The small pullback from last Friday is showing signs of being something more than just a pullback but the jury is still out deciding whether or not a top is now in place. The bulls and bears each have their arguments and now we wait for the jury (price) to decide.

Today's Market Stats

The day started with a small gap down following some disappointing earnings reports and then proceeded to sell off more strongly. The selling was stronger than we saw last Friday and that has the pullback looking a little more bearish than just a pullback. It's still too early to call a top but the pieces are falling into place for one if the selling continues on Thursday.

The bulls might have one more rabbit to pull out the hat but they can't waste any time -- they need a rally on Thursday to save the market from breaking down. The bears need another low for the pullback to provide evidence a top is in place. As always, I'll identify on the charts what we're watching for so that we'll have some early clues.

This morning's economic reports included Durable Goods shipments, which climbed +2.2%, coming in better than the expected +1.3%. It was also an improvement from the upwardly revised +2.0% in August (revised up from the originally reported +1.7%). Subtracting transports, the number was +0.7%, which was also better than the expected +0.5% and matched the upwardly revised August number.

The new home sales report was released at 10:00 and it looks encouraging. September saw sales jump nearly +19% from August, doing well in all regions except the West (only +2.9%). The current sales pace drops the inventory to 5 months from 6 months in August. The new home sales and the Durable Goods reports didn't help the market today and the home builders sold off sharply after they gapped up this morning (selling good news are we?). But the reports at least showed the economy held up despite the South getting clobbered by hurricanes.

We all know the market is stretched to the upside and with only minor pullbacks along the way. Today was the worst selloff since September 1st but we're still talking only a minor decline. As of today's close the S&P 500 has now gone 245 days without a 3% intraday decline, breaking the previous record of 241 days set 21 years ago in 1996.

Jason Geopfert, who writes the SentimenTrader newsletter, wrote last Friday about the combination of records set with Friday's close. SPX had at that time closed at a record high every day of the week (5 days) and it closed at a new weekly high for each of the past six weeks. On top of that it had closed at a record monthly high for each of the past seven months, so 5/6/7 days/weeks/months. Yea, not too stretched to the upside. Geopfert noted that the trifecta (daily, weekly and monthly high closes) is something that has never been seen before.

All these record highs have finally caught the attention of retail traders who are now jumping in with both feet to ride this northbound train. As of last week equity funds attracted the largest inflow of money seen in the past 18 weeks. This is actually not a good sign for bulls since the retail crowd is always the last to react -- they are notorious for buying the top and selling the bottom. Actually I take that back, the government is always the last one to react.

We know fear has evaporated although there are signs that that's changing. Like the market's non-stop record highs, the VIX had set its own record when it last closed below 10 on October 5th. The VIX had managed to close below 10 a total of nine times between 1990 and 2016. But in 2017 the VIX has closed below 10 so far 33 times. Interestingly, as the market has continued higher since October 5th we've seen the VIX making its way higher and the Fear & Greed index has been coming down from its high reading of 95 (out of 100, showing an Extreme Greed reading).

As I had shown in recent wraps, market tops are generally made about a week or two after a low in the VIX and a peak in the F&G index. This is a result of fewer people participating in the rally to its final high and instead they start to hedge their bets. Hence the slow rise in the VIX as more put buying occurs (the put/call ratio has been working its way higher since the end of August). The market can continue to make new highs but when it's running out of participation it's generally not a good time to chase it higher.

Most of the bulls are still in buy-the-dip mode as they've been conditioned to expect the market to keep heading higher. This was evidenced today with the bounce off this morning's low. The initial decline in the market was accompanied with a spike higher in the VIX, which had jumped +18% (+2.04 to 13.20). But then the bounce off this morning's lows in the indexes saw the VIX drop back down to only +0.6% for the day (+0.07, closing at 11.23). In other words, all fear evaporated as the bulls believed there's nothing to worry about and the bounce will lead to higher highs (after all, the market always heads higher, which reminds me of the feelings about the housing market leading to the top in 2006-2007).

The bulls could be correct in their assumption that the market will head higher but if it does it's going to need more help than it's seen in the past month. Looking at market breadth, the rally is running on fumes and we could be seeing its last gasp here. The two charts below show market breadth and it's not encouraging for bulls. The first chart shows SPX compared to the number of new 52-week highs and lows. Keep in mind that these are not timing signals but instead they only show when we should be confident in a move vs. when we should be wary of it. Right now it's time to be wary.

