There were many market participants expecting that the celestial event of Venus traversing across the face of the sun would have a positive effect on the market. Looks like the bulls got their wish.
Between a full moon on Monday and Venus traversing the sun (making the earth in line with Venus and the sun and the gravitational effect of that), the bears didn't have a chance this week. I say that somewhat tongue-in-cheek but there were many astrologists looking for a turn this week based on these celestial events. Who's to say they're wrong and certainly they can crow this week that it worked. And you thought the market only paid attention to what the Fed and ECB were up to. Silly you.
The slowdown in Europe is of course still a major concern but with a market deeply oversold on a short-term basis it was getting ripe for some relief. The EU's GDP report today showed a growth rate of 0.0% for the past month, which is a decline of -0.1% from a year ago. By all measures the EU is back into a recession and the U.S. is only one step behind. For the U.S. it will be the first time it will re-enter a recession before recovering from the previous one. I've said for years that in hindsight everyone will recognize this period (since 2000) as a period of a depression, not just a recession. The deflationary effects of this would be much greater (and beneficial if not painful for many) if the Fed wasn't doing everything in its power to re-inflate but our money (it's not the Fed's) will be ill-spent and we'll leave a huge debt for our children and their children. Shame on us.
While expectations were high that Mario Draghi would make a major policy statement today, with many hoping for another drug injection, he made no major changes. And the market rallied strong anyway! Hmm, imagine if he said he was going to inject another couple trillion. He jawboned the market higher with promises but nothing concrete. Pundits were at a loss today to explain the rally -- they really needed something from Draghi to explain the bullishness. I've said it often and I'll say it again -- news is for ninnies. News might be a catalyst but when the market is ready to move it doesn't matter what the news is. Ignore and watch the charts.
By the weekend and especially on Monday the bearish sentiment had become thick enough to cut with a knife. Many have been looking at the VIX and not seeing enough fear there was general consensus that the market was heading lower and that it needed a capitulation selloff in order to set up a bottom. I think it's way too early to be looking for a capitulation bottom. That would assume we're looking for a bottom that will be followed by another rally that will take the market to new highs. I don't think that will happen. I think the capitulation is well ahead of us and at much lower levels. For now we're just looking at the start of a larger decline, which is why VIX hasn't climbed that high yet -- too many are expecting just a pullback that will be saved by the Fed (again), hence the lack of real fear.
But as of Friday the Daily Sentiment Index (DSI from trade-futures.com) had dropped to just 5% bulls. Last August it had dropped to 4% and that still wasn't the bottom of the market (new lows were made into the October 4th low) so we could still be looking for lower lows from right here but as with the rally into September last year and then the new low in October, we can expect something similar -- a bounce this month and then new lows in July/August (the difference this time is that I think the lows will be much lower than Monday's). But with a DSI reading of only 5% bulls and a 5-wave move down from April we had a very good setup for the bounce that we're now getting. We'll look at some upside targets and timing to setup the coming trades.
It was a strongly bullish day for the stock market. The NYSE advance/decline ratio closed at 6.8:1, the strongest day since last December 20th. It was a 90% up day with 91.8% of the volume as up volume, also the strongest since last December 20th. Some of the strongest rallies occur during bear markets as over-leveraged shorts are sent scurrying to cover at any price. Shorts can be one of the bull's best friends and the liquidity provided by shorts is healthy for the market. It's why I don't understand the lack of knowledge by those who want to outlaw shorts -- you want to see a market crash with no one there to buy it? Outlaw the shorts and see what happens.
But strong bear market rallies are also known for quick reversals and complete retracements so it's one reason why you don't want to get married to a long position in a bear market and with a 5-wave move down from April/May we have solid evidence we've re-entered a bear market. This week's rally is based on hope that the Fed and ECB will save the markets. Surely they won't let it drop, right? We can't have a market that declines; it's just not right. There of course has been a huge effort to prop up the stock markets around the world in hopes it will create a "wealth effect" and spur people into buying more stuff. The problem with this theory is that many people have been abandoning the stock market so a higher stock market hasn't had the effect the Fed has been hoping for.
The problem now for the central banks is that they have very little wiggle room to simply create money and hope for the best. The money creation is having a smaller and shorter effect for each program they try. In the meantime we're seeing inflation in things that matter to us, like food and energy. With the increases in these groups people are feeling the opposite of the "wealth effect." Bernanke knows inflation could get away from him very quickly if he's not careful (same for Draghi).
Back in April 2011 Bernanke was already showing some concern about this. When asked why the Fed wasn't immediately considering more monetary stimulus his answer was, "Going forward, we'll have to continue to make judgments about whether additional steps are warranted, but as we do so, we have to keep in mind that we do have a dual mandate, that we do have to worry about both the rate of growth but also the inflation rate...
"The trade-offs are getting less attractive at this point. Inflation has gotten higher. Inflation expectations are a bit higher. It's not clear that we can get substantial improvements in payrolls without some additional inflation risk. And in my view, if we're going to have success in creating a long-run, sustainable recovery with lots of job growth, we've got to keep inflation under control. So we've got to look at both of those -- both parts of the mandate as we choose policy."
There are also now political concerns about the Fed jumping in with a massive monetization effort. If the Fed tries printing a few trillion more, Obama will lose any hope of re-election. If the ECB cranks up the printing press, Germany will not just balk but they'll walk. Merkel has made it abundantly clear they will not live with the inflation caused by too many euros running around. I recently read it might make sense for Germany to leave the euro and go back to the deutschmark and let the other countries deflate the euro so that they can reduce their debt load while using the DM as the EU's reserve currency. Makes some sense to me.
Bernanke will be speaking tomorrow (Thursday) and the market has high hopes for some kind of assurances that the Fed is prepared to step in with more money if and when needed. But the Fed is fully aware of diminishing returns on previous QE programs and I don't think they've seen the whites of the bankers' eyes yet to risk announcing a failed QE program just yet. That might cause some pouting by the market on Thursday and in fact the charts support that possibility. At most I suspect he'll announce a continuation of their "twist and shout" bond program.
If Bernanke were a real student of the markets and history, not just our own Great Depression in the 1930s, he'd know that Japan's example is not one we want to follow. They've tried eleven QE-type programs to rescue their economy and stock market (and real estate market). All they've done is create a monstrous debt (one that makes Europe look like it's playing with small numbers) while watching their stock market lose 30,000 points -- from 37K down to 7K. Each new program created a drug high followed by withdrawals and a further collapse. What's that Einstein said about insanity -- doing the same thing over and over again and expecting a different result.
Before getting to the stock market I want to take a little more time than I usually do on bonds because we could be at a major inflection point for bonds. You can see by the numbers above that the yields made a big move today, on top of a big move up from last Friday. Whether an even bigger rally in bond yields will translate to the stock market is a question right now but certainly for bond holders (or those interested in where yields are heading) it could be very important what happens from here.
Bonds had become very overbought, especially after Friday's big rally. As you can see on the monthly chart below, the 30-year bond (using ZB, the emini futures contract) poked marginally above the top of a parallel up-channel from the early 1980s. The last time it hit the top of the channel was December 2008, when the stock market was crashing lower. Now the stock market has only just begun to sell off and bond prices are already higher than the December 2008 high. Price can always go higher but clearly by this measure it is stretched to the upside. This week's selloff in bonds has now left a throw-over above the top of the channel, usually a good reversal signal.
30-year Bond, ZB, emini continuous contract, Monthly chart, arithmetic price scale
The above chart is with the arithmetic price scale and it can be fairly argued that over a longer time span like this, especially with the big price change, one should use the log price scale. The chart below is with the log scale and the top trend line fits even better. Price tagged the top trend line and has now pulled back to the line just below it. This is a clear warning to bond bulls -- this rally could be topping here or near here and ready for at least a larger pullback.
