A few people commented to me today that maybe Wednesday was the head-fake day and that too many are becoming wise to the pattern of the Thursday prior to opex being a "misdirection" day. We've seen time and again where the initial move Thursday morning gets reversed and the direction for the following week is set by the end of the day. Today's trading was unusually quiet for the pre-opex Thursday, which begs the question: was Wednesday's down day the head fake (especially with the break and then recovery of significant support levels into the end of the day) or was today's rally the head-fake move?
And of course as we head into the heart of summer vacation we might find opex to be a very quiet trading period this time around--no games, no sneaky head fakes and just smooth tradable moves. I know, I can wake up now. As I'll cover in the charts, today's bounce had the characteristics of a corrective bounce which suggests lower prices dead ahead. That would say today's rally was a head fake. We'll see what that might mean.
Today started off bullishly and added to the gains from yesterday's "stick save" when the market rallied strongly into the close and got the major averages back to or above strong support lines. Most of the day's gains were held into the afternoon but some late-day selling took the market back down for a flat finish. The trading day itself seemed somewhat listless.
There were no significant earnings stories or economic reports to get either side excited this morning. The unemployment numbers improved somewhat with initial claims down by 52K to 565K, the lowest number since January but the continuing claims number rose another 159K to 6.88M which is twice the number from a year ago. This high number was in spite of losing 146K continuing claims because people's benefits expired.
The wholesale inventories fell -0.8% from May and the inventory-to-sales ratio dropped slightly from 1.29 to 1.31, which is a good trend for both. High inventories and slow sales leads to obsolete inventories and write-downs, bad for earnings and bad for stock prices. It looks like wholesalers will continue to draw down inventories into the 2nd half of the year and dropping inventories means less production and lower GDP, bad for stock prices. Looks like a lose-lose situation for a bit more for stock prices. The little green shoots are acting more like Punxsutawney Phil after seeing his shadow.
If the market can continue to rally into next week it may be setting up for a drop into August if history is to be any kind of guide. Citigroup noted some seasonal influence in this period and identified 9 years when the market rallied into July:
1982: DJIA having started to turn sharply lower had a short-term bounce which peaked at 843.80 on 21st July. But by 09 August it was nearly 9% lower.
1987: DJIA was in a solid bull market, which peaked at a new high of 2,520 on 17th July. By 21st July it was 2.7% lower and while it then rallied strongly we of course ended up with a stock market crash in October.
1990: DJIA was in a solid bull market, which peaked at 3,011 on 17th July. By 23rd July it was 5.25% lower and by mid October it was 20% lower.
1998: DJIA was in a solid bull market, which peaked at 9,413 on 17th July. By 28th July it was 6.6% lower and by mid September it was over 20% lower.
2001: DJIA hit a corrective high of 10,758 on 19th July (again a small miss of the magic date). By 25th July it was 5.5% lower and by the 21 September it was over 26% lower.
2002: DJIA hit a corrective high of 8,765 on 17th July. By 24th July it was 13% lower and by October lower still at the base of the bear market.
2007: DJIA hit a trend high of 14,022 on 17th July. By 01 August it was 6.3% lower and by mid August nearly 11% lower.
2008: DJIA had started to move lower but began a bounce on15th July.
On 23rd July it had a quick 3 day fall of just under 5% It then rallied again into 11th August but we of course ended up with a stock market crash in October/November in a development eerily similar to 1987.
To quote Citi, "So if we look back over all these major years in over a quarter of a century (9 instances) in 7 of them the period from the 17th to the 21st July we have begun a significant move lower in equities. In the 2 instances (1987 and 2008) that we did not immediately head lower we ended up with stock market crashes later in the year...all in all an ominous set up."
Of course we can't trade historical patterns but it does provide a heads up about the period we're entering. With that let's look at the chart.
