Following 5 straight-down days in the market we were due a bounce and today provided it. Now we wonder if the dead cat will quickly revive itself before landing back on the ground.
Wednesday's Market Stats
Today was spelled R-E-L-I-E-F. Following 5 straight-down sessions off the December 29th high, today's bounce was a relief to investors who are starting to worry about the idea that this market can't go down. Exceeding 3 straight-down days, on Monday, had broken a string that was not broken in all of 2014. Not once in 2014, since December 2013, did the market drop more than 3 days straight. So dropping 5 straight days had some sitting on the edge of their chairs wondering what was happening.
January is still very young, with only 4 trading days so far but following yesterday's loss for SPX it made for the 4th worst start to the new year in all of its history. The three previous worse starts were in 1932, 2000 and 2008. Those years were not very kind to the stock market and that kind of statistic is also going to spook investors who up until now were not even contemplating a down January, or year for that matter.
The rally started overnight as equity futures started rallying as soon as the closing bell rang so it appeared somebody wanted to spark a rally this morning, which they got. Now we wonder if it was the dead-cat variety or something more bullish. At the moment I'm leaning toward the former, which I'll explain further when I review the charts. This morning's ADP employment data, which was OK but not great, and the FOMC minutes this afternoon was credited for today's rally. Hogwash. The rally was already well underway before this morning's report and the release of the FOMC minutes did nothing for the market (expect a tiny jiggle in prices at 14:00).
One of the recent fears that has caused a stronger selloff in the stock market is what's been happening to oil. While we high-five each other at the gas pumps as well as with the home heating oil delivery guy, there are many companies and employees that are not so happy. With oil prices below the cost to produce at many of the shale and tar sands areas, the drilling companies have had to slow down their activities. That means layoffs at these companies.
When you think about the number of companies supporting the oil industry you'll start to get an idea what kind of negative impact declining oil prices will have on a lot of people. Lower prices at the pump aren't going to help much if you're out of a job. Whether its producers of drilling pipe (WSJ reported this morning that U.S. Steel announced it will idle plants in Ohio and Texas, affecting 756 workers) or builders of housing in the shale oil locations, the oil industry has a huge impact on many businesses.
Much of the drilling in shale oil fields has been done with borrowed money. This is an area that was distorted by the Fed's accommodation policies -- cheap money was available for borrowing and the costs of the loans weren't much of a factor in the profit/loss formula. Just as their easy-money policies led to malinvestments (defined as flow of capital into areas that would not have otherwise received investments) in the dot.bomb industry, leading to the 2000 high, the same policies led to malinvestments in the housing industry, which led to the 2007 market high. Now we've likely had malinvestments in the oil patch and that very likely will lead to market highs here.
The assumption by the banks was that the loans would be paid back with the profits from oil that was selling for more than $80. After all, a decline below $80 would be a 6 sigma event and I mean, how often does that happen (wink)? Now those loans are starting to look like the sub-prime problem in real estate back in 2007 and the dot.bomb euphoria into 2000.
Many of the loans to the oil industry were the riskier higher-yield (junk) bonds and as I've shown many times recently, HYG (the high-yield bond ETF) actually peaked in May 2013 and then made a lower high in June 2014. Investors in these bonds started to get a whiff of the deterioration in the fundamentals well before oil started coming down. The weekly chart of HYG shows the recent break of support at the June 2013 low, at 88.27, a bounce back up from December 16th (with the stock market) but now heading back down and again testing the June 2013 low. Another break below 88.27 might not recover.
High Yield bond fund, HYG, Weekly chart
Russia also owes U.S. banks a lot of money but no one feared they wouldn't pay when they were pulling in boat loads of money from their oil and natural gas sales. Between economic sanctions, led by the U.S., and the drastic reduction in income, the Russian ruble has collapsed and this has forced Russia's central bank to prop up their currency and bail out some of their banks. How much do you think Russia will be interested in paying its debt to U.S. banks? The $60B (maybe more) that's owed might have to be written off by U.S. banks and on top of the bad loans to drillers, home builders in the oil patch regions and the plethora of businesses associated with the oil business, we could some real stresses placed on the banking sector soon. A JPMorgan analyst recently stated energy junk bonds could see a 40% default rate if oil stays below $65. All of these concerns are weighing on investors (those who are paying attention anyway), especially for the banking sector. The chart of BKX, which I'll show later, certainly looks like investors are becoming more than a little concerned. And investors in general should follow the money (banks).
