Week's Indexes

Review of Major Stock Indexes

The first week of January 2016 has been the worst start to a new year for bulls in the history of the stock market. At least that's what's in the headlines and that alone is going to freak out more than a few investors, many of whom have already been complaining about a year in which they didn't make anything and yet still had to pay management fees. There is also the January barometer making news (as goes January, so goes the year) and with the fact that the first week of January is a good tell for how the rest of the month will go, there are understandably some very nervous investors this weekend. The last thing the market needs is investors pulling out of the market out of fear we could be facing another financial crisis.

The Stock Trader's Almanac provides some statistics for the January barometer and it's actually quite impressive. Since 1950 (65 years) January has predicted how the year would finish with 87.7% accuracy. Furthermore, the first week of January predicted how January would close with 85.4% accuracy. Those are pretty good odds that now tell us 2016 is likely to be one for the bears. I wouldn't mortgage the house (maybe sell it though, wink) and short the market on that information but it does provide a piece to the puzzle about what the probabilities are for the coming year. And the STA further states that every time the month of January finished negative, without exception since 1950, it has been followed by a new or extended bear market, a flat market, or at least a 10% correction.

The table above provides a good summary for what happened to the various indexes last week. I circled two of interest -- the Nasdaq lost in one week what it took all of 2015 to gain and then lost an additional -1.6% on top of that. The biotechs, which have been on fire for the past 3 years, got hosed last week (that's a technical term by the way, which refers to a mauling by the bears). The +10.9% gain in 2015 was nearly given back with last week's loss of -9.9%. On a closing basis last week's loss for SPX (122 points) was the same as the week of August 17-21 (121 points) and that week in August was followed by another 104 points down the next two days (Monday and Tuesday) into the August 25th low before a strong v-bottom reversal. It remains to be seen whether or not the same kind of pattern will play out in the coming week but that's the kind of risk we still face. However, there are reasons to be cautious about the downside, as I'll review on the charts.

From the December high at 2114 SPX is now down -9.1%, which is a little shy of a -10% "correction" and this follows the -10% correction in August, which in hindsight could look like the shot across the bow of the USS Bullship that bulls that should have paid more attention to. While SPX is working on a -10% correction most S&P 500 stocks are already down more than -20%, putting them officially into a bear market. I haven't seen numbers after Friday's close but as of Thursday's close there were 444 of the 500 stocks hitting new 52-week lows. We've been in a stealth bear market but most traders have been unaware of it. This past week's drubbing has opened the eyes of more than a few traders and if you don't like playing the short side you should be thinking strongly about how to protect your long positions. Cash is a good position when you're not sure what the market is going to do and there's a real risk of a larger correction.

At the moment we have a price pattern that is similar to what happened in January 2008, which of course was the "year of recognition" that not all was as rosy as the Fed and economic analysts would have liked us to believe. The first week was down hard and then there was a 4-day pause in the selling that was then followed by another 5 days of strong selling before finding a tradeable bottom (January 22nd). We rarely see the market repeat exactly the same pattern but there is a rhythm to it (it's mimicking trader sentiment which tends to react the same way) and that gives us similar patterns to watch for. We have opex week coming up and it's typically bullish so we'll see if that can at least provide some relief to the selling pressure we've seen in the past week.

I have a few more charts than I'll typically show for a review of the indexes but I think it's an important weekend to take a little more time to review what we have and what it could mean for the weeks/months to come. I'll drill down from a weekly chart of SPX to intraday charts to show why we should be looking for a bounce in the coming days, and why it will be more bearish if we don't get the bounce (stating the obvious here).

A Look At the Charts

S&P 500, SPX, Weekly chart

I'll show different expectations for the coming days on the various indexes below but I want to first show some downside potential if we don't get a bounce in the coming week. There is an uptrend line from October 2014 - August 2015 that's currently near price-level S/R near 1885 and I think that makes a good downside target and support for at least a bounce before continuing lower. The bearish wave count suggests we'll see the decline stair-step lower into February/March before a larger bounce/consolidation into June. As projected on the chart, we could see the October 2014 low tested by early-mid-February. Bears are not potentially in trouble until SPX gets back above price-level S/R near 1985 and while we could see some sharp relief rallies we have to remember that those will likely reverse right back down if we're in the beginning of a new bear market leg down.

