Other than the Dow's continued relative strength, the rest of the market spent the week chopping sideways in a small trading range. Friday was no different as an initial morning decline was followed by a slow push back up. There are multiple reasons for each side to believe they'll be winners in the coming week.

Week's Market Stats

Friday's Market Stats

The Dow continues to shine to the upside, with new daily all-time highs and a 4-week winning streak, while the techs continue to struggle to hold onto strong gains before the June 9th selloff. The result is a fractured market, which is not a healthy sign, as money rotates from higher-risk stocks into the relative safety of the blue chips.

Not helping the market on Friday were the latest housing reports, which showed both housing starts and permits declining more than expected. Housing starts dropped to 1092K in May, a drop from 1156K (revised lower from 1172K) in April and much lower than the 1227K that had been expected. Likewise, permits dropped to 1168K from 1228K and less than the 1250K expected.

The chart below shows housing starts and permits from May 2001 through May 2017 and then the bar graph at the bottom shows housing starts over the past two years. The decline in housing starts from the highs in 2005-2006 (roughly 2100K) to the low in 2009 (roughly 500K) was a 1600K decline. The "bounce" off the 2009 low to a high of about 1300K last October was a 50% retracement of the decline and there are reasons to be concerned that the rollover from last October could continue.

While the decline so far in housing starts is hardly a significant rollover, the threat is there. A drop in the housing numbers would be another indication that the economy is slowing and more importantly that the housing market has once again become unaffordable to more people. There's plenty of data to show that while employment numbers look good (the data the Fed uses), it's the quality of that employment that is not so good. Losing a $100K job and replacing it with a $50K job keeps the employment data looking good but it's just one more person who can't afford to buy a home.

We're also seeing more evidence of a slowdown in consumer spending, which is likely a sign that people have reached their spending/credit limits. Consumer debt is now higher than it was prior to 2007 (as is corporate and government debt) and with average incomes in decline it doesn't take a math genius to figure out we have a problem. Loan default rates are on the rise, especially auto and student loans, and the amount of debt is staggering.

Banks are not prepared (again) for high default rates and investors are not taking into account (again) the rising risks in the financial industry. But I suppose we don't have to worry about the poor banks since they'll simply be bailed out of trouble (again). This time though it will be through bail-ins, not bail-outs. Instead of increasing their reserve accounts for bad debts, banks have been doing the opposite and all with the Fed's blessing. How quickly we forget.

The stock market is showing signs of fatigue but other than the cracks in the higher-beta stocks (techs and small caps) we're not seeing any evidence yet that the market is ready to turn down. There are reasons to believe we're close to a reversal, which I'll show, but sticking with the trend (up) has been the winning trade. Picking tops might be fun (in a masochistic way) but catching rising (or falling) knives is a risky endeavor. Trend following has been the key to investor success but as traders we also would like to avoid the big swings that go against our positions (whether long or short).

I'll start off the weekend review with the Dow since it's been the stronger index and where it could be headed and potentially run into trouble should help guide us in watching the broader market.


Dow Industrials, INDU, Weekly chart

The wave count shown on the Dow's weekly chart interprets the leg up from March as the 5th wave of the rally from January 2016 and as such will be the conclusion to the rally. What kind of correction/decline will follow is subject to lots of debate but for now I think it's important to recognize that we're due for at least a large pullback correction. The larger wave count for the rally from 2009 can also be interpreted as complete once this 5th wave completes, in which case the pullback/decline will be even larger (at a minimum, back to the January 2016 low near 15,500 (-28%).

While staying aware that the pattern can be considered complete at any time, which makes downside risk much greater than upside potential, there is additional upside potential to watch for. The trend line along the highs from May 2011 - December 2014 is currently near 21600 and if the melt-up in the Dow continues for another couple of months we could see it make it up to the top of is up-channel from 2016, which will be near 22,300 by the end of July.


Dow Industrials, INDU, Daily chart

The daily chart of the Dow shows the upside potential to the trend line along the highs from May 2011 - December 2014 and a price projection near the same. For the 3-wave move up from March 27th, the 2nd leg up would be 162% of the 1st leg at 21,618 and that projection crosses the trend line June 23rd, which is this coming Friday. That's another 234 points (+1.1%) and easily doable the way the Dow has been acting lately. It'll be an interesting setup if and when that level is reached. But there could be trouble sooner if the little rising wedge for the rally from May 18th has anything to say about it (shown better on the 60-min chart further below).

