for the bulls right now is the Dow's ability to climb back above its broken uptrend line from November-April, which has acted as support this month. Bulls want to see that trend line, currently near 21270 and rising about 20 points/day, hold as support since a break of it would indicate a top is likely in place.

Key Levels for DOW:
- bullish above 21,169
- bearish below 21,159


Dow Industrials, INDU, 60-min chart

The Dow's 60-min chart shows the rising wedge pattern for the rally from May 18th. Today it made it up to the top of the wedge and achieved the price projection near 21384 with today's high near 21392 (but closed back below 21384). This projection is where the 5th wave is 62% of the 3rd wave, a typical projection for each wave inside a rising (and descending) wedge. Notice the 3rd wave was also 62% of the 1st wave.

This is a good setup for a reversal back down into a strong selloff (wedges tend to get retraced faster than the time it took to build them) but obviously we have no evidence yet of a top in place. It's only a setup and now we wait to see if the market agrees. A continuation higher out of the wedge would be a bullish move (up to at least the 21600 area.


S&P 500, SPX, Daily chart

SPX has a slightly different price pattern than the Dow and it isn't quite as clear where it could head next. I see upside potential to the top of a rising wedge for its rally from March, currently near 2456. A choppy rally into next week could see it as high as 2465 and above that level would be more bullish, in which case I'd look for a rally to the 2500 area where it would achieve some longer-term price projections based on its rally pattern. But as with the other indexes, the daily chart is overbought and showing bearish divergence, as is the weekly chart. The bulls are toast if and when SPX drops below its June 9th low near 2416.

Key Levels for SPX:
- bullish above 2447
- bearish below 2415


Nasdaq-100, NDX, Daily chart

Heading into its high last Friday NDX presented a very nice setup for the bears to take advantage of, which I posted at the time. It was up against two trend lines along the highs, one since the end of March and the other from November 2014 - July 2015. It was also close to achieving a price projection for the 5th wave of the rally from its March 27th low, at 5906 (the high was near 5898).

Following Friday's quick morning high it then tanked and dropped sharply into Monday's low before starting a bounce correction. Note the bounce off support at its uptrend line from December 2016 - April 2017 (green line), which it again tested with this afternoon's low at 5682. We could see a larger bounce correction but with a 50% retracement of its decline and a back-test of its broken 20-dma the pieces are in place for the next leg down.

Key Levels for NDX:
- bullish above 5898
- bearish below 5633


Russell-2000, RUT, Daily chart

Following last Friday's test (again) of its trend line along the highs from June 2007 - June 2015 the RUT pulled back sharply but looked like it was going to try it again with Tuesday's rally. However, today's decline dropped the RUT below its steep uptrend line from May 31st and while there remains upside potential to at least the 2007-2015 trend line, near 1435, it's now vulnerable to a breakdown from here.

Key Levels for RUT:
- bullish above 1440
- bearish below 1386


10-year Yield, TNX, Daily chart

This morning the bond market rallied and yields tanked. TNX dropped to a new low below its June 6th low before starting a small consolidation and then a bounce back up after the FOMC announcement. The morning low at 2.103 was good enough to close its November 14th gap at 2.117. The low was also a test of a short-term trend line along the lows from May 18 - June 6 and since it's possible this trend line is the bottom of a bullish descending wedge we could see at least a higher bounce from here.

TNX remains bearish below its downtrend line from 2007-2013, currently near 2.25, and turns more bearish if it drops out the bottom of the wedge pattern. A continuation lower from here would target the double-top price objective near 2.00.


10-year emini contract, ZN, Weekly chart

Another way to look at the bond market is of course price instead of yield. The weekly chart of ZN, the 10-year emini contract, shows another reason why yields could start at least a bigger bounce, if not a new rally. Off the December 2016 low ZN now has a 3-wave bounce up to strong resistance at its broken 50- and 200-week MAs and a downtrend line from July 2012 - January 2015. All of these lines cross near 127, which was achieved with today's midday high at 127'08 before reversing back down following the FOMC announcement.

If ZN reverses back down from here it would of course drive yields back up, which is supported by the bullish descending wedge shown on the TNX daily chart above. But obviously if ZN powers through resistance it would be bullish and that would drop TNX below the bottom of its descending wedge. So it's decision time for bond prices here.


KBW Bank index, BKX, Daily chart

Financials have been one of the stronger sectors since last week, along with energy (although energy stocks got thumped this morning with oil), and that has helped the blue chips in their relative strength in the past week. BKX shows a strong spike up from June 6th but that might be all there will be to see for its bounce attempt. The spike up fits well as the c-wave of an a-b-c bounce off the April 17th low and it has so far left a bearish kiss goodbye following the back-test of its broken uptrend line from June 2016 - April 2017.

The trend line was tagged twice, on Monday and Tuesday, but the line held as resistance. For the short-term pattern I do see the potential for one more minor new high, for another back-test of the broken uptrend line, before starting back down.


