Following the bouncing ball in the market this week will only give you whiplash. The buyers are working hard to get the DOW above 14K but profit takers are making it hard. The result is a choppy market.
If you don't like the market's direction just wait a day. Monday gapped down and dropped hard. Tuesday gapped up and reversed Monday's losses. Wednesday gapped down and nearly retraced Tuesday's gains. Any guesses for Thursday? The bulls and the bears are battling for control here and the bulls see bullish consolidation while the bears see a topping pattern. Price is king and he'll let us know when he's ready. In the meantime, mind the chop!
The market hasn't had much in the way of news in the U.S. to drive stock prices and the overnight futures have been reacting to the European markets, giving us the gap starts to the day. What was bullish about today was the fact that the gap down was again bought. Monday's decline was reversed and this morning's gap was reversed. Even the bears will have to grudgingly give the bulls credit for not being scared away. Even if the indexes are up against resistance there's little interest in taking profits and that's bullish behavior. Many will of course credit the Fed for continuing to prime the pump.
One of the challenges for us is to figure out how much of the buying in the stock market is coming from the Fed's newly created money each month. Certainly the idea that the Fed is propping up the market with their money is helping investors stay, or become more, bullish about the market's future. The market (all the investors and traders) is much bigger than the Fed, especially the bond market. The Fed is led by the bond market and not the other way around. But the Fed does have influence over market sentiment. "Don't fight the Fed" is a very common phrase but what it really means is don't fight the sentiment that the Fed's actions help influence.
Because people believe in the Fed's ability to hold up the market we have many more participants who are willing to take greater risks and place their money into stock investments rather than bank CDs or other cash equivalents. This is an important distinction because it actually makes the market more vulnerable to a downside disconnect, which is of course exactly the opposite of what the Fed is trying to achieve.
Instead of the Fed's $45B or $85B coming into the market we really have much more than that coming from investors. Compounding these investments by the public is what the banks are doing with the money from the Fed -- they're leveraging it and using it to trade in the market. It's all positive and a bullish influence. Most think it will continue since there's no reason for it not to. I'm hearing once again why it's different this time. The public is making massive investments into mutual funds like we haven't seen since just before the 2000 peak. What does that tell you? The public always gets it wrong at the turns and they will again this year. It's not different this time.
What happens when the banks decide to take fewer risks with the money from the Fed? Maybe they'll want to invest it in boring cash equivalents and make only 2% on free money instead of going for more. If that money stops flowing into the market and the market starts a bigger correction do you think all those new investors are going to be worried that they bought the top again? Even the least sophisticated investor has recent memories of the market misbehaving and they'll be quicker to withdraw money this time. When we have a huge influx of people getting into the market they become a large group of sellers-in-waiting. Give them one excuse to get out and it will be done en masse. Now throw in the HFTs and algo traders, who sniff out the big buyers and sellers (the whales) and front-run them, and it's a dangerous cocktail mix.
Low volatility leads to high volatility. Stability leads to instability. The longer something like the market is stable the more dangerous it becomes as it waits for the next Minsky moment. That's because complacency gets people to take unwarranted risks and when they suddenly realize they've been had (again) the movement by the masses makes for an outsized move, typically to the downside in the stock market. At that point the Fed's measly $45B will be no more effective than a paddler trying to row upstream with just one oar.
By the way, we see this kind of fear sentiment in blow-off tops as well, especially in commodities. Fear of missing out is one driver but with commodities it's usually driven by fear from the underlying cause that's driving commodities higher. Why is oil running higher? OMG, it must be because the Mideast is getting ready to turn into a pile of molten glass. I better hoard what I can get, get long some futures and buy gold as an inflation hedge. Herd mentality is a wonder to behold at times. And when that fear suddenly evaporates (peace settlement, people can't buy anymore) we typically see all those sellers-in-waiting dump their holdings all at once (creating the v-tops typically seen following a parabolic rise).
I mentioned the bond market is smarter than the Fed would like us to believe. When the bond market participants feel corporations or governments are unable to continue down the path of more borrowing, but who borrow more nonetheless, the bond holders will require a higher yield to compensate for the higher risk of default (bond prices drop due to lower demand). We've seen plenty of examples in Europe in the past couple of years. The Fed says they'll keep interest rates low for as long as they have to and until unemployment drops below 6.5% (at least stop QE once that happens). What they really should be saying is "we'll keep interest rates near zero for as long as the bond market will let us."