SPX vs. 52-week highs and lows, Daily chart

I've drawn a vertical line through the peaks in new 52-week highs (middle chart) and the new 52-week lows (bottom chart), both of which occurred at the beginning of October. New highs have been in decline since then and new lows have been climbing. In other words, while SPX continued to tack on more points during the month it was doing so on the backs of fewer and fewer stocks while some stocks were probing lows not seen in the past year. On Tuesday, while the Dow spiked higher there were 12 Dow stocks in the red. The general is out in front of the troops but the ranks are thinning as the troops abandon their leader. Never a good thing in battle.

SPX vs. Advance-Decline line and volume, Daily chart

Another way to look at market breadth is with the advance-decline volume (middle chart below) and advance-decline line (bottom chart). This picture is actually a little worse than the chart above since the negative divergence started showing up in the middle of September. The number of advancing stocks and the amount of volume going into advancing stocks has been deteriorating for over a month while SPX has continued to march higher, oblivious to the fact that the number of participating stocks is declining.

Again, all of this doesn't mean the market will turn back down right away but the longer this goes the more vulnerable it becomes to a downside disconnect. There's already a big air pocket below us with a rally that hasn't had much in the way of backing and filling (as discussed above). Bulls need to have their eyes wide open here and not be complacent about the upside. The collapse back down in the VIX today says the bulls are complacent. Don't be one of them.

The Dow has been the stronger index so I thought I'd start with its charts tonight to see when we should start worrying about some potentially tough resistance areas. We should start worrying.


Dow Industrials, INDU, Weekly chart

The Dow has made it up to the trend line along the highs for the rally from January 2016 (the April 2016 - March 2017 highs). Both the weekly and daily charts are overbought as it hits this line of resistance and it's therefore a risky time to look for higher highs. It could happen but the setup looks good for at least a pullback.


Dow Industrials, INDU, Daily chart

In addition to its trend line along the highs from April 2016-March 2017 the Dow hit the top of a parallel up-channel for its rally from August. If the Dow can rally above 23500 and stay above that level there's a decent chance we'll see 24K but right now it's vulnerable to at least a larger pullback.

Key Levels for DOW:
- bullish above 23,500
- bearish below 23,000


Dow Industrials, INDU, 60-min chart

Looking a little closer at the Dow's leg up from early September, there are two parallel up-channels, the tops of which crossed the April 2016-March 2017 trend line on Monday and Tuesday. The pullback from there had the Dow dropping to the bottom of its smaller up-channel for this month's portion of the rally. We now wait to see if the rally will continue back up to the top of the channel, which will be near 23585 by the end of the day Thursday, or if instead today's bounce will lead to another drop lower. The bears want to see a drop below the October 19th low at 23052, which would also be a break of the uptrend line from September 8-27, which would confirm an important top is likely in place.


S&P 500, SPX, Daily chart

Today's decline for SPX had it breaking its uptrend line from August 29-September 25, currently near 2564. SPX looks more bearish than the Dow and my expectation is for it to continue lower. This market has fooled me more than once (OK, about a 1000 times) but I'll be surprised to see it make new highs from here. As noted on the chart, Monday finished with a bearish engulfing candlestick, which is an outside down day (gap up, make a higher high and then close lower than the previous day's open).

The bearish engulfing candlestick on Monday gave us a key reversal and the only way the bearish pattern can be negated is with a rally above Monday's high at 2578. It'll be interesting to see how this week closes since a close below last week's open at 2555 would leave a key reversal for the week. I expect we could see a little volatility for the rest of the week before heading more strongly lower next week.

Key Levels for SPX:
- bullish above 2580
- bearish below 2548


Nasdaq-100, NDX, Daily chart

The techs have been a little weaker than the blue chips but interestingly its pattern supports the idea for a new high into next week (hold the market up into the end of the month?) before topping out. A crossing of some trend lines near 6200 makes a good upside target if the rally continues from here. Today's low at 6011 was a test of price-level support at 6010 and the bounce back up to close near its 20-dma, at 6057, was a good showing by the bulls. They now need to hold it above 6010.

Key Levels for NDX:
- bullish above 6200
- bearish below 6010


Russell-2000, RUT, Daily chart

The RUT also has a pattern that supports the continuation of the bull run. This morning's low can be considered a throw-under completion of its expanding triangle consolidation pattern off the October 5th high. Another leg up, assuming it would be the 5th wave of the rally from August, could run up to about 1548 where it would equal the 1st wave. There would be lower targets to keep an eye on but for now that's the bullish potential if we see the RUT get above 1515. But if this morning's low at 1482 is broken it would support the bearish view that a top is now in place.