The bottom line is that there are so many tentacles reaching out from the oil industry and many reach deep into non-oil related industries and jobs. Workers moving away from the Bakken field? What happens to the homes there (and their mortgages)? What happens to the extra teachers who were hired? What happens to the Walmart employees who were being paid $17/hour in order to compete with the oil industry's needs for employees? All of these things might not happen until later in 2015 and 2016 but smart investors like to look out at least 6 months and watch for what's coming. Unfortunately retail investors tend to do their investing by looking in the rear view mirror and extrapolate from there. Did I say retail investors? Actually economists (the Fed most certainly included) do that and then make their predictions based on their rear-end assessments and then retail investors respond.
As for oil/gas prices, all of this means we should enjoy our cheap gas and home heating oil but recognize as traders and investors that the stock market doesn't like it when there's a fundamental shift in what was a driver of growth for our economy. Cheap energy will of course be of great benefit for many industries, such as the airlines, but the negative aspects of a shrinking energy industry but the negative ripples through the economy will be greater and that's what the stock market's decline in the past week has been reflecting. Scooby Doo is looking ahead and just said "ruh-roh."
The strong rally in the dollar is also causing concerns about the harm that it creates for big international companies, where the higher value of the dollar makes it more expensive to sell overseas. Reduced earnings will make it more difficult to justify the already-high P/E ratios for many of these companies.
I know 100% of the analysts who predicted what 2015 will be like are all bullish. Not one predicted a down year for 2015 and that itself should be a warning to any card-carrying contrarian. Now with the 4th worst start for a January, and what I believe will be additional downside pressure this month, we might end up with a negative January barometer. All of this is to say I think it behooves everyone to keep an open mind about the downside potential. I've received some hate mail recently about my bearish opinion, which I take as another contrarian signal. When a rally is obvious to everyone it's obviously wrong and the start to this month could be a wake-up call to some.
I'll start out with the RUT's charts tonight because it has the most bullish potential. While I am bearish the current market and believe we'll see lower prices in the coming week, it's the RUT that I'm using to keep me honest (and scared when short). The RUT has been a good canary index and I'll continue to use it that way.
The RUT's weekly chart below shows yesterday's decline found support at its 50-week MA, near 1153, and today it bounced back above to its uptrend line from October-December, currently near 1169. This keeps the ending diagonal 5th wave possibility alive (rising wedge for the move up from October to complete the 5th wave of the rally from June 2012), which calls for one more leg up to a new high. As long as the December 16th low near 1134 is not broken I'll continue to respect the bullish potential here.
Russell-2000, RUT, Weekly chart
The RUT's daily chart below zooms in on the move up from October. Today's rally stopped at its broken 50-dma, near 1176, so any failure here would leave a bearish back-test and kiss goodbye. A drop back down and below 1153 would be a bearish heads up that all we had today was a dead-cat bounce, which I think is all we'll get but I'm looking for a higher bounce before continuing lower. A rally above 1200 would have me a very nervous bear and above 1217 would be a sure bet for a new high, potentially up to about 1235 in opex week.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1217
- bearish below 1153
The uptrend line from October for SPX was broken yesterday and so far the only thing today's bounce has accomplished is a back-test of the trend line. A selloff from here would leave a bearish kiss goodbye but I'm looking for a higher bounce before selling off. The 20-dma is coming down and looks like it will cross the 50-dma tomorrow near 2043. That's the level I'll be watching to see if a back-test leads to a bearish kiss goodbye there. I'm showing the potential for a larger 5-wave decline into the end of January, getting down to perhaps the 1870 area by the end of the month. That would then set up a large bounce correction in early February before heading lower again. The bullish potential for one more new high, like the RUT, requires the bulls keep this bounce going but so far I think it's a lower probability move.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2072
- bearish below 1992
The bold blue lines on the SPX 60-min chart below are for the rising wedge pattern and the first indication that it might not result in one more new high was yesterday's breakdown. It's fighting to get back above the line, currently near 2025, and I think we'll get another leg up for the bounce, as depicted, but if it stalls around the 2043 area it will be an opportunity to short it for the next leg down. If it rallies strongly above 2045 or only pulls back in a choppy pattern I'll then be more inclined to believe in the "one more high" scenario.