One example of some cracks in the foundation can be seen in the higher-yield corporate bonds, otherwise known as junk bonds. Last week I showed the weekly and daily charts of HYG, the High Yield Corporate bond fund, and pointed out the fractal pattern for its bounce correction off the 2009 low and the multiple 62% projections lining up in the $95 area. The daily chart below shows what happened after the small rising wedge from December 26th broke on January 25th -- it quickly retraced the wedge by Monday's low. That was a 3-week rally from the end of December that was completely retraced in one week, which is what typically happens to rising wedge patterns (and a reason I love trading these patterns).
High-Yield Corporate Bond fund, HYG, Daily chart
Keep in mind that this fund represents risk -- the riskier investments go into junk bonds in search of the higher yields. Investments go into stocks in search of higher yields. This therefore is an early warning sign that some investors are becoming less comfortable with risk. When that will show up in stocks can only be guessed but consider this fair warning.
SPX's weekly chart shows price remains tucked up underneath an uptrend line from the March 2009 and August 2011 closing lows (the lowest closing low following the March-April 2012 highs), which is an important trend line when using weekly closing prices. Currently near 1512, where it closed today, it bears watching. Slightly higher, near 1520, is the trend line along the highs from April-September 2012, which fits as the top of its rising wedge pattern for the move up from August/October 2011. And a little higher still is the broken uptrend line from 1991-2002, near 1538. So there's a little more upside potential but the pieces are currently in place to call a top at any time.
S&P 500, SPX, Weekly chart
From a cycle perspective we're at an interesting time. There is a reliable 5.25-year cycle that actually goes back to 1897 (so I'm told but I have not taken the time to verify it) and the chart below shows the cycle from 1992. Highlighted in yellow, the cycle marked a high in 1992 (just off the left side of the chart), lows in 1997 and 2002 and a high in 2007. We're at the end of the next cycle and we've rallied into it. If the cycle is to hold it should be a high. The half cycles have also done a good job at identifying important turning points for the market and the half and full cycles have completed here. Just another warning sign, along with the bearish divergence since April 2012...
SPX weekly chart with 5.25-year cycles
The daily SPX chart below shows a little more clearly the trend lines of interest here (minus the longer-term one from 1991 and the uptrend lines from 2009). The weekly chart shows a grouping of trend lines in the 1512-1538 area. The daily chart shows the trend line along the highs from April-September (near 1520) and the one along the highs from November, which will be near 1528 by Friday. A drop below 1490 would be bearish but it's not clear yet whether it would be just a larger pullback before heading higher again. The form of the decline will be important to evaluate. As shown with the green dashed line, there is the potential for February to be a terrible trading month as price chops sideways to consolidate January's rally. That would be very bullish since it would indicate another rally leg into March/April but frustrating to wait for. Unfortunately the pattern is simply not clear enough at this point to suggest a higher-odds scenario and that means very short-term trading (day trading), if any at all, while we wait.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- Stay bullish above 1495
- bearish below 1490
Looking more closely at the move up from the end of December, the 60-min chart below shows a tight up-channel for price action following the January 3rd high. Price has remained inside except for the head-fake break on Monday. There are plenty of ideas for where price goes from here and unfortunately I can't show them all (and how they would play out in the coming week). I am only showing one possibility for how price could rally further this week if Monday's low holds. If Monday's low breaks then we'll have at least a larger pullback pattern to evaluate. But for now I'm looking at Monday's low as the completion of the 4th wave of the move up from December 31st and the 5th wave could form a choppy rising wedge pattern into Friday, potentially up to the 1530 area. Clearly this is speculation at the moment but it would fit nicely for the completion of the leg up from December.
S&P 500, SPX, 60-min chart
The DOW has been stalled at the top of its parallel up-channel for price action since 2010, near 14K, and its trend line along the highs from March-September 2012, near 13950. As with SPX it's not clear yet whether it's topping here or has a little higher to go before finishing the leg up from December 31st. From here, or a little higher first, we won't know if it will consolidate for a few weeks before pressing higher again (green dash line) or if we're forming THE high and getting ready to start the next major decline. The form of the next multi-week decline/pullback/consolidation will tell us what the larger pattern is. In the meantime it requires both sides to think short-term (day trades or sit tight in cash).