Key Levels for RUT:
- bullish above 1515
- bearish below 1481


10-year Yield, TNX, Weekly chart

The 10-year yield has rallied up to its long-term downtrend line from 1988-2007, which is where its rally into the March high also stopped. Currently near 2.47, TNX would be more bullish above that level, although there's a projection near 2.51 which could be tagged before TNX reverses back down. That price projection is for a possible a-b-c move up from June (not the lower low in September) where the c-wave is 162% of the a-wave. Based on that projection TNX would be more bullish above 2.51.

If bond yields have not seen their multi-decade low yet, which is the way I continue to lean, we'll see TNX reverse from resistance and start heading back down. One reason this could start is if the stock market is ready for a stronger pullback/decline. That would likely prompt rotation into the relative safety of the Treasuries and thus drive prices higher, yields lower.


KBW Bank index, BKX, Weekly chart

The weekly chart of BKX shows the past 3 weeks has seen resistance holding at the top of its parallel up-channel for its rally from 2009. There's also a short-term trend line along the highs of the bounce off the April low. Along with the high on March 1st, it's also testing the 78.6% retracement of its 2007-2009 decline (no new highs for the banks while the other indexes have done so). With the bearish divergence at the current high as it hits resistance I'm thinking BKX will at least pull back a little stronger before trying it again. The more bearish wave count calls for a major top here.


Transportation Index, TRAN, Weekly chart

The TRAN peaked with a closing high on October 12th and minor new intraday high on October 13th. Since then it has been coming back down while the Dow went on to make new highs. It's only short term but with the TRAN not confirming the Dow's new highs we have negative divergence. The TRAN was stopped by the trend line along the highs since December 2016 - March 2017 and is showing bearish divergence against those highs. It's not a bullish picture here.


U.S. Dollar contract, DX, Daily chart

The US$ is close to breaking out of its down-channel for this year's decline, the top of which is currently near today's close. Breaking out of the down-channel and getting above its October 6th high at 94.10 would be a bullish move. A short-term price projection points to 94.30 and therefore above that level would be good confirmation a low is in for the dollar. But until that happens there is still the potential for one more new low, near 90, before setting up a bigger rally into next year.


Gold continuous contract, GC, Daily chart

As with the dollar, gold is about to make a decision which way to go and it should be a strong move. Bullishly, gold broke its downtrend line from 2011- 2016 in August and then back-tested it in early October. It's now testing an uptrend line from July-October, near 1276, and if that leads to a rally above its high at 1308.40 on October 16th it should lead to a strong rally. That might happen if the dollar heads back down toward 90. But if gold drops below its October 6th low at 1262.80 it will likely lead to a strong decline. Flip a coin for direction from here but then it should be a strong move.


Oil continuous contract, CL, Daily chart

I see upside potential for oil to a price projection near 54 for two equal 3-wave moves up from June. It would be more bullish above 54 but at the moment, with bearish divergence against the highs at the end of September there is risk to the downside from here as it again approaches its broken uptrend line form April-August-November 2016, currently nearing 53.


Economic reports

Thursday morning we'll get some more housing data with the Pending Home Sales report. The number for August was a disappointing -2.6%. Other than Friday's final Michigan Sentiment number there isn't much left this week to report.


Conclusion

The market is weakening significantly and the decline since Monday morning's highs has the potential to develop into a much stronger pullback/decline. The bulls could pull another rabbit out of the hat with a rally on Thursday and into Friday. If that happens I suspect we'll see the market hold up at least through the end of the month. After that would be a coin toss. Unless we see strengthening in the market breadth, as discussed in the beginning of tonight's wrap, I think the higher this market goes the weaker it will become, which would make a coming correction that much worse. We already have a significant air pocket (more like a vacuum pocket) below us.

We have early signs that this week's pullback is the start of something bigger to the downside but no confirmation of that. The pullback to support for the techs, as well as a corrective-looking pullback pattern for the RUT, supports the idea for another rally leg, which would likely be the last one. But I think it's now especially risky to be thinking long.

If you believe in the longer-term bull and therefore do not want to sell your positions (perhaps for tax reasons or just because you hate selling and then looking for another entry point) then a good way to protect yourself is with put options, long inverse ETFs and/or short some weaker stocks. At least you'll be hedged and then later decide what you want to do with your positions.

If you're a bear itching to get in the fight, we are close to knowing whether or not it's time to enter the ring. A drop back down on Thursday, to test today's low or break slightly below it, could lead to a slightly stronger bounce into Friday, maybe Monday. From there that would be a good setup to get short for what would likely be a much stronger decline. We'll obviously know more this time next week. In the meantime both sides need to exercise caution since things could get a little more volatile.

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

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying