The DOW has now made it 6 days in a row and 11 out of the past 13 trading days closing in the red. It's about this time that's it's dialing for help to be able to get up off the floor but due to budget cuts it could be another day or two before help arrives.
The stock market has been struggling since the August 5th highs for the indexes and not helping are the overseas markets. The Asian markets in particular have been struggling and that pulls down U.S. futures in the early overnight session. The European markets have been declining over the past week and they drag futures lower as well. The early-morning pressure on U.S. markets when they open has been difficult to overcome and it seems the global indexes are stair-stepping lower together. And that makes it difficult to find somewhere to hide if you're a fund manager that needs to always be invested in something.
This morning was very quiet for economic reports and this week is void of a lot of economic reports for the market to respond to. This morning's existing home sales were positive in that the 5.39M was better than the 5.1M expected and an improvement over June's downwardly revised 5.06M. But there was barely a blip in the futures at 8:30 AM when the report was released. The new home sales number comes out Friday and that could have an impact on the home builders and overall market sentiment.
The market really didn't care about anything other than the FOMC minutes that were released at 2:00 PM. There was some additional selling in the morning as traders worried about what the minutes would spell out but then we got a little bounce as we approached 2:00. There was the usual whipsaw after the release with an initial reaction to the downside. But a huge buy program (or two or three) came in and jammed the shorts out of the market, resulting in new highs for the day. Too bad the little manipulation maneuver got no follow through since the spike up was followed by a spike back down into the close. The DOW has been weaker lately but even it spiked up 140 points, only to give back 120 of those points into the close.
It was a nice try by the Fed and banks to save the market but there was no getting around the fact that the market learned there is strong agreement by the Fed heads in Bernanke's taper talk. Most agree with Bernanke's plan to start reducing bond buying later this year "if the economy improves." Nothing new there. But while some felt the tapering needed to start sooner rather than later, most agree that it's not time to start. Nothing new there. In fact there was nothing in the minutes that we haven't heard before. It was just a little temper tantrum by the market into the close when it realized the Fed's not promising more money.
As a private consortium of banks that are doing the bond buying, most are starting to realize how much trouble they're in. These bonds have been purchased at a high price (low yield) and the selloff in bond prices is hurting their "investment."
I've been of the opinion that the Fed will be forced to promise more bond buying because they don't want to have a stock market crash on their watch. As soon as the stock market takes a bad tumble I think they'll be out promising more, not less. "Did I say taper? Silly me. I meant tamper, as in tampering with the market to prevent any selloffs. We need to keep people feeling the wealth effect."
But recently I read a very good article on why the Fed will have to taper. After many years of manipulating the bond market and tampering with the stock market, taking on $2T (that's a 'T') in debt on their books, with nothing to show for it, the bankers are starting to get scared. The Fed had $476B at the end of 2008 and now they have $2000B and the economy hasn't reacted favorably at all. They have a lot of bonds that have rapidly lost value, especially since May, and it's sitting on their books. While they may believe it doesn't matter since they'll simply hold onto them to maturity, the fact remains that these banks are saddled with poor-performing investments the higher yields climb (which they won't participate in) and the lower the value of their bonds drop. I know, it's really hard to feel sorry for them.
These bankers see what's coming and they don't like it. Foreigners have been dumping bonds and the Fed is becoming more and more the buyer of last resort. In June foreigners dumped about $5B in Fannie Mae, Freddie Mac and Ginnie Mae bonds, another $5B in corporate bonds and almost $41B in U.S. Treasury bonds. In total they dumped about $70B in long-term U.S. securities. Most of the selling has come from China and Japan, the two largest holders of our debt. Their economies are not doing so well and they may need to sell a lot more to help support their own debt. Everyone will be buying their own debt soon (monetization of the debt) as we race for the bottom in currency debasement.
The Fed has been a master bubble builder and each iteration of monetization has created a bubble in a different security, with the latest being the bond market. It would appear that perhaps that bubble is about to pop, or at least that's what the bankers are now worried about. I still haven't abandoned the idea that bonds have one more rally in them, to drop yields to one more new low, but the rally in the 10-year above 2.8% has me wondering too whether we've seen a generational high for bond prices. Is the bubble popping? And if so, what happens to all those bonds sitting in the bankers' hands. Do they want to buy more or would they like to get rid of what they have? If they are the buyer of last resort what happens when they start to taper instead of buy more? These are questions all of us have and now the bankers are questioning themselves as well.