The weekly SPX chart shows price rolling over further from its downtrend line from May 2008 and the oscillators are rolling over as well. MACD has crossed down but has not dropped below the zero line. RSI has curled over but has not broken its uptrend line from October 2007 yet. So we have bearish signals but no confirmation of a breakdown yet. As shown in pink, the current pullback could lead to another rally leg through the summer with SPX making it as high as the 1000 area.
S&P 500, SPX, Weekly chart
The daily chart looks more bearish at the moment with MACD below the zero line and nowhere near oversold. RSI was rejected at the horizontal line that was support and now resistance (just above 50). RSI hanging around below 60 is usually indicative of a bear trend. But so far the pullback from the June high is only a 3-wave move and therefore potentially bullish if it can start pushing back up. A break above the downtrend line from May 2008, near 920, would be bullish. But until that happens I think SPX is vulnerable to a sharp drop down to the 823 area (H&S downside projection and a Fib projection for the move down from the June high).
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 920
- bearish below 900
I show a sharp bounce back up from there (if it gets there) but that's only a guess at this point. The wave pattern remains corrective rather than impulsive and that makes it more difficult to use the pattern for price projections. That's why I'll keep recommending short-term trades and taking profits (or losses) quickly. Rinse and repeat.
The top of the parallel down-channel drawn on the 120-min chart is actually the downtrend line from May 2008 and the parallel is attached to the first low (June 23rd). The decline on Wednesday stopped right at the bottom of the channel (in case you were wondering why it stopped where it did). I show downside price projections for equality in the two legs down from June 11th (864.55) and where the 2nd leg down would achieve 162% of the 1st leg down (822.91). I also show the H&S price objective which falls right on top of the Fib projection near 823. If the market turns lower again on Friday I think that's where SPX is headed into opex week.
S&P 500, SPX, 120-min chart
I also noted on the chart a potential turn window on July 14-15. This is based on the ratio between previous turns over the past month or so. Therefore if we see a rally (pink) or decline (dark red) watch for a possible reversal next Tuesday or Wednesday.
The DOW was showing some bearish non-confirmation this afternoon when it could not match the other indexes in making a new high above this morning's. It was instead struggling with the 8200 level which was resistance in April, support in May and now looking to be resistance again. If SPX makes it down to 823 by next week we'll probably see the DOW testing 7500 support. It takes a rally back above 8600 to turn the wave pattern at least short-term bullish. In the meantime it's a market to short the rallies rather than buy the dips. The oscillators are supporting the bears at the moment.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 8600
- bearish below 8200
The pullback pattern for NDX is very similar to the DOW's and SPX's but shallower. At yesterday's low it tagged the level where it had two equal legs down from June 12th (near 1399) and the bottom of a parallel down-channel (looks like a bull flag). Based on just these two factors it looks like it's a setup for another rally leg into next week if not August. But like the DOW and SPX I didn't see anything today to get me excited about the upside. Today's bounce looked like a 3-wave correction to the decline and based on that it looks like selling should resume. And if selling kicks back in tomorrow, especially if it breaks Wednesday's lows, we'll likely see strong selling. I show a Fib projection for NDX near 1338 but based on the size of the decline so far I think it could exceed that and head down to its 200-dma near 1293. A rally back above 1475 would be bullish.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 1475
- bearish below 1399
I had mentioned above that there is a potential Fib turn window on July 14-15 based on some shorter-term relationships between turns over the past month or so. I've shown the weekly NDX chart a few times before to show the Fib number of weeks between major turning points and that the next one (a Fib 34 weeks from the November low) is during the week of July 12th. I find it more than interesting that the short-term projections fall within this same week.
So I looked over the weekly chart of NDX to see what could be playing out if it declines into next week but not hard. The 50-week moving average could act as support next week and it will be near 1374 so keep that number on your chart if you watch this index. I've drawn in a rising wedge pattern but that's just a guess at this time. But if it's the correct pattern then it needs one more leg up to finish it (shown in pink).
Nasdaq-100, NDX, Weekly chart
The rising wedge pattern calls for a rally up to about the 1620 area in August which would also be a 50% retracement of the October 2007-November 2008 decline. I of course have no idea if this will play out but it's got some strong merits and I think it's worthy of consideration by those who have a hard time seeing (much less understanding) why the market should rally. This pattern supports the idea that we'll see a decline into next week but then a rally to follow. This would negate the expectations I showed for SPX and the DOW for a drop down to 823/7500 (although a sharp drop down that far could still be followed by another rally leg into August as depicted in pink on the NDX chart). Like I said, it's something to consider and another reason to play the market short term while gathering clues as to what's next.
The bearish perspective of what's going on with the techs comes from Walter Deemer, who writes "Market Strategies and Insights". He made a very interesting observation last week about volume. Specifically he watches the volume on the NASDAQ vs. the NYSE and then analyzes the ratio of the 4 and 52-week averages. He has noted that readings above 1.24 signal an excessive amount of buying interest in the techs (a measure of the "animal spirits" of the market where people are so convinced of the rally potential that they want to be in the sexier high-beta stocks). Think of it as a sentiment indicator.
He put together a chart (which is hard to read because I had to squish it down) that shows the NDX vs. this ratio going back to 2002. There was a big peak in late 2003/early 2004 and you can see price consolidated before heading higher. So it doesn't mean prices will necessarily decline hard but it does provide a heads up for danger once the ratio gets too high. The last time the ratio was above 1.24 was November 2007, identified by the solid vertical pink line towards the right side of the chart. The dotted line was when the ratio almost reached 1.20 in May 2008.
NASDAQ/NYSE 4/52 Week Volume Ratio, courtesy Walter Deemer
You can also see by the vertical lines how many times this ratio has identified the tops for the NDX. While no tool is foolproof, this one has "Danger Will Robinson" written all over it. That's for those who are old enough to remember the 1960s pre-Star Trek show "Lost in
Space" with the robot flapping its arms while warning the Robinson family of approaching danger. The horizontal pink line on the chart is 1.17 and is the warning line. The red line at 1.27 is the Will Robinson Danger level. The sharpness of the spike up since March shows how gung ho people have been to buy the techs over everything else. It's time to be defensive in the market, even if there is to be one more leg up (or I should say especially after one more leg up if we get it).
Like the others, the RUT has a very similar pattern and not much else needs to be said about it. A break below Wednesday's low would be a confirmed break of its 200-dma which clearly provided support in June.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 520
- bearish below 473
In the YCMTSU (you can't make this stuff up) category, Morgan Stanley is back to their old games in selling crap, uh I mean, toxic waste, uh I mean more SIVs (why do I think "shiv" when I read that? Perhaps because I'd feel like I've been shivved if I buy a SIV, a Structured Investment Vehicle). Since it worked so well the first time, especially with the taxpayers bailing them out of trouble, MS has decided to try it again. In an article in Bloomberg.com yesterday, written by Pierre Paulden, Caroline Salas and Sarah Mulholland, they report "Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings..." Oh boy, give me some of that stuff.
Apparently MS plans on selling $87M worth of these securities once they get the AAA rating on what were Baa2 securities (the second-lowest investment grade by Moody's). The alchemy used to create AAA-rated products from horse dung has apparently not been discredited by the last credit crisis. Banks have been repackaging commercial mortgage-backed securities in recent weeks (will we ever learn??) and now MS is repackaging CDOs (collateralized debt obligations) of loans.
Sylvain Raynes, a principal at R&R Consulting in New York said, "Youâ€™re manufacturing AAA out of not AAA, therefore allowing those people who have AAA written on their forehead to buy." In other words, those pension and endowment fund managers who can only buy AAA products will line up once again to throw good money after bad into these very stinky products. Shame on them for not learning and shame on the banks for playing this game. Next we'll be hearing how AIG is selling insurance against these products.
This is being done at a time when many commercial mortgage-back securities are being downgraded. About $400B of commercial real estate debt is due to reset between now and the end of the year. They will have as much difficulty (if not more) refinancing their debt as home owners have had. To protect themselves against losses on these loans the banks have now created re-REMICs (resecuritizations of real estate mortgage investment conduits), the name given to the repackaged commercial loans that they're trying to sell. The name I've given them is Collateralized RealEstate Asset Products (CRAP). Goldman Sachs plans on selling about $217M of this repackaged commercial debt by carving up four bonds sold in 2006 which GS fears may be vulnerable to failure. It sounds like they're trying to pawn it off on some unsuspecting fund managers who only look for AAA rating and buy it no questions asked. It's true that some people never learn. Barnum and Bailey had it right.
Banks are in further trouble from the housing market as holders of subprime-mortgage bonds flood the market with foreclosed homes at prices that are much lower than where many banks are willing to sell them. The banks are facing the choice of keeping more homes on their books (and subjecting themselves to vandalization of the properties) or selling them at a steeper loss. A loss will of course have a negative impact on their bottom line. If they hold them on their books they will of course carry them at full value. Hmm, I wonder which one they'll choose.
So far the banks have been able to pull the wool over most investors' eyes and even the pullback from the May high has been shallow. I can look at this two ways: the bearish view is that the banks topped in May and were not able to rally with the broader market to new highs in June (which was a warning back in 2007); or the bullish view is that the pullback looks more like a bull flag or bullish descending wedge. The pink wave count is looking for a rally out of this pattern and a break above 113 would confirm it. Otherwise it may simply be getting ready for a strong breakdown in which case the Fib projection near 74 makes for a good initial target.
Banking index, BIX, Daily chart
The housing market continues to struggle. Whitney Tilson and Glenn Tongue of T2 Partners have updated their analysis on the housing and mortgage markets and have concluded that "We are in the 'middle innings' of the mortgage and foreclosure crisis. House prices have at least another 15%-20% to fall and won't bottom until the middle of next year. The recent signs of stabilization are the 'mother of all head fakes'." That's certainly not very encouraging for those home owners who have been holding onto hope that we've hit bottom. History shows we've unfortunately got a ways to go before we see a bottom in housing and the bottom will likely be 'L' shaped.
After holding for over a month above its support line near 206 (the early 2001 lows) the home builders index broke that support level this week. The next support level is near 182 where its uptrend line from November 2008 is located. If that holds next week (assuming the market declines into opex) there is the potential for another rally leg into August (supporting the idea for a rally described for NDX) to finish the upward correction off the November low. A move below 180 would suggest new lows, or a test of the November low, is the more likely move.
U.S. Home Construction Index, DJUSHB, Daily chart
If the housing and commercial real estate markets are in for some tougher times ahead it stands to reason that the REIT (real estate investment trust) market will not do well either. The Dow Jones Equity REIT index is showing a breakdown this week. The line of support near 120 broke Wednesday and unlike some of the larger indexes this one did not recover into yesterday's close or today. It tried but was rejected today at that support-turned-resistance line. It's a lopsided H&S pattern but it projects down to about 97, or back to the initial congestion area in March following the low.
DJ Equity REIT index, DJR, Daily chart
The Transports have an interesting pattern at the moment, outlined on the chart with the downtrend line from January 2009 and the horizontal support line near 2990 (where Wednesday's low found support). This is creating a potentially bullish descending triangle which calls for another up-down sequence, shown in pink, to complete it. A strong rally leg out of it into the fall would be the expected outcome. That kind of move is a little hard to swallow right now so I continue to lean towards a breakdown instead. However, I'll let price lead the way on this one.
Transportation Index, TRAN, Daily chart
Yesterday gold broke below the June low and tried to recapture that level today but couldn't hold onto the day's gains. It looks like a setup for further selling in which case a drop to its 200-dma near 878 could be next. Another rally attempt could have it testing its broken uptrend line from November-April, or potentially higher as shown in green. I think gold is headed lower, even if it first gets a slightly higher bounce first. And the reason it could get a bounce first is because of what I see for oil (chart after gold).