30-year Bond, ZB, emini continuous contract, Monthly chart, log price scale
When using EW with bonds it's important to note that big moves happen in corrective (3-wave) fashion. I'm not sure why but it's just the way it works. Zooming in a little closer to the move up from 2009 shows a double zigzag wave count (a-b-c-x-a-b-c) and the a-b-c move up from February 2011 has a Fib projection at 153.812, where the c-wave would be 62% of the a-wave. It's possible we'll see the stock market make a new low in the next week or so and bonds make a minor new high but that would be just a guess here. As can be seen on the monthly charts above, the spikes up to the top trend line have typically been followed by spikes back down and that may happen this year. How that might translate to a stock market rally can only be guessed but I'm thinking we're going to move into a period where bonds and stocks sell off together (where all asset classes become vulnerable to selling). Have I mentioned cash is a good place to park idle money?
30-year Bond, ZB, emini continuous contract, Weekly chart
Looking a little closer at the move up from 2009, the final c-wave (the leg up from March) has now completed its extended 5th wave (a little shy of the projection at 153.44 where it would equal 162% of the 1st wave) and a drop below its 20-dma, currently near 148, would be good confirmation that we've seen the high for now. But with Bernanke speaking on Thursday we can expect some volatility so we'll have to see where bonds settle out at the end of the week (the weekly closing price being the most important).
30-year Bond, ZB, emini continuous contract, Daily chart
Looking at bond yields, which are of course inverse to price, the 10-year (TNX) shows it remains highly correlated to the stock market (bonds and stock prices moving inversely). Last Friday TNX dropped down to the bottom of its parallel down-channel for its decline from March/April and today it made it back up to the top of the channel, a big jump in only 4 days. If it can break above today's high at 1.67% and then its 20-dma at 1.70% it will be a confirmed bullish breakout (bearish for bond prices). But for the moment there remains the possibility for another leg down within the down-channel, especially if the Fed announces a new twist-and-shout program that will produce massive demand for Treasuries. The trend line along the lows from 2003-2008, near 1.38% (if not lower), would be a downside target.
10-year Treasury Note, TNX, Daily chart
Moving over to the stock market now, the SPX daily chart shows it managed to poke above its downtrend line from May 1st, the first sign that we could be looking at a bottom for the leg down from April (a 5-wave move, which identifies the new trend -- down). Resistance at its 20-dma is just above, near 1317. Also near that level is the bottom of its previous parallel up-channel from October. So if we get a little pop higher Thursday morning I think it would be a good setup for at least a pullback to correct the leg up from Monday before pressing higher (or not).
S&P 500, SPX, Daily chart
Key Levels for SPX:
- short-term bullish above 1300 and more bullish above 1360
- bearish below 1267 and much more bearish below 1225
With this afternoon's push to a new high for the day it has created a small 5-wave move up from Monday and that should mean we're only looking for a pullback to correct this week's rally and then get another leg up for a larger a-b-c bounce off Monday's low to correct the leg down from April. For now I'm showing a bounce up to the 50% retracement near 1344 before heading lower in a stronger decline into July/August. If the stock market heads lower I'll be looking for a low around 1250 (any lower would mean the market is in more serious trouble).