So the bottom line is that I've been of the opinion that the Federal banking cartel, I mean Reserve has boxed itself into a corner and can't afford to let the stock market crash and least of all they can't afford to let the bond market sell off as well. Either could spark more promises from them to create more money to buy more bonds. Countering that is their concern that they're the ones who are going to be left holding the bag with all these poor-performing bonds. What's a poor Fed head to do? One thing can be certain -- the banks will take care of themselves in the end and it won't be a pretty sight when they do. We of course care about the impact to the stock and bond markets but as far as the bankers go, it will be every man for himself.
I am not the only one who's not sure what the Fed will do and that's of course upsetting the market. The stock market hates uncertainty and right now we've got a lot of it. Anyone who can read numbers knows the stock market has long been disconnected from reality and just about every other stock index in the world. The rally has been built on sentiment, not fundamentals, and that leaves a huge air pocket below us. I've shown in the past the huge separation between commodity prices and the stock market, two indexes that are typically in synch. I think we're starting to see that sentiment crack and we're running out of people to plug their thumbs in the dike.
The big question on most people's minds is whether or not the August high was THE high. I think it was but I'm probably still in the minority of stock market analysts. I'm still waiting for confirmation with an impulsive decline in the stock market, something which we do not have yet. I'll start tonight's review with the RUT since it's a good sentiment indicator.
The RUT has one of the cleaner patterns and channels so a top-down review of this index will hopefully be instructive. The weekly chart shows the August high was right at the top of its two up-channels -- a larger one from October 2011 and a shorter-term one from November 2012. It's still inside both up-channels and therefore on a weekly basis the bulls are clearly still not in trouble. The bottom of the steeper up-channel from November is near 990 and therefore longer-term traders could tolerate a pullback to that level before worrying about a larger breakdown.
Russell-2000, RUT, Weekly chart
Based on the wave count leading up to the August highs for the stock indexes I think there's a better than even chance that THE high is in place, which I mentioned following the August 5th highs. That's the reason I'm showing an expectation for a large 5-wave move down into November (to confirm a trend change to the downside), followed by a bounce correction into the first of the new year and then down hard from there.
We don't have evidence that THE top is in place until we see a smaller impulsive (5-wave) move down and so far we only have a 3-wave pullback from August 5th. The daily chart below shows an expectation for one more leg down following the bounce off Tuesday morning's low, which would give us a 5-wave move down and that would be the first confirmation that we have a more significant top in place. A bounce off the low, expected next week, into early September would then set us up for a stronger decline into October (as part of wave-iii on the weekly chart above).
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1043
- bearish below 1020
A closer view of the decline from August 5th is shown on the RUT's 30-min chart below. You can see that the decline is so far only a 3-wave move and as such it could be just an a-b-c pullback correction that will lead to more new highs. That's the risk for bears who want to be short the market. We can't assume anything here. Again, based on the larger pattern leading up to the August high I believe we are starting the next bear phase but the first piece of evidence needed is a 5-wave decline from August 5th, which is what I'm showing on the chart.
Russell-2000, RUT, 30-min chart
One more leg down for the RUT, to what might be just a minor new low early next week, would complete the 5th wave and then set up a larger bounce into early September. If the bounce from here climbs above the August 7th low near 1043 it would confirm we've had just a 3-wave corrective pullback. It could develop into a larger pullback correction, so new highs right away would not be assured, but it would mean we probably haven't see the final high for the market, or at least the RUT (and NDX as well probably).
