Looking at several indexes it's fair to say the market is at a very important decision point. It's a good setup for the bulls to step back in but the bearish setup says they better do it now.
Equity futures had a wild ride Tuesday night as election results poured in. When it looked like a race that was going to be too close to call the futures started declining and ES (S&P 500 emini) hit a low of 1411 (-14.50). But then as it became clearer Obama was going to win the futures climbed nearly 21 points to 1431.75 (+6.25). The feeling by many market participants was that Romney would apply lots of pressure on the Fed to stop all the QE efforts and let the economy get on with healing itself (a painful but necessary process that the Fed is preventing). Romney had no intention of extending Bernanke's term once it expires in January 2014.
BTW, here's a little factoid for those of you who like Fibonacci ratios, especially the golden ratio of 61.8%. Obama won with 332 electoral votes vs. Romney's 206 and 206 divided by 332 is 62%.
The stock market cares about one thing -- more liquidity, not who the president is. The market wants someone who will hand out more money and they have a better chance for that with Obama. So why the selling today? According to CNBC today was the worst post-election day in the stock market since Harry Truman's election (against all odds when Dewey was expected to win). Unfortunately some troubling news started coming out of Europe and their stock markets started dropping, which then pulled our futures back down. By the time the cash market opened ES was back down to its overnight low and opened at 1410.25 (-15.25). That prompted more selling at the open and before the market found its bottom near 11:30 AM ES hit a low of 1390 (-35.50, -2.5%). It got a small bounce into the afternoon, but not quite 10 points before giving back most of it into the close. It was not a good day for the bulls.
Spooking the market were words from the ECB's Mario Draghi talking about the European economy and the struggles that it faces. The big question is why was this news? Of course now that the election circus is over we can now concentrate on what really matters to the stock market -- global economies. Draghi's comments indicated that the EZ area is expected to remain week and that the slowdown may have reached Germany. Again, this is news? We've known Germany has been slowing down and may itself enter a recession. But it was an excuse to sell stocks and as I'll get into with the charts, the bounce pattern into Tuesday's high was a perfect opportunity to short the bounce. It just needed a catalyst to start the selling. I even predicted either a Romney win or a hung jury, waiting on Ohio, which would trigger the selling. I had the pattern correct but I was completely wrong on my political prediction. I'll stick with the charts from now on.
Leading into Tuesday's election, especially with the market rallying, the thought was that the market was expecting Obama to win since he would leave the Fed alone to do what they do best -- pump massive amounts of drug money into the stock market. Today's selloff says "never mind, we don't care about that." So what does the market care about now? Europe's woes of course, but the other thing popping back up now is the looming fiscal cliff. We have the same president, the same Democrat-controlled Senate and the same Republican-controlled House. In other words, nothing has changed. The fear is neither side will talk to the other (Reid was quite vocal about his refusal to work with Republicans) and nothing will get done to solve the fiscal cliff issues.
Obviously many buyers of the rally on Tuesday were sorely disappointed on Wednesday and the big gap down and the complete reversal of Tuesday's gains has trapped a lot of bulls. The ISEE call/put ratio finished at a very high level, indicative of the number of traders buying calls vs. puts for an expected rally on Wednesday. Oops. I had read that an incumbent president has a 90% chance of winning re-election if the DOW closes positive on Election Day. Might Tuesday's rally have been "engineered" by someone who wants to keep his job? I'm talking of course about Bernanke (wink). Come Wednesday with his job done he figures he can let it fall back down now, springing a very market un-friendly bull trap.
One thing that could be bullish for the stock market is a "solution" out of Congress to solve the fiscal crisis coming our way. Even just a relief rally could be significant if the bears get too aggressive and then are forced to run for cover.
Another concern out of Europe is Greece. Really? Wow, didn't see that one coming. Their parliament is expected to vote on a new package of austerity measures and the people are already rioting in hopes of preventing it from passing. If the bill does not pass then Greece will not receive its next installment of the 31.5B euro loan on Monday. If no loan then they could be forced into bankruptcy and the EZ will have to deal with the ramifications of that. In other words, no change in U.S. politics and no change in Europe. All those who were buying on the hope for something better must have realized things are not quite as rosy as they had hoped and are not predicted to improve yet.
While I feel bearish about the market, and have for some time (I know, this comes as a surprise to many of you, wink), there's one pattern that has me watching very carefully for bullish clues so that I avoid getting sucked into a bear trap, only to serve up lunch when the short-covering rally comes. It's called the Election-year pattern and is shown on the chart below.
Election-Year Pattern for the stock market, chart courtesy Bespoke Investment Group
The red line is the average for the S&P 500 for all election years from 1928 and the blue line is this year's result so far. As is readily apparent, the peaks and valleys this year correlate very well with the average for the year, including the pullback from September into the current low. This pattern suggests we should be looking at dips now as buying opportunities for a rally into year-end (about +8% if it rallies 110 points from 1390 to 1500). That would be a very nice trade but will we get it this year. Are there enough global risks that suggest the pattern might not hold from here? Will we pull back a little further, to better match the average depth of the pullback, before rallying?
In 2008, which was not a "normal" year as we were dealing with the financial crisis, there was a very steep decline from September into a low in mid-November and then a bounce into January before rolling over to a new low in March 2009. There obviously was no new high into the end of the year in 2008 but there was a bounce into the end of the year. How this year's pattern will play out into the end of the year is anyone's guess but this pattern deserves respect by both sides until it's proven it won't work for the rest of this year.
In my last update, in the weekend wrap, I showed the SPX weekly chart using the log price scale, which is my preferred scale when viewing weekly charts with longer-term trend lines. It showed SPX holding above its uptrend line from October 2011, then near 1400, including last Wednesday's low near 1406. I had mentioned 1400 as a key to the downside since a break below 1400 would signal additional weakness that should have bulls getting more defensive.
With today's decline we got a clear break below 1400 (today's low was 1388.14) and it broke its uptrend line from October 2011 in the process. But now switch to the arithmetic price scale and you can see that SPX continues to hold its uptrend line. So which one is correct? They both are since traders use both and that's why it's important to switch back and forth and check it. By tagging and bouncing off its uptrend line the bulls stay alive. If the election-year pattern is to hold then this is a perfect spot to get long and place your stop just below today's low.
S&P 500, SPX, Weekly chart
If the market does rally from here I see upside potential for SPX up to the 1500 area before the end of the year where it would run into the top of rising wedge pattern from 2010 as well as the top of its parallel down-channel from 2007 (taking a line parallel to the trend line along the lows from 2002-2009 and attaching it to the 2007 high). This would fit the election-year pattern very well and remains a good possibility as long as it doesn't break down from here.
The choppy pattern for the decline from September 14th, shown on the daily chart below, can certainly be viewed as a bullish continuation pattern (descending wedge in this case). It's holding (almost) where it needs to -- at price-level support near 1396, the uptrend line from October 2011 and the bottom of a descending wedge pattern. The challenging part here is that I've seen so many previous major highs look just like this -- the choppy topping pattern looks bullish but then it suddenly breaks down instead. That's why a break of the uptrend line from October 2011, and especially a break below the 200-dma near 1380 would be bearish, no questions asked. The bearish wave count is looking for a strong breakdown but the bears need to prove that the count is correct.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1435
- bearish below 1380
While we wait for the bulls or the bears to show who is stronger, keep in mind that there is a fractal pattern (different from the election-year pattern) that looks like the setup in front of the 1987 crash. The price action between September and November of this year looks similar to the price action between August and October 1987, which then led to the market crash in October 1987. The market doesn't always repeat but it often rhymes and if support at SPX 1380 breaks we could see a flood of sell orders hit the tape. You'll want to be flat or short if that happens. But if SPX can climb back above 1400 it would be a good sign for the bulls. They'll then need to rally back above Tuesday's high near 1433 to prove the pullback from September has finished, in which case get ready for a rally into December.
But if we assume the top is in for the market (we still have to make the assumption since there's no confirmation yet), it's a challenge figuring out which high (September 14, October 5 or 18) is THE high and therefore where the count for the move down should start. For now, based on the truncated finish on October 18th being the completion of the rally, the 1st wave down completed at the October 26th low and the 3-wave bounce correction into Tuesday's high was the 2nd wave. Today's decline would be the start of the 3rd wave down and is the 1st of the 3rd, which means we're looking for another bounce that's smaller than the 3-wave bounce off the October 26th low. I'm showing a depiction for another leg up on Thursday to the 1410-1411 area to complete another a-b-c correction, which would then set up a very strong decline in a 3rd of a 3rd wave down into next week. The risk for those hoping for a higher bounce is that today's could be all we'll get.
S&P 500, SPX, 60-min chart
The green wave count shows an a-b-c-x-a-b-c pullback from September 14th and today's decline would be the completion of this corrective pullback. This is the wave count that supports the bulls and says we should start buying the dips again. It's going to be tough to tell which wave count is correct and while it's a wide spread, we really are not going to know until SPX either breaks above 1434 or below 1388 before we'll have a better idea how the market will likely run into next week and into December.
Compounding the problem of not knowing yet which team is on offense, the DOW's pattern is different enough from SPX to say both sides may be better if they play defense and not worry about scoring yet. Because the DOW's bounce off its October 25th low did not overlap its October 12th low its decline from October 5th can be counted as a complete 5-wave move down to complete a larger-degree 1st wave. This calls for a larger bounce into next week to correct the decline from October 5th, one that could easily test/exceed Tuesday's high and not be bullish. It will be the form of the bounce that will help determine whether or not it will be bullish. As I'll point out on the DOW's daily chart, one wave count that fits both is a more bearish 1-2, 1-2 wave count to the downside, which is why a break below today's low could turn into some very strong selling.
Dow Industrials, INDU, 60-min chart
Looking at the DOW's daily chart below, if THE high for the rally is the October 5th high (which was a new high unconfirmed by the other indexes) then it's possible we had a 1st wave down to the October 12th low, a 2nd wave bounce to the October 18th high and then the 1st of the 3rd wave down to the October 25th low. That was followed by another 2nd wave correction and today's decline would be the start of the 3rd of the 3rd wave down. This would be expected to be a powerful move to the downside and a strong reason to short the bounce off this morning's low.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,340
- bearish below 12,970
Further complicating the question about the wave count, and therefore where we could be in the decline, is the NDX pattern. It says today's decline may get a little more follow through to the downside but nothing strong and then another multi-day correction before heading lower again to finish a larger 1st wave down before the end of November, to be followed by a large bounce back up into the end of the year.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2700
- bearish below 2660
AAPL's weakness continues to pull NDX lower and until that stock can find some buyers it's going to be a drag on the overall market. It has clearly moved into the "risk off" category. As can be seen on its daily chart below, it has now broken all its uptrend lines, including the one along the highs from 2000-2007. Today's decline (-3.8%) broke price-level support near 570 and the price projection for two equal legs down, near 571. The decline is accelerating, as evidenced by the steepening downtrend lines, never a good sign. If it can rally back above Tuesday's high near 591 it would confirm the break of the downtrend line from October 17th and negate the bearish picture calling for a drop down to the 521-529 area (2nd leg of its decline would be 162% of the 1st leg down near 521 and its May 18th low is near 529). I would give it a little leeway on a bounce back up to Tuesday's high since it could be going for a back test of its 200-dma, currently at 592.58, before dropping lower.
Apple Inc., AAPL, Daily chart
AAPL's weekly chart below has been kept simple to help with clarity. The trend line along the highs from 2000-2007 is the one that was broken today. This line was broken to the upside in February, back tested in May, held on last Friday's pullback but broke today. Unless it's just a one-day head-fake break I think this is an important break, especially following the break of its uptrend line from 2009. The new high in September was met with a very bearish divergence against its April high and a break below its May low near 529 would confirm a double top. This could change quickly but at the moment this chart has BEAR written all over it.