Gold continuous contract, GC, Daily chart
Oil stopped at the bottom of its parallel up-channel from February and RSI is looking oversold. The combination could be a good setup for a rally to start. The bullish wave count calls for a 5th wave up for the count from the February low. Back up to the top of the channel could have oil well over $80. The bearish wave count calls the June high the end of an a-b-c correction to the decline from 2008 and after perhaps a consolidation above the uptrend line we'll see a break of it as oil heads for new lows over the next several months. We should get some clues over the next week or two once the bounce pattern (assuming it will bounce from here) can be identified.
Oil continuous contract, CL, Daily chart
What the US dollar does next could help figure out what commodities, like oil and maybe gold, will do next. The price pattern has me thinking we'll see another rally leg out of its current sideways consolidation. As depicted on the chart, I see the possibility for a rally up the 82.71 Fib retracement (38%) level before turning back over and heading to a new low. That would give us a little throw-over above the parallel down-channel equal to the throw-under at the beginning of June (that kind of symmetry is very common). A rally above 83 would be bullish the dollar (bearish commodities and stocks). If the dollar breaks below 79.56 we could instead see a new low in July and then the start of a strong rally into the end of the year.
U.S. Dollar, Daily chart
Tomorrow's economic reports will be another light day and have virtually no impact on the market:
Economic reports, summary and Key Trading Levels
Normally opex week, which includes the couple of days prior to opex, are a little more volatile than usual. Today was not in that category and it might be an indication that we're going to have a quiet (boring) opex week. Tomorrow being a summer Friday could be even more quiet than usual. But if we see a decline get started, especially with the lower trading volumes we're seeing, then opex squaring could exacerbate the move down. If Wednesday's lows give way I suspect there are many stops now positioned as traders decide not to take another break of support and instead take profits off the table. I recommend the same if you're long the market.
I see the possibility for a quick (perhaps strong) decline into early next week (Tuesday/Wednesday) and then a reversal. That would meet some Fib timing windows. If the selloff does become strong keep an eye on SPX 823 for support. If we instead get a rally we could see a high on Tuesday/Wednesday instead of a low and then a resumption of the selling. SPX 917-920 will be key to watch to the upside since a break above that level could be an indication of a stronger rally into at least the latter part of the month. As always, because it's opex week coming up, be careful of low-volume spikes with no follow through. It's generally an unreliable time to initiate new trades for anything other than a day trade.
Lastly, what fun is life if you can't find the humor in any situation. With that in mind I thought I'd pass along the 10 ways you can identify a tough economy (these are not mine but I don't know the original author):
Ten ways you know the economy is getting tough...
10. You can now buy a corporate jet on Craig's list.
9. The IRS starts offering air-miles rewards for tax payments.
8. You get a pre-declined credit card in the mail.
7. People in Beverly Hills fire their nannies and learn their children's names.
6. Hotwheels and Matchbox cars are worth more than U.S. car company stocks.
5. The most highly-paid job is jury duty.
4. Mothers in Africa tell their kids, "finish your plate; kids are starving in America."
3. The Mafia starts laying off judges.
2. You buy a toaster oven, they give you a bank.
And number one way you know the economy is getting tough...
1. When your check is returned for "insufficient funds" you need to call your bank to ask if they meant you or them.
Good luck in the coming week and I'll be back with you on Monday (Todd and I will be switching nights as I'll be traveling the latter part of next week to attend my son's wedding--the 3rd and last one).
Key Levels for SPX:
- bullish above 920
- bearish below 900
Key Levels for DOW:
- bullish above 8600
- bearish below 8200
Key Levels for NDX:
- bullish above 1475
- bearish below 1399
Key Levels for RUT:
- bullish above 520
- bearish below 473
Keene H. Little, CMT
Chartered Market Technician