SPX has been struggling to climb back over its broken 50-dma since breaking it last Friday. I was actually surprised to see no bounce off that important MA, especially since so many are aware of how supportive it's been since November (except for the big head-fake break in June). Instead of bouncing off it we've seen it hold as resistance on back tests. Not bullish. Today was the 3rd attempt to rally back above it, currently near 1658 but giving up this afternoon's post-FOMC rally probably sealed the deal for the bears -- look for a kiss goodbye and lower prices.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1687
- bearish below 1658
But like the RUT, SPX looks like it only needs one more leg down to complete a 5-wave move down from its August 5th high (one interpretation calls for a down-up-down sequence as it stair-steps lower into early next week but if you're short I'd want to lower stops on any new lows from here). On the daily chart above I show the potential for SPX to drop down to its uptrend line from November-June, near 1624. I would be very surprised if that line broke on the first test considering we should be in the 5th wave down and support should hold. If it does break then we have a more bearish wave pattern playing out and it could get ugly to the downside (mini crash kind of move down). But at the moment I consider that a lower-odds scenario.
As shown in more detail on its 30-min chart below, SPX could finish its decline as early as tomorrow at a downside projection near 1633 where the 5th wave would equal the 1st wave. A larger bounce from there into early September would provide an opportunity to trade the long side through the holiday but remember it would now be a counter-trend play, not a buy-the-dip in an uptrend. A new low would confirm the new trend is down and that would put us into a sell-the-rallies mode.
S&P 500, SPX, 30-min chart
After breaking below its uptrend lines from November (through the December low and the June low) the DOW is trying to hold minor support at 14900-15000, which is where it consolidated in late June/early July on its way up to its August high. The 62% retracement of its June-August rally is also at 14974 so it's currently below that support level. The July 3rd low is at 14859, which was almost tagged with today's low at 14880. Below this zone there's not much support until the June low at 14551. The DOW has been the weaker index and we've seen very small bounces since the spike down on August 15th and I keep expecting a bigger bounce for at least a correction to its decline before it heads lower, but nothing yet. I've fallen and I can't get up.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 15,350
- bearish below 15,100
The short-term pattern for the tech indexes, following the big gap down on August 15th has been a choppy whippy mess. It could be a bullish basing pattern and the bulls would love nothing better than to see it gap up out of the consolidation, thereby leaving an island reversal. But I can use the same downside wave count as the others, which calls for one more leg down for the 5th wave of the decline from August 5th. If it continues lower from this afternoon's high it would become equal to the 1st wave near 3570 and based on its megaphone pattern that has developed since August 15th a low on Monday would do a nice job completing the pattern and set up a larger bounce into early September.
Nasdaq Composite index, COMPQ, Daily chart
Key Levels for NDX:
- bullish above 3691
- bearish below 3573
I mentioned TNX earlier when discussing the conundrum the Fed finds itself in (of its own making I might add) and they're now battling the decision to keep money freely flowing into the markets, through their bonds purchases, or to start to "taper" off the monetization effort. They need to keep up the buying as a way to try to prop up prices and keep yields down while trying to extricate themselves from being the buyer of last resort and ending up with a lot of badly performing assets on their books.
I've been viewing the bounce in TNX since its July 2012 low as an a-b-c bounce correction to the longer-term decline. This is based largely on the 3-wave bounce from July 2012 to the March 2013 high. The sharp rally from May 1st should be the c-wave and once complete we should see a complete retracement of the 3-wave bounce. That interpretation suggests a bond rally is coming and yields will drop to a final low some time in 2014, potentially down to about 1%. The Fed would breathe a huge sigh of relief if that happens (but it won't last since that would be a generational low for bond yields). One reason I can see for this happening is if the stock market tanks and investors run for the safety of bonds (from overseas as well). Throw in some more QE monetization in an effort to prop up the stock market and we could see a lot of buying power come into the bond market. Time will tell.
TNX has pushed marginally above its downtrend line from 1981-2007 but it is overbought on the daily and weekly charts and showing bearish divergence. I think we'll soon see at least a pullback and if it chops lower in a pullback correction it would be a good indication that we could expect it to then head higher (green dashed line on the chart). That would be confirmation that bond yields are headed higher and that the Fed has lost control of the bond market (it never had it but traders like to think the Fed is in control). The a-b-c bounce off the July 2012 low says the whole thing should be retraced. That's why it will be important to see what kind of pullback/decline follows the current rally leg.
10-year Yield, TNX, Weekly chart
The banking index, BKX, has been dancing on top of its 50-dma for the past 3 days and it might find support at it, near 63.90 (today's low was 63.79). But assuming the market has at least one more minor new low before a larger bounce into early September we should see BKX test support at its uptrend line from April, near 63.35. A corrective bounce into early September would be a good shorting opportunity to ride the next leg down into October.