Apple Inc., AAPL, Weekly chart
Follow the down-channel for the RUT. Any questions? The bottom of the channel is near 797 on Thursday and there's price-level support near 790. At the moment there's no arguing the bearishness of the break of its uptrend line from October 2011 after price consolidated on top of it for almost two weeks. And today's break of the 200-dma, if it stands, would be another feather in the bear's cap gun.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 831
- bearish below 807
To pull the different indexes together, the OEX chart below is a less cluttered view of the current situation and it's bearish until the bulls take this away from the bears. Today's decline had OEX dropping its uptrend line from October 2011 and price-level support in the 643-647 area. It dropped down to the bottom of its down-channel from October and could get a bounce on Thursday, possibly after first testing its 200-dma near 631 (today's low was 633.75). Clearly it would be more bearish below 631 since it would also be a break below its down-channel, which is always a sign of acceleration in selling (3rd of a 3rd wave down kind of move). Rallying back above 660 would have me turning bullish for a rally into December. Otherwise look at bounces as shorting opportunities.
S&P 100 index, OEX, Daily chart
TYX (30-year yield) hit a low of 2.806% today, essentially testing its October 12th low. I don't currently see a good setup for a rally from the test but that's still a possibility. The higher-odds scenario is for bond yields to break their 2-month consolidation and start heading lower (bond prices rally, which would likely be bearish stocks).
30-year Yield, TYX, Daily chart
The banks got hit hard today and BKX was down -4.6%. Following the money says follow the bears. The bullish descending triangle pattern that has built over the 6 weeks has broken down instead (this goes back to what I said at the beginning of tonight's wrap -- this market loves to put in tops that look like bullish continuation patterns). Until BKX drops below its uptrend line from October 2011, near 46.50, another rally leg can't be ruled out but at the moment the bearish pattern gets the nod.
KBW Bank index, BKX, Daily chart
The dollar also had a wild ride during last night's and today's trading session but made a new high and closed nearer the high. It is also holding above its 200-dma. The bounce pattern leaves some doubt as to what it's doing but until I see something more bearish I continue to look for a higher rally in the dollar.
U.S. Dollar contract, DX, Daily chart
Gold's 3-day bounce made it up to its 20-dma at 1722.30 but not to its 50-dma at 1738.80. If the bounce off Monday's low is to be a correction of the decline from October 4th there's a chance it will go higher, possibly after first pulling back some. First resistance to a higher bounce is its 50-dma and then a little higher, near 1750, for a 62% retracement. I expect to see gold head lower once the current bounce finishes, potentially right from here.
Gold continuous contract, GC, Daily chart
Gold held up today but oil did not, dropping -4.3% and making a new low for the week. If the dollar continues to rally it will put additional pressure on the commodities and right now I see downside potential for oil to the $80 area.
Oil continuous contract, CL, Daily chart
Tomorrow we'll get only the unemployment claims numbers so nothing market moving. News out of Europe, especially as it relates to Greece and their austerity vote, will have an impact on our market so we'll have to see how they do with that.
Economic reports and Summary
Today did a lot of technical damage but a one-day break of support/resistance is seen all the time in this market. It's the next day or two that count, especially the weekly closing prices. In tonight's charts I show support either breaking or holding (sometimes based on whether we're viewing an uptrend line with the arithmetic or log scale). If we get a bounce on Thursday but it has overlapping highs and lows and looks choppy (similar to the bounce off the October 26th lows) I would look to short it. If we get a sharp bounce that's followed by a choppy pullback then buy the dip for what could be the start to a year-end rally.
At the moment we're stuck in the middle of what will likely be a big move over the next couple of weeks. Based on the election-year pattern we should expect a rally (although it could start from a little lower) and therefore look at this decline as a buying opportunity. But based on the wave pattern (especially if itâ€™s a 1-2, 1-2 count to the downside) and a break of some important support levels, I'd look to short any further breakdown and the small bounces on the way down. Catch the move correctly and you'll be rewarded with a very nice trade. If you catch the wrong move and don't honor your stop you could be in a lot of pain in a couple of weeks. Nibble in the direction you feel comfortable trading and then add to a winning trade, stopping out of the losing one.
Good luck as we head into opex next week and I'll be back with you next Wednesday. One last thing --remember that the Thursday prior to opex (that's tomorrow) tends to be a head-fake day so a morning decline could be a bear trap and a morning rally could be a bull trap. Opex weeks tend to be bullish but when they're not they tend to be very bearish, which fits where we are in the pattern at the moment. We'll know in the next day or two.
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