S&P 500, SPX, Daily chart

The daily chart shows how a stair-step pattern lower might look. I think we'll see at least a small bounce in the coming days but then a turn back down to the 1885 area. That bounce might come after a flush on Monday/Tuesday. Assuming we'll get at least a small bounce and then lower, as depicted (bold red line), the pattern calls for a larger bounce/consolidation into early February and then down to the October 2014 low at 1820 before the end of February. If we get a stronger bounce in the coming week, while it could be bullish, especially if it gets above 2021, I think it would actually set up an even more bearish wave pattern. That will have to be evaluated if and when it happens. For now stay bearish below 1971, neutral-to-bullish above that level and then more bullish above 2021. It would turn much more bearish below 1885 (think flash crash).

Key Levels for SPX:
-- bullish above 1971
-- bearish below 1885

S&P 500, SPX, 60-min chart

Now we start drilling down into the intraday charts for clues for the next few days. The current decline could drop to a price projection near 1902 (where the leg down from December 29th would be 162% of the December 2-14 decline) before starting a bounce correction but the point I want to make here is that the decline from December 29th would look best with at least a small correction (4th wave) before dropping lower, with a downside target at either the 1885 level shown above or the August low at 1867. Just keep in mind that the market is oversold (it can always get more oversold) and showing some bullish divergence on the oscillators (waning selling momentum), which suggests shorts need to be very careful chasing this market lower.

S&P 500, SPX, 15-min chart

For these weekend reviews I will rarely get into the intraday charts, especially one as short-term as the 15-min chart below. But because of the big move I think it's important to review what to look for on Monday, which could set the tone for the week. Notice the descending wedge pattern for this past week's decline, with the bullish divergence often seen for this bullish reversal pattern. Friday finished with a small poke below the bottom of the wedge, which is a common way for these patterns to finish (throw-under or a throw-over in a rising wedge) with a small capitulation to finish the move. This one chart suggests Monday will be an up day and we could see a high bounce (think short covering spike) that quickly retraces the decline from last Tuesday (the start of the descending wedge. That would be a 100-point rally in the coming days, which obviously is not something you want to be fighting if you're looking to be short. If anything, this chart told me on Friday to fade the selling and get long. The flip side is that if Monday breaks down it will likely break down hard (failed patterns tend to fail hard). Hence I did not get long late Friday and actually preferred the comfort of being flat over the weekend. :-)

S&P 100, OEX, Daily chart

OEX shows a double breakdown -- on Thursday it dropped below the bottom of a parallel down-channel from November and it broke its uptrend line from August-September. The bulls need OEX back above 885 to at least have a chance at getting a new rally going. We might see support here or slightly lower near 852 where the 3rd wave in the move down from December 2nd would be 162% of the 1st wave. I show a bounce/consolidation into the end of the month before heading lower into mid-February to complete the larger-degree 3rd wave in the move down from November.

Key Levels for OEX:
-- bullish above 885
-- bearish below 850

Dow Industrials, INDU, Daily chart

The DOW's pattern is the same as OEX above. We have a good setup for a bounce/consolidation into the end of the month and then lower into mid-February and then a larger bounce/consolidation before heading lower again in March. Bulls need to get the DOW back above price-level S/R near 16900 to at least give them a fighting chance at something more bullish and it would turn much more bullish above last Tuesday's high at 17195. If we don't get a bounce on Monday I'd look for the next support level near 16K.

Key Levels for INDU:
-- bullish above 17,195
-- bearish below 16,515

Nasdaq Composite, COMPQ, Daily chart

The Nasdaq has a price projection at 4623 for the 2nd leg of its decline from December 2nd, where it would be 162% of the 1st leg down. Friday's low near 4638 might have been close enough and when this leg down from December 29th completes we'll then have either a bullish a-b-c pullback that will lead to the start of a new rally (I have my doubts about that but it remains possible) or a bearish 1-2-3 that will lead to only a bounce/consolidation for the 4th wave before heading lower to complete a 5-wave move down from December. The form of the coming bounce/rally will tell us which way to lean in the coming weeks. If the market drops lower on Monday watch to see if the Naz finds support at its uptrend line from April-October 2014, near 4535.