KBW Bank index, BKX, Daily chart
Before taking a look at the U.S. dollar and metals I thought I'd show the gold miners ETF (GDX) to see if it might provide some clues for both stocks and the metals. The bullish thing I see is the break of its downtrend line from October 2012 - January 2012 (it broke its downtrend line from January with July's rally and successfully held on a back test in early August). A pullback to the 2012-2013 trend line, currently near its 20-dma at 27.32, that holds as support would be bullish. The only thing concerning about that kind of a pullback is that it would overlap the July 23rd high at 28.35 and that would have the bounce off the June low looking like a 3-wave bounce correction. We could see a higher corrective bounce pattern develop or we might have seen GDX already top out (it achieved two equal legs up at 30.03) and the 3-wave bounce will be completely retraced as it heads for new lows. For the bulls to maintain control here they'll want to see this stay above 28.35 otherwise the bears might go on the attack again.
Gold Miners ETF, GDX, Daily chart
The U.S. dollar hasn't been able to get a rally started and if it doesn't start from here I think we'll see it drop down to the 79.50 area. I broke support on Tuesday, at its uptrend line from 2011, but immediately recovered today. No harm, no foul? Another drop below the key level at 80.90 would be bearish. It's currently stuck below its 20- , 50- and 200-dma's and the 20 has already crossed down below the 50 and is currently crossing the 200 at 81.66. That's the level the dollar needs to climb above in order to look stronger.
U.S. Dollar contract, DX, Daily chart
Like GDX, gold so far has a 3-wave bounce off its June low. I'm calling it an a-b-c bounce correction that will lead to lower prices but a 1-2-3 bounce can't be ruled out yet. An overlap of the July 23rd high at 1348.70 would point to the a-b-c interpretation and turn more immediately bearish gold. At the moment it looks like it could get a minor new high before either consolidating before pressing higher or starting back down but it's battling its downtrend line from February-April as well as its short-term broken uptrend line from April-May, which it broke below in June. Above 1450 would turn me more bullish gold
Gold continuous contract, GC, Daily chart
Silver's pattern is the same as GDX and gold except the 2nd leg of its bounce is stronger (it achieved 162% of the 1st leg). If it's a 1-2-3 bounce then we should see choppy consolidation for a week or two and then higher. It stays bullish above 22. But if it has completed an a-b-c bounce then it should waste no time heading back down. A drop below 20.50 would confirm the bears are in control.
Silver continuous contract, SI, Daily chart
The way oil has been consolidating on top of its broken downtrend line from May 2011 it's looking like preparation for another rally leg. The wave count for the move up from April supports another new high into September to complete a 5-wave move up. That will either complete an A-B-C bounce off the June 2012 low, to be followed by a decline that will take oil below 70, or it will be followed by another multi-month choppy correction before heading higher again at the end of the year or early next year. A drop below 102 would have it breaking back below its broken downtrend line, the bottom of its up-channel from April and its 50-dma so bulls need to defend 102. The pattern would turn more bearish below 97.
Oil continuous contract, CL, Daily chart
There are no market-moving economic reports Thursday so the market will be left to itself and what happens overseas, at least for the start of the day.
Economic reports and Summary
The indexes are looking lower but the wave count suggests caution if thinking about chasing it lower. The 5th wave could complete at any time and start a larger bounce into early September to correct the decline before setting up stronger decline into October. The one caution for those thinking about buying the next low, looking to play the bounce into September, is the potential for a much stronger decline. Think mini crash. I think that's a lower-odds scenario but then again, crashes always are. But the market is oversold, we've had a cluster of Hindenburg Omen signals and there's still a high level of complacency in traders' expectation for the market to come back. It's out of these conditions that the market crashes so there's that risk.
We should be looking for a new low in the next day or three and it should show us bullish divergence against Tuesday's. If we get a strong decline, one where SPX rips through 1620, stand back and enjoy the show since it could get violent in both directions. If the Fed sense they've lost control, as it appears they have with the bond market, they will promise all kinds of goodies to the market to stem the losses. Soon that won't work but for a while longer it will. Tis the time to be careful.
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