Sentiment has switched from greed to fear and now most believe the market is heading lower. That makes this week's bounce just a dead cat bounce. But there's potential for another rally.
Following a hard selloff, which we saw from last week's high, a bounce is always suspect. We don't know if it will be just a dead cat bounce (DCB) or an actual reversal of the decline. With the indexes breaking important uptrend lines and 50-dma's it's easy to look at the decline from May as only the beginning of something more bearish. But the pattern of the pullback suggests we might see something more than a DCB.
There's been a lot of speculation about why the market sold off so strongly following last week's FOMC and Bernanke's press conference. What's interesting is that the market learned nothing new from the Fed or Bernanke. The taper talk is just that and Bernanke said he could increase or decrease purchases over time, depending on the needs for either step. The market's negative reaction to that statement, and blaming it on Bernanke, was just an excuse for big money to sell. I'll be the first to blame Bernanke for a lot of things but the selloff in the stock market (or gold for that matter) was not due to what Bernanke said or didn't say.
Jim did a great job updating us over the weekend and in his Tuesday wrap about what's happening with China and their banking crisis. Almost all stock market crashes have been a result of some kind of credit crisis, even the 1998 crash as a result of little Thailand running into trouble. Usually the market is overextended and the crisis becomes a catalyst for taking profits. As I've said many times in the past, when you have a market full of traders who own stocks they become sellers-in-waiting. Give them an excuse to sell and all of a sudden everyone becomes a seller.
The interesting thing about what's happening in China is that they're trying to force some discipline on the banks by getting them to bring loans back to their balance sheets and improve their reserve levels for bad loans. In other words they're trying to provide some tough love, something the U.S., Europe and Japan don't seem capable of doing. I liked what Todd Harrison from Minyanville had to say about it on Tuesday:
"So here we are, in the irony of ironies: The United States of America, home of The Statue of Liberty, The Constitution, and The Freedom Tower, continues its attempt to guide markets on a course they deem to be in the best interest of our nation.
"Across the world, communist China, where they don't even enjoy the freedom of speech, is attempting to ensure the forward freedom of their markets. It would be amusing if the stakes weren't so darn high."
Of course one problem with the Fed's QE program is that more and more people are beginning to realize they've painted themselves into a corner with no escape. This whole global QE effort is one grand experiment that's never been tried before on the scale that it's being done. There's no prior time that can be used for lessons learned and how to exit the program. The Fed and other central banks are stuck and they'll implement more and more QE (look at Japan) until there is a collapse of the fiat currencies.
The continued effort to inflate economies has not been effective. Today's GDP revision was downward to +1.8% from the previous +2.4% estimate, proving once again that the majority of economists and their +2.4% estimate were wrong. Why does anyone listen to these economists? They've been wrong at every major economic turn. Every one. So despite $10 trillion of artificial stimuli our GDP is dropping and even with a relatively small pullback in the stock market it remains hugely disconnected from reality.
Of the four components making up GDP -- consumer purchases, business investments, exports and government spending -- all except government spending were all revised lower. So basically government spending, which is mostly wasteful spending (think broken window theory), is the only thing propping up the economy right now. Of course this was perceived as good news by many since it means the Fed will be forced to back off its "taper" talk.
As we know, sentiment is the big driver behind the market's moves. Most often news means nothing; it's the reaction to the news that means everything. Swings between major highs and lows in sentiment often coincide with major turns in the market. From May's high, which was marked with over-the-top bullish sentiment (greed), to Monday's low, which has now been marked with a complete switch in sentiment to fear, we can see how the market is driven by these two primary sentiments.
When the most traders get bullish, complacent and greedy they buy with both feet, using as much margin as possible (we know margin levels were higher than in 2000 and 2007). Most everyone in May was saying we were due for a pullback and that it would be a great buying opportunity. Suddenly those same people are afraid to buy and suggesting the market is heading lower. CNN Money had an interesting article that recently pointed out the emotions in this market.
The CNN Money report looked at seven indicators:
-- stock price momentum, SPX vs. its 125-dma
-- stock price strength, # of stocks hitting 52-wk highs and lows
-- stock price breadth, advance-decline volume
-- put and call options, put/call ratio
-- junk bond demand, spread between investment grade and junk bonds
-- market volatility, VIX
-- safe haven demand, difference in returns for stocks vs. Treasuries
Fear and Greed index, chart courtesy money.cnn.com
On the above chart you can see important lows coincided with significant lows in the fear-greed index, showing spikes in fear. Is the current low going to mark an important low for the stock market? One could easily make that argument and it's why it's a very good buying opportunity. It's another higher low in the index since 2011, which could be bullish, or it could mean there's lower to go before fear spikes lower into a lower low. Either way, it's a time for caution and a warning for both sides.
