October has continued the uptrend from August and it has most feeling very bullish about the market. Oddly enough, the bulls would have a better chance for a bullish month if it had started in a downtrend. There's a lot that's conspiring against the bulls this month but most are not considering the risk.

Today's Market Stats

The day started a little weaker than most recent days by gapping down instead of up. But the little dip was immediately bought and the indexes were pushed to new highs. That was followed by a steeper pullback for the RUT and tech indexes but only a partial pullback for the blue chips. As can be seen in the table above, the volume was on the low side and market breadth was about as neutral as it can get.

Following a long run higher, today's price action is either a bullish consolidation day or it's part of a topping process, even if the top will only lead to a multi-day pullback before heading higher. As I'll get into, there are a few reasons why October might not be kind to all those who are expecting the rally to continue this month, but it's also clear it's not a good time to try catching rising knives. I think it's a good time for both sides to exercise some caution.

Before the bell we got the ADP Employment report and at +135K it came in weaker than expectations for 160K and less than the +228K in August (which was lowered from the initial report of +237K). There was virtually no reaction in the futures after the release of the report and the same thing might happen with the nonfarm payrolls report this Friday. The impact from the recent hurricanes will get the blame and therefore any number will likely be ignored.

But with a continuation decline in Federal tax receipts there's reason for worry about a slowing economy, regardless of any government employment numbers. And it seems there's still only one concern -- WWFD (What Will the Fed Do). Any signs of economic weakness, which is not good for the stock market, is trumped by a Fed that will be forced into remaining accommodative to the stock market, I mean economy.

The ISM Services report was released at 10:00 and showed an improvement to 59.8 from 55.3 in August. It was also better than the 55.3 that was expected. Again, no reaction from the market. Economic reports are simply being ignored right now.

It's a quiet time for the market as it waits for earnings season to kick off and in this quiet period it's been good to be a bull. Just keep buying the little dips (that's all we're getting) and stay long. We're entering a typically volatile month so staying long through larger price swings could be a challenge for some, especially if they're late buyers. Each trader/investor needs to know where you want your stop levels (or none if you believe in the longer-term bull market) and then be sure to honor them. Or buy some puts for downside protection and then hope you don't have to use them (like all insurance we buy, we hope we'll never have to use it but it's nice when it's needed).

We made it through August and September unscathed by the bears and now it seems most everyone is looking forward to a bullish conclusion to the year as we enter the typically bullish 7-month period (October-April). But in a year that has defied the typical seasonal patterns should we be careful about the next seasonal pattern? Perhaps we should be a little more careful than the bullish masses right now and keep checking our six (behind us) now and then to be sure a bear attack doesn't sneak up on us.

For one thing, Octobers in the years ending in 7 have a reputation as bull killers, not the normal bear killer associated with the month. For another, entering the month of October in an uptrend tends to end up being a bearish month. October is known for its volatility so we should at least be prepared for a little more price swings than we've seen since August. That alone could jar more than a few bulls who have come to expect nothing but up.

What should be worrisome to bulls right now is that they're not alone. From a contrarian perspective, there are simply too many bulls (and therefore likely already invested in the stock market) and not enough bears. Trading in the direction of the majority works well (the trend is your friend) but it's important to identify when that trend could be in trouble. In a volatile month a reversal of the trend could lead to a whipsaw move to the downside and the fast move would likely come from panic selling.

The CNN Fear & Greed index following yesterday's close hit 92, a high not seen since before 2015 (as far back as the chart goes). The index closed a point lower at 91 today.

To give a sense for where we are with this Fear & Greed index, the chart below shows the past 3 years and compares the F&G highs with highs for SPX. The last time it was this high (above 90) was in July 2016, which was followed by a decent pullback into November. But notice that the highs for the index tend to be a little early in indicating when a market top is found. This chart tells us we're in countdown mode into a market top, even if for just a larger pullback/consolidation.

The bulls would certainly like to see nothing more than a flat consolidation this month and then higher into the end of the year. But there are additional reasons why the bulls might not want to test that theory, as I'll discuss further below.

CNN Fear & Greed index vs. SPX, October 2015 - October 3, 2017

As I mentioned earlier, the month of October tends not to do well when it starts off in an uptrend. I read some interesting statistics from Paul Schatz, Heritage Capital, where he discussed October stats that are dependent upon how it starts. Overall the month of October averages +0.5% since 1950, so not bad. But as Schatz notes, the average doesn't tell the whole story, especially for a month with October's reputation for volatility (and we're entering the month with nearly record-low volatility, which means put protection is cheap). He notes that any month typically does well when it starts in an uptrend and it's above the 200-dma, but October tends to fight this trend.

Statistics can't be used solely for trading but they do offer some heads-up information for what to be aware of. When the S&P 500 begins October in an uptrend, here are the stats:

-- First 5 days average return +0.66%
-- Second 5 days average return -0.26%
-- Third 5 days average return -0.30%
-- Last 5 days average return -0.25%

As opposed to the above stats, October tends to perform very well when it starts in a downtrend, which is typically how October starts when following a weak September. That did not happen this year.

From this, what we should be aware of is weakness for this October after the first 5 days. We're into the 3rd trading day, with lower performance than the average, and the statistics show that following this week it could be a more challenging environment for the bulls.

Combining October's stats with the extreme greed indication from the Fear & Greed index has me thinking October could be a lot worse than most expect. Add in the fact that we're now in October in a year ending in 7 (think October 1987, 1997 [Asian crisis] and 2007), mix in the problem with passive investing through ETFs and we might find out how difficult a "normal" pullback might be this month. That's all speculation but I see a tremendous amount of risk in this market right now. And I realize I'm in the minority with my opinion and I'm quite OK with that.

I think it's worth reviewing again the similarity between this October and October 2007, which I showed in my weekend wrap, since I also now see similar price projections have been met. To review, the next two charts below focus on the price action for SPX between July and October. Flip back and forth between them to focus on the price patterns and their similarity.

S&P 500, July-January 2007, Daily chart

Following a 3-wave pullback correction, July-August, another rally for the bull market continued into the October high. What I'm focusing on is the wave count for the rally from August into that October high, which is labeled i-ii-iii-iv, etc. An impulsive count is 5 waves and then multiples of 4 thereafter and the completion of an impulsive count is when to expect at correction of the move, if not a reversal.

The rally into the October 11th high was the 7th wave (wave-vii on the chart) and the expectation was for a pullback (wave-viii) and then one more push higher to complete the 9th wave (wave-ix). That final little 9th wave (the 5th wave of the series) was a no-show and I find this to be a common occurrence after a long run.

Back then I was pounding the table for bulls to get defensive (like I am now) and for bears to get ready. This was based on a long-term EW count and a price projection at 1576 (tagged to the penny on October 11th) and a shorter-term price projection based on the wave pattern for the August-October rally. The shorter-term projection is shown at 1571.52, which is based on a 5-wave move up from the August 28th low (the first pullback following the jump up off the August 16th low).

Adding to my bearishness at the time was the rising wedge pattern for the August-October rally (common in the final wave of a rally). But notice there was no bearish divergence at the October high, which is an example of why you can't always use bearish divergence/no divergence as proof of a trend's continuance.

With both price projections having been met, at 1571 and 1576, along with the reputation for the final little 5th wave (wave-ix) being a no-show, the break of the uptrend line from August was a key trigger event since it was the first indication the rally had completed. Now review the present chart further below.

S&P 500, SPX, Daily chart

The 3-wave pullback from July into August, like in 2007, has been followed by a rally into October. The wave count for the rally is labeled like above and shows we're now into the 7th wave (wave-vii), which has reached the top of a rising wedge pattern for the rally. It's also at the top of a parallel up-channel from April and it has met the price projection at 2540. That price projection is again based on the wave pattern and is like the 1571 projection in 2007. It's where the 5th wave of the leg up from August 29th (the first pullback low following the bounce off the August 21st low) equals the 1st wave.

So far the pattern is just like it was into the 2007 high. Now we wait for the next pullback to see if it will lead to one more push higher (wave-ix) or if instead the final little wave higher will also be a no-show. The next pullback will provide the clues needed -- a choppy pullback that holds above the uptrend line from August, currently near 2515, should lead to another push higher. The upside projection would be close to 2550. But a sharp decline that breaks the uptrend line could be another trigger event like it was in 2007.

Given the statistics about this month, discussed above, which suggests the rest of this month will be negative, now is a good time to take advantage of cheap put protection. The risk for those long the market is that a move down could accelerate quickly and possibly start with big gaps to the downside. Any sharp decline would spike the VIX and the cost of puts. Just some food for thought as you evaluate your own risk profile. The bigger risk, as I see it, is for the start of the next bear market, like 2007-2009 but maybe worse.

Key Levels for SPX:
- bullish above 2540
- bearish below 2488


S&P 500, SPX, 60-min chart

A closer look at SPX, with the 60-min chart below, shows the 2540 price projection was met today. If the rally continues on Thursday (it's been a steady accumulation since the September 25th low) I see upside potential to the top of a parallel up-channel for the leg up from the end of August, which is now near 2550. This is a slightly different look than the rising wedge shown on the daily chart above. But the bottom of the wedge (the uptrend line from August 29th) and the bottom of the up-channel from September 5th are close, both near 2520.

A multi-day choppy sideways/down pullback (from wherever a top is made) would provide us a clue that another new high should be expected (not guaranteed). A sharp break below 2520 would be the first clue that a major high could be in place (as significant as the October 2007 high).


Dow Industrials, INDU, Daily chart

There's a rising wedge pattern for the Dow and the top of it, currently near today's high at 22685, was hit yesterday and today. It did a little throw-over above the line today but closed below it. That's a very short-term sell signal and we'll see if we'll now get at least a little larger pullback correction before heading higher (depicted with the bold green lines).

The bottom of the wedge is near 22500, as is the uptrend line from November 2016 - May 2017, and therefore that's an important level for the bulls to defend. A break below 22500 would be the first indication a major high could be in place. Better confirmation of that would be a drop below the August high at 22179. The Dow is clearly in an uptrend and that needs to be respected until proven otherwise.

Key Levels for DOW:
- bullish above 22,820
- bearish below 22,179


Nasdaq-100, NDX, Daily chart

NDX is also sporting a rising wedge pattern but much shallower than the blue chips. It's currently near the top of the wedge, at 6023, and while the NDX could rally much higher, it's a good place to watch for a reversal. The bearish divergence since July supports the bearish interpretation of the wedge. If the bulls can keep the rally going and NDX makes it above 6027, for two equal legs up from September 25th, maybe we'll see a melt-up to the trend line along the highs since November 2014, currently near 6140.

Key Levels for NDX:
- bullish above 6027
- bearish below 5840


Russell-2000, RUT, Daily chart

If you want to see what a melt-up looks like just looks at the RUT's rally from August. If you look at an intraday chart you'll see the uptrend lines have been getting steeper and only yesterday did it break its steepest uptrend line (from September 26th). It's now showing bearish divergence since the September 27th high (not on the daily chart) and with it up against the top of a steep and narrow up-channel it's looking ready for at least a consolidation.

For the bullish potential I show just a consolidation over to the bottom of its up-channel where it intersects the uptrend line from February-November 2016, near 1496 next Tuesday. From there (assuming it will chop its way over to there) another leg up into mid-October would give us a 5-wave move up from August. But will get the final 5th wave? A drop out of the up-channel and below 1485 would have me thinking a top is already in place.

Key Levels for RUT:
- bullish above 1485
- bearish below 1452


Biotechnology index, BTK, Weekly chart

I was looking through other indexes to see if any are providing clarity to what we should expect next. The banks are in a choppy pattern and not much help. The TRAN has reached the top of a parallel up-channel and looking ready for a rollover but no clear signals there either. I then noticed an interesting weekly pattern for the biotech index. The strength in this index (+40% this year) has helped the RUT and therefore is worthy of a look-see in order to help determine what could drive the RUT higher (or not).