Key Levels for COMPQ:
-- bullish above 4811
-- bearish below 4570

Nasdaq-100, NDX, Daily chart

NDX is a little weaker than the Nasdaq in that it has dropped below the 162% projection, at 4279, for the 3rd wave down. But it's close enough and we could see an immediate bounce off support on Monday. The same April-October uptrend line referred to for the Naz above is not shown on the NDX chart since it's already been broken (with last Monday's gap down). If the bulls can drive NDX back above 4475, which was the bottom of its trading range in November-December, they could at least turn the chart neutral. But at the moment the chart is more bearish than bullish and playing the long side should be considered counter-trend with the usual precautions (short-term trading, tighter stops, careful risk management, don't spit into the wind, don't eat yellow snow, etc.).

Key Levels for NDX:
-- bullish above 4475
-- bearish below 4279

Russell-2000, RUT, Daily chart

The RUT has been warning us for a long time (along with other important indexes like the TRAN and commodities) that not all was well with the market, regardless of how well the big indexes were being held up (by just a few large stocks, such as the FANG group). On Thursday the RUT held support near 1065 (two equal legs down from December 2nd and at the bottom of its down-channel) but then it broke support on Friday. I show an expectation for support at 1040 (the October 2014 low) to hold but only a small bounce/consolidation in the coming days before heading lower to the projection at 1005 where the 3rd wave of the move down from December would equal 162% of the 1st wave. A recovery back above 1065 would at least neutralize Friday's bearish move and then above 1080 would be a little more bullish. But a high bounce could actually set up an even more bearish price pattern so it will require caution about getting long. No complacency allowed for either side. The pattern for price action this coming week should provide the clues we'll need to help determine what it will look like into the end of the month and into February.

Key Levels for RUT:
-- bullish above 1080
-- more bearish below 1040

SPDR S&P 500 Trust, SPY, Daily chart

Looking at the ETFs for volume information, the SPY chart shows a setup that has resulted in good tradeable bottoms in the past. One caveat here -- in a bear market the usual buy setups run the risk of being false setups. Many traders today have not traded a bear market and it's important to realize that all the buy setups we've had since 2009 will not work in a bear market, which I believe we've entered. So be careful here. But we do have a buy setup with the volume spike on Thursday and Friday, price below the lower BB and the MFI down near 30. As shown with the vertical blue lines, these conditions have led to at least a nice rally that made money for those brave enough to fade the selling. But as you can see what happened in August, oversold can get more oversold and another 10 points lower on SPY would be a lot of pain for someone buying here and not stopping out.

Powershares QQQ Trust, QQQ, Daily chart

Similar to SPY, we have a reversal setup if it works out the same as in the past. Williams %R is buried below -90 while volume has spiked above the 50M mark and price is pressing below the lower BB, all of which suggests shorts should be playing defense and longs could work very nicely for at least a large bounce back up. But again, in a bear market oversold can get a lot more oversold and in a market that is susceptible to flash crashes I would be very cautious about trying to catch falling knives.

ISEE Index, January 2015 - January 2016

Another reason for caution is trader sentiment. The ISEE chart below is updated every day (including intraday readings) that you can find at ISEE Index and it's a bit different from the standard put/call ratio in that it looks at long-only puts and calls. This tends to be a better reflection of sentiment since it discards the short options that are often part of income strategies. It also discards trades from large firms and market makers because, again, those trades are usually hedges and/or simply taking the other side of a customer's trade. You can read more about the indicator at the link provided above and receive daily updates if you'd like.

Naturally I watch for extremes in sentiment to show me when the boat is about ready to tip over from too many running over to one side. Our job is to high side this when it happens.

The ISEE has hit 50 (twice as many puts as calls) and as you can see on the chart below, that's a warning sign that the boat is about to tip. This in combination with the reversal setup shown on the SPY and QQQ charts was enough reason for me to dump my short positions and wait for Monday to see whether or not the market is going to crash or reverse. If we follow the August pattern we could see another 100 points lower for SPX before the reversal so I did not want to be long over the weekend. But with the number of things lining up for a reversal I felt it was too risky to stay short. Flat was the perfect position (for me) and now we'll see if opex week can hold to its bullish reputation for at least a choppy bounce/consolidation before heading lower.

Trade safe, have a good week and good luck with your trading. I'll be back with you next weekend.

Keene H. Little, CMT

Technicians look ahead. Fundamentalists look backward. The true language of the market is technical. - Joe Granville