As a side note about the SPX weekly chart above, the Bollinger Band is not something I normally show on my charts. You can see how it poked above the top of the band into the May high, followed by a pullback to the center of the BB (20-week MA), which is often support in this kind of pullback. Another test of the BB with bearish divergence is a setup the bears would want to take advantage of. Also, a break below Monday's low would likely see a drop to the bottom of the BB, currently near 1500.
Moving to my regular SPX weekly chart, it's the strong break below the uptrend line from November-April, as well as its 50-dma (both near 1617 at last Thursday's breakdown), that looks bearish, especially since both have held pullbacks since the November low. So far it's finding support at its long-term broken uptrend line from 1991-1994-2002, currently near 1580. A break above it in March followed by a back test here could be a bullish setup for at least a test of the May high, which is what I'm showing in green. The broken trend line along the highs from 2000-2007, currently near 1595, is also being tested after SPX broke above it in early May.
S&P 500, SPX, Weekly chart
Upside potential for another rally leg is to 1689 where the 5th wave of the move up from June 2012 would be 62% of the 1st wave (green wave labels) and essentially a retest of the May high. It's possible we'll see a rally up to about 1768 where the 5th wave would equal the 1st wave Notice the 3rd wave (or wave-c), which is the leg up from November, achieved 162% of the 1st wave at 1679. The big question here is whether or not we're going to get the 5th wave or if instead the a-b-c move up from June 2012 completed the 2009-2013 rally. It's either done or it has only one more rally left.
Today's rally overlapped the June 6th low at 1598, which means it's not a 4th wave correction in the move down from May (unless it's part of a larger descending wedge pattern but that's not the higher-odds pattern here). The two highest-odds scenarios here are: one, the pullback from May is a completed a-b-c correction to the rally and another new high is coming (shown in green) or this week's bounce is another 2nd wave correction and we've got a 1-2, 1-2 wave count to the downside, which calls for a very strong decline for the next leg down (a 3rd of the 3rd wave down). I currently lean long the market for a ride up to at least a test of the May high in mid-July (to meet a confluence of cyclical turn dates) but a drop back below 1565 would be bearish and potentially very bearish.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1629
- bearish below 1565
The bounce off Monday's low has achieved a 50% retracement of the leg down from June 18th. This is potentially important for the bearish case, which calls the bounce a 2nd wave correction, which typically retraces about 50%. A strong decline from here, even before it breaks below 1560-1565, would have me leaning more bearish. It's possible we'll see a larger bounce correction, which I'm showing in red on the 60-min chart below, and that should develop into an even larger bounce if we're going to get at least a test of the high. Whether the new rally leg is quick or choppy is the question right now but as long as it stays above 1560 it will remain potentially bullish.
S&P 500, SPX, 60-min chart
On the chart above I left the downtrend line from May 22nd through the June 10th high in place (the gray downtrend line) because they often continue to show where S/R can be found. In this case, in addition to the 50% retracement the downtrend line is resistance until proven otherwise. A pullback followed by another push higher would clearly keep the bullish potential alive but assuming it played out that way we'd still have consider it just a higher 3-wave bounce before heading lower (shown in bold red).
The DOW has the same pattern as SPX. In fact all the broader indexes are in synch here and presenting the same wave pattern. Today's rally will either end in miserable failure for the bulls are it's going to lead to another rally (after a pullback) that will completely demoralize the bears, who will collectively give up in disgust just in time for a major market high. It's too early to tell which way this will resolve from here so key off the key levels from here -- bullish above 15K and bearish below 14640, keeping a tight control over your trade until the bigger move confirms.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 15,000
- bearish below 14,640
NDX bounced off support on Monday at its uptrend line from November-April, which was also the bottom of a parallel down-channel from May (before breaking out the top of the channel in a head-fake move last week). Closing its June 20th gap down, at 2959.50, would likely lead to further upside. Dropping below Monday's low near 2825 would likely lead to further downside. Watch the chop in between.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2960
- bearish below 2825
Since the June 6th low I've been looking at the RUT as the reason why we'll see a new high. The 3-wave pullback from May is a strong reason to believe the correction to the rally will be followed by another rally. I still lean that way but interestingly it currently looks the most bearish if only because it's stuck below resistance. Today's high was at its broken 50-dma and uptrend line from November-April, both at 967.25. Because of its pullback from the morning high it ended up being the weaker index today. That needs to change, with a rally above 968 before the bulls will be in better shape. Above last Thursday's gap down, at 987, would signal new highs are more likely. Back below Monday's low at 942 would tell us to get short and hang on for the ride.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 987
- bearish below 942
The 10-year Treasury price had dropped to a low of 125'005 on Monday, ticks shy of a 124'29 price projection, which is where the c-wave of an a-b-c pullback from July 2012 is 162% of the a-wave. It then immediately bounced back up and is currently trying to get back above its uptrend line from 2007-2011 and its 200-week MA, at 126'10 and 126'05, respectively. Today's close was 126'05 and if the rally in bonds can continue there's a good chance the a-b-c pullback from July 2012 is complete. So far the weekly candle is a bullish hammer (dragonfly doji) at support and a weekly close like this would be bullish. The bullish potential from here is for one more rally leg into the end of the year to a new high (new low for yields). But if we see a choppy consolidation near the trend line/200-week MA followed by a drop lower it would be a very good indication that the July 2012 was THE high for bonds. There's one more chance for the bond market to agree with Bernanke that he can reduce yields through the QE program (possibly an expanded QE program) but the bond market is starting to get nervous.