Key Levels for DOW:
- bullish above 21,450
- bearish below 21,159


Dow Industrials, INDU, 60-min chart

The rising wedge pattern for the rally from May 18th is shown clearly on the 60-min chart. This pattern calls the leg up from June 9th the final 5th wave to complete the short-, intermediate- and long-term wave counts and is a reason to be very cautious about the long side. While there's upside potential to the at least the 21,600 area, this chart says bulls could soon be in trouble.

Bulls will be in better shape with a rally above 21,440 to bust out of the bearish rising wedge (which has confirming bearish divergence at new highs). Keep in mind that rising (and descending) wedges tend to get retraced a lot faster than it took to build them and this one could break at any time. Keep a close eye on this pattern since we could find out early in the week how the rest of the week is likely to go.


S&P 500, SPX, Daily chart

The choppy price action since June 2nd for SPX leaves a question mark as to how it's going to resolve. The bullish interpretation is that it's a sideways consolidation and that's a bullish continuation pattern following the rally. We could see price chop sideways a little longer (maybe midweek) to complete a sideways triangle pattern and then launch into another rally leg. For now I'd use a break above the June 9th high and low, near 2446 and 2416, as the direction to trade. Be more careful about the upside though since I believe we're in an ending pattern and a swift breakdown, like we saw in the techs, is likely close at hand.

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


Nasdaq-100, NDX, Daily chart

Following the breakdown in the techs on June 9th we've seen the tech indexes consolidate but nothing more bullish than that (so far). NDX did a back-test of its broken 20-dma on Tuesday/Wednesday but then gapped back down on Thursday. It tested its 50-dma Thursday morning, which has held as support, but was not able to close the week back above its uptrend line from December 2016 - April 2017, currently near 5702.

However, the trend line break is based on using the log price scale, which is my preference for trend lines. Using the arithmetic price scale, the line is near 5668 and it held as support on Friday. So it's a toss-up as to whether or not the trend line is broken. Short term, I'd use a break above Wednesday's high, near 5774, or below Thursday's low, near 5634 (which would also be below the 50-dma), for the direction of the trade (again, staying cautious about the upside since we could get just a higher bounce before turning back down).

Key Levels for NDX:
- bullish above 5775
- bearish below 5634


Russell-2000, RUT, Daily chart

Following the June 9th test of its trend line along the highs from 2007-2015, its 3rd test in 3 months, the RUT has pulled back sharply. But it's still above its 20- and 50-dma's, now near 1398 and 1390, and it wouldn't surprise me to see another test of the 2007-2015 trend line (if only because the bulls have been very stubborn about buying the dips).

The overall whippy price pattern since last December makes it very difficult to figure out where the RUT is going. But a slowly rising choppy pattern is generally an ending pattern and that's how I'm interpreting the RUT's (a shallow rising wedge off the January low). That makes the June 9th test of the 2007-2015 trend line potentially the final one.

Key Levels for RUT:
- bullish above 1437
- bearish below 1386

This past week we received some inflation reports that showed inflation is slowing, much to the consternation of the Fed. They think it's a temporary thing (either that or they're just saying it so that they can continue on their rate-increase path) but I'm surprised they don't understand the fundamental reasons why they're fighting a deflationary cycle (demographics -- aging population and a slowing population growth -- technology and slowing velocity of money, to name just a few). They have been fighting hard to increase inflation with their massive money printing scheme and while they've won a few battles they're losing the war.

I'm sure the slowdown we've seen since inflation peaked in 1981 will continue into a true deflationary period. We have been brainwashed to believe deflation is a bad thing and it is for borrowers (think government) but one of the results is it makes our companies and economy more efficient since they can't hide behind poor performance. We of course will benefit from lower prices for most things. Poor and poorly run companies and governments will be the ones who get hurt. And banks too, which is of course the real reason the Fed keeps pushing for higher inflation. The chart below is a good thing.