S&P 500, SPX, 120-min chart
The DOW's downtrend line from May was also marginally broken today. If the market continues rallying Thursday morning watch for the 20-dma near 12470 to be resistance. A pullback to its broken downtrend line would be a good opportunity for a back test and kiss goodbye for a bullish play into opex week. A rally up to its 50% retracement near 12687 is a good upside target for now.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- short-term bullish above 12,320 and more bullish above 12,840
- bearish below 12,035
Similar to the blue chips, NDX broke slightly above its downtrend line from May and closed marginally above its 20-dma, near 2539 tomorrow. As with the others, I'll be looking for an a-b-c bounce into opex week next week and a 50% retracement near 2620 makes for a good upside target before looking to get short for the better trade. NDX is the only index to not break below its October high and therefore from an EW perspective maintains the possibility for a 5th wave to a new high for the year (or test of its April high). I consider that a lower probability but something to keep in mind once we start looking for a short entry.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- short-term bullish above 2540 and more bullish above 2660
- bearish below 2400
As with the others, the RUT rallied even stronger today (+2.6%) to close marginally above its downtrend line from May 1st and at its 20-dma. It could start a pullback from here before pressing higher but if it gets a little pop higher in the morning watch for potential resistance at its October high at 769.46.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- short-term bullish above 762 and more bullish above 803
- bearish below 714
BKX continues to trade very well around its Fib targets. The 3rd wave of the decline from March reached the 162% projection of the 1st wave at its May 21st low. The 5th wave, the move down from May 30th into Monday's low came within 10 cents of achieving equality with the 1st wave. It's a clean 5-wave move down from March, setting the primary trend (down) so now we're looking for a 3-wave correction (or possibly something a little more complex) before heading lower in a stronger selloff. I'm showing a bounce up to its broken uptrend line from October-November where it crosses the 38% retracement of its decline on opex Friday, June 15th. We'll have to see how the bounce develops into next week (assuming we'll get the bounce) to hone in on an upside target. Getting short for the next leg down should give us a real money maker.
KBW Bank index, BKX, Daily chart
Last Friday the dollar had rallied up to the top of its steep and narrow up-channel from May 1st and then pulled back sharply (on the same day the stock market tanked). Yesterday it broke down out of the channel, recovered into the close and then dropped out of it again today. This morning it bounced back up to the bottom of the channel (uptrend line from May 1st), gave it a kiss goodbye and proceeded to sell off sharply. The euro rallied at the same time, presumably on expectations the ECB will do what it has to in order to save the banks and therefore the euro. I've been expecting a pullback in the dollar but only a correction to its rally. Once the correction is over (later this month is best guess at the moment) we should see the dollar continue much higher. I'm showing two correction ideas: the first is an a-b-c pullback to the 50% retracement of the leg up from May 1st (like the stock market but inverse); the second is more of a sideways triangle consolidation through July before heading higher again. The difference is based on what kind of bullish wave count I consider so we'll know more over the next week or two (or three).
U.S. Dollar contract, DX, Daily chart
The euro's DSI reading a week ago, like the stock market, was only 5% bulls, making it ripe for a rally (and a pullback for the dollar). All it needed was a catalyst to spark some short covering and some interest in buying the beaten-down euro. The EU's financial heads appear to be ready to try whatever they can to save their banks and in turn the euro.
Mario Draghi has assured us that he's "ready to act" if the economic situation worsens. I guess he's waiting for the sky to actually fall onto Europe before he does something. Everyone of course knows there's little he can do but most also expect him to come up with another plan where Germany can look the other way while more money is made available to the banks. An expansion of the LTRO program is certainly an expectation -- lend the banks money created out of thin air, the banks lend it back and now all banks have "assets" on their books and they can lend it out again, ad infinitum. Or so the theory goes. We know how well economic theory has been working lately.
Gold has been reacting to fears of inflation -- should the Fed, ECB and the rest of the world's central banks move ahead with more money creation it will be inflationary. That's the theory anyway and normally it would be true. Unfortunately for the financial system it's not working this time because debt destruction (paying it down and/or writing it off) is happening at a faster rate than money is being created. The fractional reserve system (where a bank holds onto less than 10% of its money and lends out 90+%, repeated through several banking levels) is required to inflate the money supply. The lack of lending/borrowing by people and businesses, along with tighter lending standards by banks, is keeping a lid on money growth, which keeps deflation the bigger worry (imho). Gold will have its day but not yet.