10-year Treasury Note, ZN, Weekly chart
If Treasury yields start coming back down there would likely be relief in the housing market, including the home builders. Interestingly, as the Treasury prices look ready for a turn back up (yields down), so too does the home construction index. The weekly megaphone/diamond topping pattern that I've been following shows price dropped to the bottom of the pattern and has started a bounce back up. It's possible it will rally up to a lower high within the diamond top (or something less than that) but if it instead breaks below 425 it will turn more immediately bearish.
DJ Home Construction index, Weekly chart
Currencies worldwide have been volatile and no less so for the U.S. dollar. Following the strong May-June decline in the dollar it has reversed just as sharply back up. So far it has retraced a little more than 62% of the decline and my guess is that it will head to new highs from here. The only thing that surprised me in its climb higher is the sudden and sharp decline from the May high. As depicted on the weekly chart below, a choppy continuation higher into the end of the year is what I expect to see, with an upside target near 87. But a drop back below 80.50 would turn the pattern more bearish, in which case we could see the dollar head for 75.
U.S. Dollar contract, DX, Weekly chart
Along with most commodities since their highs in 2011, the metals have taken it on the chin and the selling continued hard this week. One of the big problems for commodities is that the fear of inflation is fading. No matter how hard the Fed and other central banks try they cannot get inflation to increase. I've discussed the reasons for this in the past but simply stated, they can't increase demand for products just because they make it cheaper (from a credit perspective) to buy. The decline in the velocity of money shows banks are not lending and borrowers are not interested in borrowing.
The chart below shows the CPI since 2009 and while Shadow Stats shows higher actual inflation numbers, they both are coming down. With all of the massive stimulation going on by the Fed they have been unable to stoke inflation. All the buying that was going on in gold, hedging against inflation, has proven to be a bust and gold has experienced a long bout of selling since 2011. Deflation is on its way.
CPI, 2009-June 2013, chart courtesy agorafinancial.com
All the recent taper talk is likely to be proven incorrect if deflation becomes more of a worry for the Fed. They are programmed from birth to fight deflation with every tool they can imagine and will bankrupt this country before they admit defeat against deflation. I think there's a greater chance of QE-I+ (QE to infinity and beyond plus more) than any kind of tapering. In fact the chart below shows what the Fed calls their "5-year TIPS (Treasury Inflation Protected Securities) indicated break-even inflation" and it's something the Fed watches closely. They use it to help determine when the next round of QE is needed. Whenever the indicator drops much below 2% the Fed panics and runs out to buy more printing presses. Based on what's happening we should anticipate another QE announcement soon, especially if the stock market starts to break down from here (instead of one more new high into July).
5-year TIPS-indicated break-even inflation
The problem with the QE efforts is that each round has a shorter and shorter half-life and creates a smaller and smaller bounce. They may soon feel the need to go big or go home and could make "Abenomics" look weak by comparison. It's all part of the race for the bottom between countries and their central banks.
All of this deflation-fighting has only slowed it down but it's still coming and that's what the price of gold is reflecting. In fact gold has now given up all of its gains since Bernanke announced QE2 in his annual Jackson Hole meeting in August 2010. It has lost more than a third of its value from its 2011 high and the loss just this year has been -27% (-40% for silver). The quarterly loss for gold so far has been the largest since 1968 (since Reuters has been tracking this). The good news is that gold is still up about 400% from 2001 when it was trading near $300. But I'm sure gold bugs don't feel very good about that one, especially if they didn't buy back in 2001.
The wave count that I've been following since the September 2011 high is now close to achieving a tradable low. It could happen with a low from the current leg down from the June 6th high but ideally we'll see one more up-down sequence to then achieve the downside projection at 1151-1155. It would turn at least short-term bullish with a rally above the June 6th high near 1423, which is now a long way (nearly $200) above the current price. Watch the bottom of its parallel down-channel from the September 2011 high, currently near the April 16th low at 1321.50, for resistance if tested.