Following a 3-wave pullback from July 2015 into its February 2016 low it now has a 3-wave rally (both the pullback and the rally are labeled a-b-c). The c-wave of the rally, which is the leg up from November 2016, is a rising wedge and the 5th wave of it looks like the leg up from August 21st. The c-wave would be 162% of the a-wave at 4348, which is not far from today's high at 4297. It's near the top of the wedge and if the rally fails from anywhere near here it's going to look like a double top.

The downside projection out of this pattern is well below the February 2016 low at 2575 since a big C-wave in the A-B-C pullback pattern off the July 2015 high is 162% of the A-wave. That projection is near 1304 and would result in a test of a longer-term uptrend line from 2002-2008 by mid-year next year. That would be a 3000-point drop from 4300 (70% decline). This is the kind of downside risk I see in the next bear market and the risk for the RUT is equally as severe. That's not so much a prediction as a warning about the risk for those who simply hang on during the next decline because "it always comes back." Maybe in two decades.


U.S. Dollar contract, DX, Weekly chart

The US$ might have bottomed and started a reversal back up. I thought it would make it down to 90 to hit the trend line along the lows since 2015 (the bottom of an expanding triangle), and it still might. It will be important to see what happens in the coming week since a continuation higher would be a clear breakout from its down-channel from April. It would leave a head-fake break below its 200-week MA in September and with the weekly oscillators turning back up we could soon see a stronger rally.

A stronger dollar, if it continues to rally from here, could hurt stocks, especially the large international companies. Also likely to get hurt would be commodity prices since most are priced in dollars. A higher dollar would also hurt emerging markets since many countries have debt priced in dollars and a higher dollar devalues their local currencies. So it's important what the dollar does from here.


Gold continuous contract, GC, Weekly chart

Gold is nearing a critical support level, which is the broken downtrend line from 2011-2016, currently near 1263. If gold is to remain bullish it will use a back-test of the trend line as support and then continue rallying. A drop below 1263 would be a heads up warning and then below its uptrend line from December 2016 and its 50-week MA, both near 1244, would a further bearish sign. We'll have to let price lead the way from here before we'll have more clues about the larger pattern. If silver is any indication, it's looking more likely gold will break down.


Oil continuous contract, CL, Daily chart

Oil looks ready to reverse back down, which supports the idea that the dollar is ready to rally stronger. Oil's weekly chart shows it bounced back up to its downtrend line from May 2015 - January 2017, its broken uptrend line from 1998-2008 and its broken uptrend line from April-November 2016, all of which were between 52 and 53 last week. Two equal legs up for the rally from June is near 54 and therefore a rally above 54 would be a bullish break of several layers of resistance. But until that happens I think there's a greater likelihood for oil to break down and head for the January-February 2016 lows near 26.


Economic reports

Thursday's economic reports will likely be ignored, especially if there are no surprises. Friday's nonfarm payrolls report could spark a little volatility but the bar has already been set low, with expectations for only +100K, so there likely will be little reaction to whatever the number is.


Conclusion

I've outlined my reasons for why I think we could be facing a major bear market following a high this month. I think the risk of it happening is a good reason for using some downside protection (puts, shorts, inverse ETFs, etc.). Or stop out on a breakdown and get into cash and wait for the next buying opportunity.

But many are calling for this rally to not just continue but to continue into a melt-up, similar to what was seen in the late 1990s. That's certainly a possibility, in which case our technical indicators essentially need to be thrown out the window. Just get long and hang on for the ride. It's a big reason why bears need to be super cautious here and be sure to honor stops if short and the market keeps rallying. Or buy some cheap call options for insurance. Another 100-200 points for SPX could happen quickly.

I lean bearish but I'm waiting for confirmation from price and right now we do not have any indication that a high is in place. I see the risk for a high in place here but stick with the trend (up) while leaving the exit door propped open for a quick exit before the crowd jams the doorway. I sense an early Halloween boo scare in the next few days. Stay on your toes!

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

Keene H. Little, CMT