The market has been working hard the past two days to hold up during opex week, a typically bullish time for the market. But today's selling might be an early indication that an important high is in place and we'll look at the possible long-term ramifications of that.
Wednesday's Market Stats
Today the stock market spent much of its time just like yesterday -- a small drop in the morning and then flat for the rest of the day. It was looking like we'd got out flat like it did yesterday as well (although down for the day) but then some stronger sell programs hit just after 2:30 PM and lasted for about an hour. The indexes got a little bounce off the mat in the final 30 minutes but some technical damage, though minor, hints of worse to come. But the pattern looked good for a bounce back up on Thursday so we'll see if that comes to pass.
The bond market rallied overnight after the ECB and BOE indicated they were prepared to take some action to support the markets, I mean their economies, and that had yields gapping down this morning. That in turn had money running from the stock market into the bond market and there are some early signs that might continue.
The only economic report of significance this morning was the PPI for April, which came in higher than expected and the same as March. PPI was +0.6% while Core PPI was +0.5% (these are reversals of the March numbers), indicating inflation is climbing above the Fed's target rate of 2%. The futures didn't react to the numbers when released at 8:30 AM but with PPI numbers heading higher (the Fed could be getting its wish) businesses will either have to absorb the higher costs, reducing their profit margins (making it more difficult to justify the high valuations), or they'll need to pass along the costs to their customers.
Thursday morning we'll get the other half of the inflation picture with the release of the CPI numbers. If they remain relatively flat, which they're expected to do, it will mean businesses have been unable to pass along their higher costs. An early sign that the consumer is not in the mood to pay higher prices, or any prices, came from yesterday's retail sales numbers, which were lower than expected. This tells us the consumer is already pulling back and therefore any further price increases could scare consumers back into their homes and decide to make do with what they have. In other words, once again, the Fed's efforts could backfire on them.
Trading volume was again pathetic today, coming in only marginally higher than yesterday's lowest-volume of the year (except for January 22nd), so it's hard to take away anything from a market move on low volume. But while volume is a bull's friend, it's the bear's enemy, so today's low volume may actually be favoring the bears right now. During the initial part of a decline, if it's to turn into something more significant, the volume is often absent. Bears are timid and bulls are just waiting for the next dip to buy, hence low volume. I call them stealth declines because by the time it's recognized as something more than just a pullback it catches both sides by surprise. Strong volume in a decline is often found at bottoms as investors capitulate (puke is the endearing term), which is why volume is a bear's enemy. You want to see strong volume in a rally but bears do better with less volume in a decline.
Since the market's corrective 3-wave pullback into the April 11th lows I've been bullish and expecting new highs for the blue chips (and NYSE). We got those highs and since Tuesday's high I've turned bearish, with the knowledge that a final high might not be in yet. Today's pullback could be just a correction to the rally before heading higher again, but as I'll get into later, we've got a setup for an important high and now it's a matter of looking for more evidence to see if an important reversal has been made.
We know we have lots of complacency in the market right now and most pundits call every pullback just another buying opportunity. I don't like to put much credence into put/call ratios and the VIX during opex but today's decline barely moved the VIX (+0.04 for the day) and that has me thinking the lack of fear could be another thing in the bear's favor. A rapid rise in the VIX, just like volume, is the bear's enemy.
For tonight's review, considering the potential for a very important market high, I thought it would be a good time for another review of the bigger picture of the stock market (at least as I see it) and work my way down to what the shorter-term patterns suggest this week. I'll use the DOW since it's such a widely-followed index and most can easily relate to its levels. Looking at the really long-term view, showing the DOW since 1900, provides a good perspective of where we've been and where I think we're going. The good news is that once the current bear market finishes we'll have a generational opportunity to own stocks. The bad news is there's a lot more pain before the bear is finished mauling the bulls.
I'll start a little out of order with a monthly chart of the DOW, looking at prices since 1996 and then show that in relationship to the bigger picture. The chart below shows an expanding triangle pattern for the DOW since the 2000 high. This is a relatively rare pattern and fits as either the left half of a very bearish diamond topping pattern (look for the next 100 years to be down, mixed with secular bull market bounces along the way) or it's a large sideways correction in a longer-term bullish pattern. I'd prefer to believe the latter and as I'll show in a bit, the idea of a correction within a larger bullish pattern also fits better.