Gold continuous contract, GC, Weekly chart
Silver's decline has now brought it close to the downside target I've been pointing to for several months -- $18, which is the apex of a previous sideways triangle back in 2010 (a common S/R level when first revisited). The bottom of a parallel down-channel from 2011 is currently near 17.50 and its longer-term uptrend line from 2003-2008 is near 14.60. Ideally the wave count calls for one more up-down sequence in order to finish a 5-wave move down from October 2012, which would then complete a 3-wave move down from April 2011 and will set up at least a larger bounce and therefore a tradable low. While it's risky playing the downside from here I also think it's too early to go bottom fishing. I'd rather see confirmation of a tradable low with an impulsive move back up to indicate.
Silver continuous contract, SI, Weekly chart
With the metals getting beat up badly it's not unusual to see the miners getting beat up as well. But the miners are getting beat like a rented mule. The gold miner's index, GDX, shows the strong decline from September 2011 but unlike gold it is now getting close to its October 2008 low, which for gold is at 681. Think a few gold bugs might freak out if gold gets down there?
You can easily see the rounded top in the price pattern on the weekly chart below. I have the decline from 2011 labeled as an A-B-C pullback, which could be part of what will become a large sideways consolidation, or it could be followed by a high bounce. If it's a 1-2-3 to the downside we'll see a sideways/up consolidation, perhaps near the 2008 low, in a 4th wave for the rest of this year before heading lower again next year. At the moment there's too little information to help figure out what the next move will be.
Gold Miners ETF, GDX, Weekly chart
So what's happening to the miners? Basically the miners have been forced to write off the value of inflated assets purchased in past years. As the price of gold has dropped it has exposed the problems the miners are facing (let the water out of the pool and we find out who was swimming naked). Collectively they spent almost $200B on acquisitions at inflated values when gold was zooming higher. Now they're being forced to revalue those assets and write off the difference. While the price of gold has dropped that's not true for the costs of mining gold and their profit margins have dropped accordingly. The table below shows the operating margins for some of the miners in 2012 vs. today and how badly they've declined.
Miners' Operating Margins
Some of the bigger miners are in real trouble, especially Newmont which is basically operating at break-even right now. Its stock price looks like GDX and is also nearing its November 2008 low at 21.17 after reaching a high of 72.42 in November 2011. But Barrick Gold (ABX) might be a leader to the downside -- last week it broke below its October 2008 low at 17.27, after bouncing off it in April, and dropped lower this week, hitting a low of 14.75 today. This follows a high of 55.95 in September 2011. The 1998-2003 lows are 12-14 so that should be a stronger support zone. What happens from there is anyone's guess but I'm sure it won't be much more than a consolidation before heading even lower if the decline from 2011 is to be an impulsive decline.
Last week oil had poked above its downtrend line from September 2012, which fits as the top of a sideways triangle consolidation since the June 2012 low. Following the head-fake break (throw-over finish to the triangle?) the drop back below the line is a bearish move, especially if it stays below it on a back test, currently near 96.50. But the larger pattern remains unclear and will not be clearer until it breaks out of the larger sideways triangle pattern, the top and bottom of which is currently near 103 and 81. There is the potential for a strongly bearish outcome here since the wave count can be considered a 1-2, 1-2 to the downside from its May 2011 high, which calls for a strong decline from here. We'd likely see a move down to at least 50, possibly before the end of the year. From here I don't see anything more bullish than a rally up to about 103.
Oil continuous contract, CL, Weekly chart
Tomorrow morning's economic reports including personal income and spending, pending home sales and the usual unemployment claims. The market was set up for a pullback on Thursday so perhaps there will be a disappointing reaction to some of the data.
Economic reports and Summary
The decline into Monday's low and the bounce back up had me suggesting getting long the market since the 3-wave pullback from May suggests we're going to get one more push higher into July to meet some important cyclical turn dates. We could see a retest of the May high or a new high, which would set up an outstanding shorting opportunity (especially if sentiment turns uber bullish again). But we'll need to see the downtrend lines from May broken to push this potential to the top of the list.
There is the possibility we'll get a bounce to a lower high that's followed by a drop below Monday's low. That would be potentially very bearish and lead to a very strong decline into July, one that could wipe 2000 points off the DOW in less than a month. Take a drop below Monday's low very seriously. But until proven otherwise I continue to lean long the market and hope to see one more new (and final) high, with lots of bearish divergence, into July. Now we let price lead the way.
Trade carefully and good luck. 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