U.S. inflation rate, 1915-May 2017, chart courtesy tradingeconomics.com


30-year Yield, TYX, Daily chart

The bond market has also been sniffing out lower inflation one of the better indicators is the long bond, the 30-year (TYX). Investors are not going to want to own the 30-year bond if inflation is climbing. They'll want higher yields (lower prices) in order to compensate them for the risk. The bond market is one of the smarter markets (unlike the stock market, which is driven more by emotion) and right now it's telling us inflation is less of a concern than it was at the end of 2016.

TYX had found support at price-level S/R at 2.85% in April but recently broke support at the beginning of June, back-tested it this week and then dropped lower. Currently it's testing an uptrend line from July-September 2016 but I don't think that will hold. We should see rates continue lower despite what the Fed is trying to do. They might increase the shorter-term yields but that will only flatten the yield curve, which is a sign that a recession is coming. Damned if they do, damned if they don't -- that's the corner they successfully painted themselves into.


DJ US Home Builders index, DJUSHB Weekly chart

If interest rates do head back down it will at least help the home builders since it would make their houses more affordable. But at the moment the home builders stocks look like they could be in trouble. The weekly chart of the index shows a bearish setup that can only be negated with a rally above Wednesday's high at 698.

There's a little rising wedge pattern off the April low and the top of the wedge is along the top of a parallel up-channel for the 3-wave rally from February 2016. Wednesday's high was a quick throw-over above the top of the wedge and the subsequent drop back into the wedge creates the first sell signal. The second signal would be a break below the wedge, the bottom of this is currently near 665.

In addition to the wedge and the top of the parallel up-channel, as well as the bearish divergence against the March high, the reversal comes after reaching the 127% extension of the previous decline (August 2015 - February 2016), which is a common reversal Fibonacci extension. Interestingly, the home builders index has retraced a little more than 50% of its 2005-2008 decline, about the same as the recovery in the housing starts (first chart above). It's only a preliminary signal but it's looking like we might have seen the top for this index.


U.S. Dollar contract, DX, Daily chart

The US$ has been chopping sideways for about a month and it's looking like a bearish continuation pattern. I have a downside target for the dollar around 95 before setting up either a larger consolidation or a stronger rally. If the dollar gets back above its May 8th low at 98.35, which would also be above its descending 50-dma and downtrend line from April-May, I'd then start thinking more bullishly about the dollar but not yet.


Gold continuous contract, GC, Daily chart

While the dollar looks like it will continue lower it doesn't look like it will help gold, which also looks like it will continue lower. There should be solid support at its uptrend line from December-May, especially since it coincides with its 200-dma at 1242.60. That could launch another rally in it choppy move up from last December but at the moment I'm thinking we've seen the high for the bounce in gold. A little bounce off support and then a continuation lower is what I think we'll see for gold. Price action will be the only thing that tells me when to change my mind.


Oil continuous contract, CL, Daily chart

Oil is struggling to hold onto its uptrend line from August 2016 - May 2017, currently near 44.65. Thursday it broke slightly below the line and then Friday about 3 cents above the line. A break of a steep downtrend line, currently near 45.50, would be a bullish heads up that support is going to hold. A drop below Thursday's low at 44.22 would confirm support is not going to hold.


Economic reports

The coming week will be short on economic reports, one of which will be existing home sales Tuesday morning. New home sales will be reported on Friday.


Conclusion

This coming week will likely provide direction for the rest of the month. The SPX pattern, which I consider a good proxy for the broader market, has either a very bearish pattern, one which will break down hard in the coming days, or it's going to chop sideways for another couple three days and then launch higher. So a breakdown on Monday or Tuesday would be bearish for the week and the rest of the month while a sideways consolidation on Monday/Tuesday would likely be bullish into the end of the week and month.

Helping the bears, slightly, is then a short-term bearish pattern for the Dow with its rising wedge pattern off the May 18th low. This suggests maybe a little higher (less than 100 points) and then a strong move down. So again, we should find out early in the week which direction this market will likely head in the coming week and into the end of the month. In the meantime, mind the chop.

Good luck and I'll be back with you next Wednesday. See below for a good deal on an OIN subscription.

Keene H. Little, CMT


 

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