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 14,000
- bearish below 13,860
Follow the bouncing ball for the NDX and all you'll get is whiplash. There's been no change since the January 2nd high and it will be at least short-term bullish above 2770 and more bearish below 2700. The slight up-channel for price action following the January 2nd high has me thinking ending pattern and therefore has me leaning into the bear camp.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2770
- bearish below 2700
The RUT has been stuck underneath resistance at the top of its parallel up-channel from March-July 2012, currently near 912, since January 28th. As with the other indexes, it appears to be either forming a small rolling top or it's consolidating in preparation for another move higher. For the move up from November it's either completing its final 3-wave move of its rally from October 2011 or it needs to finish a 4th wave correction and then head higher in a final 5th wave (green dashed line). It stays bullish above 895 and turns more bullish above 916 but bearish below 894.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 916
- bearish below 894
Along with near-universal agreement that stocks will continue to rise is agreement that bond prices will continue to fall. Buying bonds is now thought to be one of the stupidest things you can do with your money. Professionals, advisors and the public are all on board -- put your money into stocks and don't be stupid investing in bonds (but somebody's being stupid because there's still a lot of money flowing into bonds). The sentiment picture is very reminiscent of the stock market highs in 2000 and 2007. As I mentioned earlier, the public is notoriously wrong at the major turning points, when the trend is fully established and running out of time. But is it really a bad time to buy bonds?
Using the 30-year bond prices (ZB is the emini futures contract) the price pattern for bond prices has been difficult to decipher since the high in June 2012 but as shown on the weekly chart below, it's very choppy and this has me still leaning toward interpreting it as a corrective pullback that will be followed by another leg higher. The wave count for the move up from June 2009 also supports the need for one more leg up. A rally into the summer could see ZB hit its trend line along the highs from 1986-2009, near 156-157 by June. That would be about a 9-10% rally from 143. But in order for this to happen I think it needs to get going from here. Much lower than 142 and I'd be forced to reevaluate.
30-year U.S. Treasury Bond, ZB, Weekly chart
Note that if we do get one more new high out of the Treasury market it should mark a generational high, just as the low in 1981 was a generational low. It's where you'll want to lock in the lowest rates you'll see for decades to come. And if the bond market does rally from here might that mean fear is reentering the stock market? I'll continue to watch this closely and report on it. BTW, when the bond market does turn down I don't believe it will help the stock market. We've been in a period where stocks and bonds have traded counter to one another but that's not always the case and we should soon be entering a period where both sell off together. Higher interest rates are not going to be good for the economy.
Supporting the bulls right now are the banks. Looking at the banking index, BKX, I see a pattern very similar to the DOW and SPX (banks heavily influence SPX) so there's no bearish non-confirmation going on there. That's a good thing. I went looking at a couple of banks that I consider good bellwether banking stocks since so many look to them for guidance on the health of the banking sector -- JPM and GS. What I see are interesting setups for both of them.
Between price-level resistance near 49 and two price projections in the same area I'm watching JPM closely to see how it handles this level. The high so far, which was today, is 48.83, only 3 cents shy of the projection at 48.86 where the 5th wave of the move up from June 2012 will be 162% of the 1st wave, a common relationship when the 5th wave extends, as this one has. Slightly higher, at 49.47, is where the move up from October 2011 would have two equal legs up and the price-level resistance near 49 starts back in 2006. If JPM can rally above 49.50 I'd turn more bullish but right here is potential trouble and the longer-term pattern suggest the 3-wave move up from October 2011 will complete a long-term sideways triangle consolidation following its 2000-2002 decline. That leg down should be followed by another one that takes it below its 2002 low at 15.26.
JPMorgan Chase & Co., JPM, Weekly chart
GS has now rallied slightly above its downtrend line from October 2009 and has nearly achieved a 62% retracement of its 2009-2011 decline, at 151.83. Two equal legs up from June 2012, to complete a double zigzag wave count (a-b-c-x-a-b-c), has been achieved at 149.89. Today's high at 151.14 is only about 70 cents shy of its 62% retracement. Above 152 would be more bullish for this stock but keep an eye on how it does here since a drop back below its downtrend line, near 149, would leave a bearish throw-over finish to its rally.
Goldman Sachs Group, GS, Weekly chart
Last week I showed the weekly chart of the TRAN to point out the price projection at 5917, which is the projection out of the rectangular consolidation pattern in 2012. Yesterday's high was 5895 and the short-term pattern suggests it could make at least one more new high and tag that level. With some significant bearish divergence on the daily chart between its January 28th high and this week's highs, along with the overbought weekly oscillators, this is not the time where you want to be thinking long the trannies. IYT is one ETF could use to buy puts if you wanted to play a reversal.