DOW monthly chart, 1996-present
All triangles consist of a 5-wave move, labeled a-b-c-d-e, and it's a very good way to anticipate the end of a triangle to get ready to trade the reversal. With the expanding triangle shown above, the rally from 2009 fits as wave-D and it has rallied up to the top of the triangle, which is the trend line along the highs from 2000-2007. The wave count calls for one more leg down to complete wave-E, which will complete a large 4th wave correction in the long-term bull market. The bottom of the triangle, which is the trend line along the lows from 2002-2009, will be near 5500-5600 in 2017-2018, the expected completion of the bear market (secular markets tend to last about 16-18 years).
As noted on the chart at the expected low near 5600, assuming the top is now in place at 16735, the decline would be about a 66% loss, greater than the two previous declines. The majority of market participants think this scenario is ridiculous. I merely show a typical pattern; you decide how you want to play it (or at least protect yourself from it).
Now moving out, the chart below shows the DOW from 1900 and the expanding triangle 4th wave is put into perspective with the monster rally from the late 1800s. In an EW (Elliott Wave) pattern I like to use parallel channels to help identify the higher-probability wave count and there are two channels on the chart. The inner up-channel is for the rally from 1932 and is for the 3rd wave of the move up from the late 1800's. That 3rd wave completed in 2000 with a throw-over above the top of the channel (typical in a parabolic finish) and the DOW is currently back up to the top of the channel at the same time it's hitting the top of its expanding triangle.
DOW monthly chart, 1900-present
The long-term bull market from the late 1800s calls the 1929 top the 1st wave and the 1929-1932 crash the 2nd wave. It's common for the 4th wave to alternate in form with the 2nd wave, which it's doing (2nd wave was sharp, 4th wave is flat). As I showed on the first chart, the bottom of the expanding triangle will be near 5500-5600 by 2017-2018 and it crosses the bottom of the up-channel from 1929 at the same level/time, which adds credibility to the projection for the next and final move of the bear market.
But here's the scary part -- it could drop down to the bottom of the larger up-channel from 1929-1932. A common technique for an EW channel is to draw a trend line from the 1st to the 3rd wave (1929-2000) and then attach a parallel line to the bottom of the 2nd wave (1932) -- that's where the 4th wave often goes to. This would suggest a larger/longer decline that could take us into 2025 and drop down to 3500.
I'll be the first to say I surely hope the DOW is not going that low and I especially don't want to be in a bear market that lasts another 10+ years. But go back to the first chart and see my note at the bottom -- the beginning of the parabolic rally that completed the 1982-2000 bull market was around 3520 in 1994. Parabolic rallies are often completely retraced, which means a return to 3500.
Needless to say, a bear market that lasts another 10 years and drops the DOW down to 3500 would mean a very painful period and could be the result of the big correction to the Fed's distortion of the market for too long and enabling it to rally too high with the yield-chasing crowd. Corrections of market distortions are not fun (unless you're on the winning side of the trade, which is our aim here at OIN) but weâ€™ve got a little time to worry about that possibility, although, again, it's a good reason not to hold on through the next decline with the expectation that "it'll come back."
I'm just the messenger here so don't shoot me. But if you question why I'm strongly recommending investors not hold on through the next decline, with the belief that "the market always comes back," this tells you why. The market should come back but it might be long after you're dead. Forget the idea that you should be a buy-and-hold investor in your 401(k) and get into the mode of becoming a trader. Your financial life depends on it. You can disagree with me all you want, and most do, but at least you know where I'm coming from when I say I'm bearish the stock market.
OK, now we move in closer. The 2009-2014 rally is a 3-wave move, as each leg in a triangle pattern will be, and the 2nd leg up started from October 2011. There are a couple of ways to look at the EW counts for that leg but one of them is shown on the DOW, which calls it an A-B-C move. Without getting into the nitty-gritty details of the wave count, the final wave of the count is the rally from February and it has formed a small rising wedge as it approached the 2000-2007 trend line (the top of the big expanding triangle). This trend line stopped the rallies in December and April and so far has stopped the current rally. This could be a 3-drives-to-a-high topping pattern.