S&P 500, SPX, 60-min chart
The DOW did a better job holding onto its uptrend line from October-December, breaking it yesterday but closing only slightly below it. Today's bounce brought it back up to its broken uptrend line from October 2011 - November 2012 (bold green line) and is only a little shy of its 50-dma, near 17632 today. It should be close to its 20-dma in the next day or two, probably near 17650. A 50% retracement of the decline is at 17683 so that gives us a target zone to watch for the bounce to set up a reversal for a short play. Much higher than 17800 would have me thinking a little more bullishly for the same pattern as discussed for the RUT and SPX.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 18,100
- bearish below 17,262
NDX never achieved a new high in December, above its November high so it's tough to tell if we've got a slightly different wave count. For now I'm calling the December high a truncated finish to its rally, to keep it in synch with the other indexes, in which case the depiction for a 5-wave decline (bold red) is the same as the other indexes as well. But if the lower high in December is a b-wave bounce in what will be a large a-b-c pullback from November then the rally to a new high will come after the pullback completes, possibly down near its 200-dm that's currently nearing 3930, as well as its uptrend line from November 2012 - June 2013. That's just food for thought for now and something I'll contemplate further if and when NDX gets down there and looks to be finding support.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4277
- bearish below 4064
As the stock market sank lower this past week the bond market enjoyed another rally, which drove yields lower. It's now decision time for the bond market, at least for the 30-year bond. As can be seen on its weekly chart below, TYX dropped down to a price projection at 2.476 with yesterday's low at 2.472. This is a price projection for two equal legs down from December 2013 and could be setting up a big bounce back up within its longer-term down-channel. The decline is also testing price-support near 2.5, which is where it dropped to in 2008 and 2012, as well as the bottom of a down-channel for its decline from December 2013. So there are plenty of reasons for a bounce from here (selling in bonds) and stock market bears should remain aware of the potential for rotation out of bonds and back into stocks. But if TYX drops much below 2.47 it's going to add to the bearishness for the stock market. I continue to believe TYX will see 2% before it sees 4%, maybe even before it sees 3%.
30-year Yield, TNX, Weekly chart
The banks are perhaps providing one of the stronger hints that we've had a change in character for this market. Unlike the broader averages, BKX has dropped below its December low. More than half of the 2-1/2-month rally from October was given back in a week and while it's possible we'll get another v-bottom reversal like we saw in October (where's a Fed head and a bullish statement when you need one?), I think the bearish setup into the December 29th high, followed by the very strong decline, tells us something has changed. The 3-drives-to-a-high pattern in November-December, with bearish divergence provided a strong hint of a coming reversal.
KBW Bank index, BKX, Daily chart
On the BKX chart above I added the trend lines that show an expanding triangle, which is an ending pattern that shows how price volatility can increase dramatically at an important high. But, not surprisingly, support at its uptrend line from March 2009 - October 2011, near 69.90, pulled in the buyers (and short covering at support) and now we wait to see if support will hold longer-term. If a bounce is followed by another break lower it's going to be a strong signal that the 2009-2014 bull is finished. The bulls still have a chance here but at the moment I think it's for the bears to lose.