Gold's bounce off its May 16th low gave us an outstanding setup this morning to get short, which I had mentioned several times over the past few days for what to watch. I was looking for the completion of a 5-wave move up from May 30th, which completed a 3-wave bounce off the May 16th low. That 3-wave move is either an a-b-c correction of the larger decline or it's a 1-2-3 if the bulls have taken over. There were a few upside targets I was watching for, giving us a target zone of about 1636-1651 to complete its rally. The 5th wave of the rally from May 30th was 62% of the 1st wave at 1636.33 and it would be equal to the 1st wave at 1650.90, defining the target range. The 2nd leg of the bounce off the May 16th low would be 162% of the 1st leg at 1647.58. Today's high was 1642.40, to the penny at the apex of the previous sideways triangle pattern (March-April), a common support/resistance level when retested.
Gold continuous contract, GC, 120-min all-hours chart
One other potential resistance level was near 1649, which is the top of a parallel down-channel (a line parallel to the broken August-November downtrend line is attached to the February 29th high), shown on the daily chart below. So there were several reasons I really liked the short play setup today on gold. Once it made it up inside the target zone I had mentioned this morning to short a break back below 1635, the lows of the morning trading range, which made for a tight-risk play. We got the entry and I'm now looking for lower prices (the stop is at today's high for now and I'll lower it once price drops, bounces to a lower high and then continues lower). The daily candle is a bearish shooting star at resistance so we'll see if there will be downside follow through on Thursday. There could be some volatility around Bernanke's speech and monetary discussions.
Gold continuous contract, GC, Daily chart
Looking at the bounce off the May 16th low, the chart below shows it as an a-b-c correction and the c-wave is the leg up from May 30th. It needs to be a 5-wave move up and as I had mentioned a few times this week, once we get the 5th wave it will be a good time to short the rally. Today the 5th wave achieved the minimum expected at 1636.23 (62% of the 1st wave) and has a little higher potential to 1650.90 (equal to the 1st wave). The ideal target zone is roughly 1647-1651 and today's high at is a good setup to look for a short entry. If we see gold start to chop sideways/down in what looks like a 4th wave correction in the move up from May 16th then we'll know to exit the short and look for a 5th wave up, which would be bullish for gold into the summer. For now the pattern remains bearish below 1651 and turns more bearish below 1599 (the May 21st high).
Earlier I had mentioned the DSI bullish reading for the stock market had dropped to 5% last Friday. Oil's DSI reading had also dropped to only 5% bulls making it ripe for a bounce. At Monday's low it came close to achieving a price projection at 80.59 (81.21 was the low), which is where the c-wave of the a-b-c decline from late February would be 261.8% of the a-wave, which is a common Fib projection for an extended move. I can only guess what kind of bounce we'll see in oil. As worries over a slowing economy mount we'll likely see oil head lower, especially if it stays trapped inside the parallel down-channel I have on the chart. I'll have to update this chart as price dictates.
Oil continuous contract, CL, Daily chart
Tomorrow morning the Bank of England (BoE) will announce its rate decision (not expected to change from the current 0.5%) and announce their asset purchase target, expected to increase by 50 billion pounds. We will only have unemployment claims and then in the afternoon the Consumer Credit so no market-moving reports. Friday will likewise be quiet.
Economic reports, summary and Key Trading Levels
Following a 5-wave move down from April and the big bounce we've seen this week it's looking like the market is ready to correct the decline. The 5-wave move gives us our trend direction (down) so I'm only looking for a correction of the decline before it heads lower again. A typical 3-wave bounce into next week (opex) should retrace roughly 50% of the decline and then set up the next leg down.
The leg up from Monday could press marginally higher on Thursday but then should pull back to correct the leg up before heading higher again. Watch the broken downtrend lines for support to set up a long play into next week. But then the better money-making trade will be a short trade for a big drop into July. Hopefully that will be setting up nicely by this time next week where we can review some exit targets for longs and entry targets for shorts.
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