Transportation Index, TRAN, Weekly chart

Since its December high the TRAN has been trading in a sideways choppy trading range. Following the rally from January 2016 the choppy consolidation can certainly be viewed as a bullish continuation pattern. But there are some signs of weakness that suggest any new highs from here might not hold for very long.

The weekly chart below shows the recent rally off the May 18th low has brought the TRAN back up to its broken uptrend line from June-October 2016 for what is likely to be just a back-test before turning back down. One reason for thinking that is because of the extreme bearish divergence seen on the weekly oscillators.

Daily is now overbought and looking ready to turn back down at any time. That would leave essentially a triple top since December with bearish divergence and a huge "SELL ME!" sign hanging over it. IYT is the transportation ETF that can be traded (e.g., buy puts) if you agree with the bearish setup.


U.S. Dollar contract, DX, Weekly chart

Today was a little wild for the US$ as it spiked down in the morning (presumably on the negative inflation number and perhaps a sudden fear the Fed might back off on another rate increase) but then spiked back up following the FOMC announcement of another rate increase. The dollar finished the day lower but the morning low might have been a good test of last week's low and with bullish divergence since the May 23rd low it's looking like the dollar could get at least a decent bounce.

The weekly chart, which I haven't shown in a while, helps keep the big picture in mind. There are a multiple possibilities for where the dollar will trade inside its large megaphone pattern off the March 2015 high. The dollar has been chopping up and down in a widening trading range and that might not change much in the next year or two.


Gold continuous contract, GC, Daily chart

Gold did the opposite of the dollar today -- it spiked up on the 8:30 economic reports but then spiked back down on the FOMC announcement. Today's high could have completed a bounce correction to its June 6-13 decline but so far the back-test of its 50-dma near 1261 is holding and it remains bullish above 1261. However, on the bear's side, this afternoon's spike high was a perfect 62% retracement of the decline and a back-test of its broken uptrend line from May. This follows the June 6th test of its downtrend line from September 2011 - July 2016, which potentially completed the larger bounce correction off the December 2016 low. The larger pattern suggests lower for gold and we should soon find out if the market agrees or not.


Oil continuous contract, CL, Daily chart

Oil has been trading in a choppy sideways trading range since June 2016 and it's decision time for oil traders. This morning oil spiked down and landed on an uptrend line from August 2016 - May 2017. It then traded in a very tight sideways consolidation for the rest of the day, which has it looking like the trend line will break. That would obviously be more bearish and a drop below the May 5th low at 43.76 would confirm another leg down for the decline from January was in progress.

The price pattern for the decline suggests the selling could accelerate and drive the price of oil well below 40 soon. But if oil gets a bigger bounce started we could easily see 50 again before rolling back over. Until I see evidence to the contrary I believe we'll see oil at least test its February 2016 low near 26 before we'll see oil above 55.


Economic reports

Thursday morning will be busy with economic reports, some of which could be market moving. The Philly Fed index is expected to show a drop from 38.8 to 26 but if it's worse than that, especially in light of this morning's numbers showing a further decline in retail sales and the slowing of inflation (disinflation, not the dreaded word deflation), there could be a negative reaction. It will be interesting to see what the Import/Export prices look like since it will either mirror or counter the inflation numbers we got today.

But the Empire Manufacturing index is expected to show a gain from -1.0 to 6.0 so that would balance out fears about the Philly Fed index. And if both jump higher we could get a nice pop up in the morning. Mitigating any difference between the two, the Industrial Production number is expected to drop to 0% from 1.0%.


Conclusion

The market is fractured at the moment with different indexes doing different things. Money appears to be rotating out of the riskier high-beta stocks and into the safety of the blue chips. Even the utility index has been relatively strong, which is another defensive sector.

While the indexes appear to be holding up for opex I think it's vulnerable to topping at any time. The techs look like they've already topped while the blue chips could hold up for a little longer. I don't think the risk:reward ratio supports betting on the long side but bears obviously need to be careful in a market that always seems to turn back up no matter what kind of selling hits. That I think is about to change but that opinion and $3 will buy you a cup of coffee.

The bottom line is that I see price patterns that support the idea that we're close to getting a strong selloff, even if that selloff is only going to be a larger pullback correction before heading higher again later this summer. Depending on your trading/investing timeframe, now's a good time to pull stops up a little tighter and maximize your profits before going to either cash or trying some short positions.

Good luck and I'll be back with you for Saturday's Market Wrap as I fill in for Jim. See below for a good deal on an OIN subscription for the rest of the year. And in the process you'll be supporting starving writers (wink).

Keene H. Little, CMT


 

INDEPENDENCE DAY SPECIAL!

Welcome to our mid-year Independence Day Subscription Special. Save 50% or more on your subscription!

The options market isn’t waiting for you.  And you shouldn’t wait to keep Option Investor coming at the lowest prices you’ll see until December! There isn’t a minute to spare.  Order now.

Renew for as little as $249
for six months,
ONLY $1.38 per day