The Energizer Bunny. That's the name we need to give to the U.S. dollar right now. The rally just keeps going regardless of resistance levels that it runs into or target prices achieved. It's hard to see on my weekly chart below, but the dollar has now reached a price projection at 92.46 (with this morning's high at 92.51) where the 5th wave of the rally from May is equal to the 1st through 3rd waves, a common projection for an extended 5th wave. If the 5th wave extends to where it will be 162% of the 1st through 3rd waves it will continue to rally to about 97. There's another projection at that level, which is where the 2nd leg of the rally from May 2011 would be 162% of the 1st leg (for either an a-b-c or 1-2-3 move up). The top of a parallel up-channel for the rally from April 2008 is currently near 93.30 so that's a level of interest if reached. Unfortunately we've got mixed signals between RSI and MACD, as far as divergence, so they're not helping. The dollar is bullish until we get a sizeable breakdown.
U.S. Dollar contract, DX, Weekly chart
Gold gets a relatively small bounce and I get inundated with emails telling me why this is it! This is the time to buy gold before it heads for $5000! As long as so many keep looking to buy the low in gold we should keep looking for new lows. The bounce off the November 7th low has been very choppy and therefore it continues to look like a correction to the longer-term decline. It's once again testing the top of its down-channel from 2011-2012 so a break above yesterday's high at 1223 would be at least short-term bullish, perhaps for a run up to a price projection I have for a larger bounce at 1276 but regardless, I think we're looking at lower prices still to come.
Gold continuous contract, GC, Weekly chart
How low can it go? That's of course the question everyone is asking about oil. As can be seen on its daily chart below, the steepening downtrend lines is an indication of a waterfall decline and not something you want to try to catch. There are a lot of bloody hands out there trying to catch falling knives. The last downside projection I have for oil, once it broke below 49.81, is 43.63-44.42, which are price projections based on the wave pattern. At 43.63 the extended 5th wave of the move down from June would equal the 1st through 3rd waves. At 44.42 the 5th wave of the leg down from November 21st (which is the larger 5th wave down) would equal the 1st wave. Once this leg down from December 22nd completes it should complete the larger 5-wave move down from June and set up a multi-month bounce/consolidation. If we're to get a 4th wave correction in the decline from August 2013 it's not going to be a good environment to trade since the only ones who benefit in a 4th wave correction are the brokers.
Oil continuous contract, CL, Daily chart
Tomorrow's economic reports will not have anything that's market moving but Friday morning will be important as we get the NFP report. About this time traders are getting a little nervous about how the Fed is going to deal with an improving employment picture (which won't last if the energy market starts to deteriorate further) while the stock market declines. Do they talk about QE4 (wait, you'll see, and it won't be far away) or do they start trying to remove their accommodative stance. The Fed is boxed in and it's just a matter of time before the market really gets it.
Economic reports and Summary
The Santa Claus rally is from about mid-December through the first few trading days in January so one could argue it was a bust this year. Maybe a little net rally but certainly nothing like the bulls had expected. And when Santa fails to call at Broad and Wall...plus now we've got a negative start to January (4th worst one in its history and only matched by previously bad years for the market) and that portends a negative January. A negative January says the year will be negative. Fighting all this are bullish tendencies for the market (3rd year in a 2nd term presidential cycle, year ending in '5') so traders can take their pick of signals, especially if January finishes negative, which at the moment I think will happen.
As for me I'd rather stick to the charts rather than Trader's Almanac or any other source of "well, normally the market is bullish/bearish during this period." There is nothing normal about this market and all the false propping by the Fed (much of it only verbal, which Mario Draghi has perfected) has led to enormous economic distortions, which I discussed in the beginning of the wrap about what's going on in the oil field and its huge impact on the economy. I can only derive clues about the coming year from what the EW pattern is telling me and that's hard enough (subject to interpretation). At the moment I'm expecting more downside this month, possibly starting from a slightly higher bounce on Thursday, but after that I'll put the pieces together as they develop and my opinion will be based on the developing pattern.
In the meantime I think it's prudent to trim your stock holdings, establish hard stop levels and trade short-term. If you're bearish and itching to get in on the short side I think we've got a good trading opportunity here. It goes without saying bears should be trading short term and go for base hits -- bear markets are tough to trade, especially when you have central bankers coming out and promising more money in an effort to stop any market decline. Bear market rallies tend to produce the sharpest rallies that then fail in v-top reversals, catching both sides offside.
Good luck in the coming month 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