Dow Industrials, INDU, Weekly chart
The bearish divergence at the highs since December, and actually since May 2013, tells us trendline resistance is likely to hold. There are also two longer-term price projections near this 2007-2007 trend line that make it a high-odds setup for the bears: first, two equal legs up from 2009 is at 16686; second, for the 3-wave move up from October 2011, the 2nd leg is 162% of the 1st leg at 16702. The correlation between these two projections with the 2000-2007 trend line has been the reason I've been projecting a top for the DOW near 16700. Tuesday's high was 16735.
The DOW's daily chart below shows a smaller 3-wave move up from February and the 2nd leg is 62% of the 1st leg at 16735.30. Tuesday's high was 16735.51 -- close enough for government work. This is a repeat of the pattern for the 3-wave move up from October 2013 to December 2013 where the 2nd leg up was 62% of the 1st at 16603, shown on the left side of the chart below. That time the DOW missed achieving it with a high of 16588. Tuesday's high was a throw-over above the top of its rising wedge pattern for the rally from April 11th and today it dropped back inside the wedge, giving us a sell signal. Yesterday's small shooting star followed by the big red candle today, at Fib/trendline resistance, is another sell signal and the only way to negate it now is with a rally above 16735. Confirmation of a top being in place won't come until it drops below the May 7th low at 16357.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 16,735
- bearish below 16,357
In a continuation of 3-wave moves, it's possible to count the move up from April 11th as a 3-wave move and the 2nd leg is 62% of the 1st leg at 16697 (continuing the fractal pattern with 62% projections), as shown on the 60-min chart below. Along with the throw-over above the 2000-2007 trend line it was also a brief throw-over above this 16697 projection and the reversal back down leaves it as a bearish head-fake break. It remains possible the rally will continue from here, especially since today's low held at the bottom of a parallel up-channel for the leg up from May 7th, but at most I'm anticipating a bounce on Thursday to correct the decline from Tuesday, maybe as high as 16700, but then a continuation of the decline following the bounce.
Dow Industrials, INDU, 60-min chart
It's a similar pattern for SPX although slightly weaker. It missed its 62% projection for the 2nd leg of its 3-wave move up from February by about 2 points (the projection is at 1904.37 and Tuesday's high was 1902.17). There's higher potential to the top of a larger rising wedge pattern, which is the trend line along the highs from December-March-April, giving us an upside target near 1920. In between is 1910, the important level on the Gann Square of 9 chart. But Tuesday's gravestone doji followed by today's red candle gives us a sell signal and the bulls need a rally above 1903 to negate the bearish setup here.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1905
- bearish below 1859
A closer view of SPX is shown on the 60-min chart below. The little rising wedge for the move up from April 11th shows the 5-wave count and since each leg needs to be a 3-wave move (or something more complex but corrective), the 3-wave rally from May 7th counts well for the completion of the rally, which is why I liked the setup on Tuesday for a short play. The throw-over above the top of the wedge followed by a drop back inside gave us our first sell signal. Use a bounce on Thursday to get short and use Tuesday's high for your stop.
S&P 500, SPX, 60-min chart
NDX, like the RUT, has been a very choppy pattern since its March high and that makes it very difficult to get a bead on its direction. At the moment I lean bearish if only because it was unable to hold yesterday's break above its 50-dma, near 3599. But until it can break below its uptrend line from April 15, currently near 3542, it could continue to chop its way higher. A break of its downtrend line from March, near 3642, would be bullish. The 100 points between 3542 and 3642 could see a lot of chop.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3676
- bearish below 3650
The RUT is just a more bearish version of the choppy NDX pattern. The pattern is not at all helpful in identifying the primary trend but the failure to hold above either its 20- or 200-dma with today's drop keeps it in the bear's hands. A rally above Monday's high at 1137 would be at least short-term bullish for a run up to its 50-dma, currently near 1153.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1137
- bearish below 1080
Bond futures rallied during the overnight session and yields gapped down when the bond market opened this morning. TNX (10-year yield) gapped down below support near 2.57% and its May 5th low. This is an important support level and unless it will be just a 1-day head-fake break this could be the start of a more serious decline in yields. A strong rally in bond prices would put downward pressure on the stock market.