Transportation Index, TRAN, Daily chart
I came across the chart below a few days ago and it caught my eye because it's counter to what we've been hearing from the market pundits when talking about the robust housing market and how it's going to pull us higher this year. Someone forgot to tell the consumer this. This chart shows the steady decline and then flattening in mortgage flows since 2007. The dark green line is the 30-year fixed mortgage rate, which has been steadily declining (a goal of the Fed's), but the gray line shows home mortgages have been running flat since 2009. This is another example of leading a horse to water but not being able to make him drink. The Fed continues to push on a string when making more money available for cheaper prices but still finding no takers (and bankers have been tightening their lending standards).
Mortgage Flows, Quarterly chart, 2007-Q32012
We know the home builders have been building at a much higher rate recently as they anticipate a higher number of new homes to be sold in the spring. I showed a chart last week that pointed out the large difference between foot traffic and home buying -- foot traffic has been increasing while new home sales remain flat. Home sales remain under 400K annualized while home builders are nearing 1000K annualized. Throw in a lot of foreclosed homes hitting the market this spring and I believe there will be a nasty surprise for most of the bullish pundits.
Updating last week's chart of the home builders, price has stalled near the 500 area that I had pointed out. Maybe investors are starting to get worried about all the building that's been going on but not believing sales will be good enough. There's been no breakdown yet to call the rally complete for the home builders but price has stalled where it should if there's to be a reversal. Back below 460 is needed to confirm its rally has finished.
DJ Home Construction index, DJUSHB, Weekly chart
The U.S. dollar bounced off support where it needed to -- at its neckline running across the lows from February 2012, near 78.90. At the moment I am not more bullish than expecting the dollar to make it back up to its downtrend line from November 2012, currently near 80.60. I show it making its way up to the line by the 3rd week of February, near 80.50, to finish a sideways triangle consolidation pattern before starting a more serious decline. More bullish potential still exists but at this point I need to see a break of its downtrend line, confirmed with a rally above 81, before I turn more bullish the dollar.
U.S. Dollar contract, DX, Daily chart
Gold's chart is a bit of a mess and I'm about at the point where it's flip and coin to figure out where it might go next. It remains in a down-channel from October 2012 so by that measure you stay bearish until it breaks out, confirmed with a rally above 1698. The more bearish potential is very bearish as it has a few degrees of 3rd waves to unwind to the downside. The bearish count suggests a sharp selloff that will drop it out the bottom of its down-channel, currently near 1590. This is the way I'm leaning but not with a lot of confidence.
Gold continuous contract, GC, Daily chart
Oil topped out where I thought it should if the bounce off the November low is to be just a correction and not something more bullish. The $98 dollar area should be the top and the next big move should be down and eventually break below the November low near 84. But a rally much above 98.35 would have me thinking more bullishly about black gold.
Oil continuous contract, CL, Daily chart
As a side note on the use of channels on the oil chart, I had a parallel up-channel based on the uptrend line from November-December, the top of which was broken to the upside in January. It's very common to see a move up to a "double-wide" channel -- the upper channel is the same width as the lower one and notice that's where price rolled over. Try it on other symbols and you'll be surprised how effective it can be. I noticed years ago that IBM trades channels remarkably well.
The rest of the week will remain quiet as far as economic reports go. We'll probably be at the mercy of what happens overseas and then back to your regularly scheduled manipulation, I mean rally, during the day.
Economic reports and Summary
I don't have a chart of the VIX tonight but I do note that we've got a higher low on VIX this week relative to its lows two weeks ago while SPX pushes to new highs. That's bearish divergence, something we've seen at previous important stock market highs. It's not a timing signal but simply another warning that the stock market rally is running on fumes now and smart money managers are positioning themselves for protection. We already know the commercial traders hold a historically high net short position while the public is at a historically high net long position.
While we all know the market can remain irrational far longer than we can remain solvent fighting it, here's another chart showing the disconnect between reality and hope. The reality is that earnings have been declining for the past 1-1/2 years, including since last November when the stock market started rallying in anticipation of improved earnings (forward looking P/E ratios were showing the market as "undervalued"). The chart below shows the decline in earnings (meeting or beating estimates is smoke and mirrors -- look at actual earnings growth) while the stock market has rallied strong. It's only a matter of time before someone looks over to their trading partner and asks "did you bring a rope for us to get back down?" Hence we're seeing more put buying and as Jim mentioned last night, someone placed a huge bullish bet on the VIX heading higher from here.
Earnings vs. Price estimates for Q42012 and Q12013, chart courtesy MoneyGame
The market is ignoring a lot of warning signs right now and that's bullish. The problem is the same level of complacency and uber-bullish sentiment have created very difficult times for the market in the past. We have no idea what the catalyst for selling will be. Sometimes it's just selling that begets more selling. Keep an eye on that exit door and don't let it close on you. 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