10-year Yield, TNX, Daily chart
The U.S. dollar has had a strong bounce off its May 8th low and nearly made it up to its downtrend line from January, near 80.34 (yesterday's high was 80.28). Dollar bulls face stiff resistance at this downtrend line, its broken uptrend line from May 2011 - October 2013, near 80.47, and its 200-dma, coming down toward the same level. Obviously the dollar would be more bullish above all of these but it probably won't happen until after a pullback to recharge its batteries. Dollar bears want to see it back below last week's low at 78.93, which would confirm the bearish wave pattern that calls for a decline to the 75 area. The potential descending wedge pattern for the dollar's slow decline from November 2013 has me leaning toward the long side of the dollar.
U.S. Dollar contract, DX, Daily chart
The metals were up today and for gold it could be at/near the finish of a sideways triangle consolidation since its April 1st low. It has the requisite wave count inside the triangle (a-b-c-d-e) and might be held down again by its 50-dma, currently near 1311 (the last test on May 7th resulted in a pullback). If the triangle consolidation is the half-way point in a decline from the March 17th high we should see another leg down to about 1195, as shown on the chart below. The bigger pattern for gold suggests more downside potential than that but one leg at a time. Gold needs to break its downtrend line from October 2012, currently near 1347, in order to turn the pattern more bullish.
Gold continuous contract, GC, Daily chart
Oil's rally off the May 1st low has now made it up to the downtrend line from August 2013 - March 2014 (which was briefly broken with the rally into April), currently near 102.40. It has also retraced 62% of the April decline, at 102.60, with today's high at 102.65. A little higher, near 103.65 (which would be a 78.6% retracement of its April decline), it would back-test its broken uptrend line from January-March. A rally above its April 16th high at 104.99 would be a bullish move but at the moment I'm looking for resistance to hold and the next leg down to begin. The bearish potential from here is significant and a fast move down is possible. But it's also possible we'll see oil stay trapped in a 90-100 trading range for a few months before a bigger move.
Oil continuous contract, CL, Daily chart
Thursday will be busy with economic reports, most before the market opens so we'll see how the futures market reacts. The setup by the end of the day today was for a bounce so at least a small gap up (to catch those who were leaning into the short side at the end of the day) is the potential, as long as there are no scary-bad reports.
Economic reports and Summary
We've got early signs of a market reversal to the downside following a good setup for the reversal. The decline from Tuesday looks impulsive, indicating a trend change, which means we should get no more than a bounce correction on Thursday before heading down stronger on Friday. If the market simply heads lower right away on Thursday that would obviously be more bearish. The bulls need to reverse the decline now and drive the indexes back above Tuesday's highs in order to negate the bearish setup. Until that happens I suggest shorting the bounces rather than buying the dips.
The rally has been weakening, bullish sentiment is climbing (bearish from a contrarian perspective), market internals are decidedly bearish and we've got seasonal pressures on the market (sell in May and go away). The May 2008 high was followed by a "crash" course in how to short the market. If you're not comfortable with the idea of shorting the market, buy puts or inverse ETFs since you're "buying" and both can be done in an IRA account (get yourself option approval if you don't already have it). Bear markets are real money makers so don't be afraid of them. Get comfortable switching hats and most importantly switching them quickly. Give up your bias and simply trade what the chart is telling you. Turn off the TV and don't get swayed by the chorus of voices out there. Do your own analysis, using resources like OIN, make your trade decision, set your stop where the pattern proves your opinion wrong, set up the next trade, rinse and repeat.
Here's a little interesting note a reader sent to me, showing a possible parallel between the last bear market (1966-1982) and the current one. Starting to bubble up to the surface is the news about an investigation into the Benghazi attack and one wonders if it will amount to much of anything other than politicians flapping their gums. But keep in mind that bear markets are a result of negative mood swings in public sentiment. As the reader (thanks Ralph) noted:
"A president, two years into his second term, trying to wind down military operations in a region where the US military has been bogged down in a protracted war, with two daughters, falling poll numbers, declining GDP and a scandal which has been carried by virtually only one media outlet of an event that happened just prior to the previous presidential election, turning into a slow conflagration as his support in congress starts to pare off......hey I've seen this movie! Nixon and Watergate."
Good luck through the rest of opex and remember that moves come out of nowhere and it's a riskier time than usual to trade. I'll be back with you next Wednesday, by which time we should have confirmation that either a top is in place or we'll be looking for the next potential stopping point.
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