The bears escaped at the turn of the new year and they've been mauling the bulls non-stop. They seem to be exacting revenge for being held hostage for so long and now the bulls are wondering how to get them back in the cage. Their only hope at this time is that the bears have feasted enough to now rest and digest.
Review of Major Stock Indexes
There's been some real damage done to the charts over the past two weeks and to say the market is now oversold would be an understatement. It's been a horrid start to the new year, unless you're a bear and you were positioned for the big move down, and the selling might not be done yet. But a dead cat bounce is probably not far away and there's nothing like a short-covering rally in a bear market to get the bears screaming as if their fur caught on fire.
As you can see in the table above, several indexes have now entered "correction" territory, defined as a decline of -10% or more. It's important to remember that many stocks have been in their own bear market (using the -20% definition, which of course is a bit arbitrary) for months while the indexes were held up by only a few stocks. The value line geometric index, which weights all stocks the same, is already down -24%. We have been in a stealth bear market for months and only now are we seeing the major indexes "catching down." We've seen poor market internals while the major indexes held up and it was warning us of the coming decline. The only question before the decline was how long it was going to take to arrive, not if it would happen. Now we look for signs for when and where we might find a tradeable bottom, but as of Friday it did not look like a good time to step in and try your hand at catching falling knives, except that some important support levels are now being tested.
The blue chips are testing their September, if not August, lows while the techs are a little stronger in that respect and the small caps weaker. The semiconductors are weaker than the tech indexes and that's another bearish warning since it's a reflection of the fact that the indexes are not yet reflecting the weakness in important stocks. The semiconductor stocks, like the transportation stocks, are good canaries to watch -- when they fall off their perch it means the rest of the group is in trouble. The TRAN has now dropped down to a level not seen since 2013, as has the RUT. Both the transportation stocks and small caps have been hurt by the drastic slowdown in the energy field and that doesn't look like it will get better any time soon. Both reflect a slowdown in the global economy.
A global economic slowdown has significantly reduced the need for oil, coal and natural gas and all the industries which supply this industry. The strong decline in commodity prices since mid-2014 (really since the 2011 high) has been another warning sign that things are not well in the economies and we knew the stock market was ignoring these signs for a long time (I showed several times in the past the widening gap between the commodities index and the stock market). The strong price decline in the stock market the past two weeks now has us wondering if this is a real breakdown or just another scary one like the August decline. I believe the August decline was the shot across the bow of the USS Bullship and the rally back up into the November/December highs was the retest that offered bulls their free get-out-of-jail card. I know most did not take the opportunity offered by the market.
Unfortunately for most investors they've been conditioned to just sit tight because "the market always comes back." Depending on your age that's advice that has generally worked well but it of course depends on when you bought in and when you need to sell. In a secular bear market, which we've been in since 1999, market timing has worked much better than buy and hold. Even if you use just a long-term moving average, such as a 21-month, you would have good timing signals to avoid most of a bear market decline and capture most of a bull market rally, as I'll point out below with the chart.
A Look At the Charts
I'm going to take a top-down look at the DOW Industrials to show where we've been and show a longer-term projection that is my expectation based on the large correction pattern following the 2000 high. I'll start with the monthly chart of the INDU.
Dow Industrials, INDU, Monthly chart
The first thing to note on the DOW's monthly chart below is the expanding triangle, which is obviously the opposite of a contracting triangle and both are continuation patterns. This one follows the strong secular bull market from 1982 into the 2000 high and we've been in a secular bear since then. People look at the new highs in the stock market as a reason why we're not in a secular bear but a review of most economic indicators, including employment data (declining earnings, et.al.) and it's clear we have not broken out of the recession/depression that started in 1999.
For the expanding triangle, as in all triangles, I'm looking for the completion of a 5-wave count, labeled A-B-C-D-E on the chart. Expanding triangles obviously have a lot more price volatility than a contracting triangle and that's exactly what we're seeing. The next, and last, leg of the triangle, which appears to have started, could finish short of the bottom of the triangle (like it did in the smaller-degree expanding triangle 4th wave correction during the 1970s into the 1982 higher low) but I think it's important to see the downside risk. It's not a guaranteed move but there is risk for the DOW to drop below 6000 in the next couple of years.
As I mentioned above, the 21-month moving average for the DOW offers investors a relatively simple way of knowing when to be long and when to be in cash/short. It's like those expensive trading systems offering green up arrows and red down arrows to tell you when to buy and when to sell. There would have been a couple of whipsaws but you can see it would have worked to avoid most of the 2000-2002 and 2008-2009 bear markets and captured the majority of the 2002-2007 and 2009-2015 bull markets. If the DOW closes below the 21-mo. ema this month, currently at 16951, it will be a signal for longer-term investors to get into cash and perhaps a few short positions. Most of us are much more active traders and the signals from this are way too slow but maybe for your retirement account with mutual funds that you don't want to actively manage.
On the monthly chart above I show a rising wedge for the c-wave of the a-b-c move up from 2009, which broke in August (providing an important sell signal). One thing to note is RSI -- it can't be seen on the squished chart but it broke its uptrend line from October 2011 in January 2015, which was the first warning sign of trouble for the bulls. It then bounced back up to the broken uptrend line in February 2015 before falling away (back-test followed by a bearish kiss goodbye) and showed us strong bearish divergence all year before price finally let go. This is an excellent example of how to use a trend line on RSI -- it's one of the better forecasting tools that's simple to use. It's common for RSI to break its uptrend line (and downtrend line in a decline) before price does. And the back-test of the line is usually a good indication price will soon follow the break.
Dow Industrials, INDU, Weekly chart
If I draw a parallel up-channel for the rally leg from October 2011, as opposed to the rising wedge on the monthly chart above, the bottom of the channel is currently near 15530, almost 500 points below Friday's close, and is shown on the weekly chart below. I think that's where the DOW could head in February if we get a bounce into the end of January and then a continuation lower. We could see the DOW stair-step lower to the February 2014 and August 2015 lows at 15340 and 15370, resp., by March (maybe a lot faster) before setting up a stronger bounce into mid-year and then lower into the end of the year. From a pattern perspective I can't yet rule out the possibility for another rally leg (light green dashed line) but at the moment I consider that a lower-odds probability, and this game we play is all about probabilities, not guarantees. At the moment the DOW is finding support at 16K, which has acted as support several times in the past so it's an important level for the bulls to hold.
Dow Industrials, INDU, Weekly chart
A simpler way to look at the DOW's weekly chart is shown below. An uptrend line from October 2011 was broken in August and we had an important back-test into the November 3rd high. The selloff from there was a big "SELL ME!" signal and while the market continued to jerk up and down into January, we saw a succession of lower highs and lower lows before it let go with a bang the past two weeks. That was a classic setup for the bears (always so easy to see in hindsight, no?). The other bearish signal here is the rolling top pattern. The combination of this topping pattern and the trendline break is bad news for bulls. Use rallies to sell into.
Dow Industrials, INDU, Daily chart
The daily chart below shows an idea for what to expect in the next couple of weeks, which assumes we'll see the market stair-step lower into March as it works its way down to the 15340 area. The pattern for this past week's decline, with a hint of bullish divergence, suggests we might see a choppy move lower to a minor new low before bouncing but the bearish risk is that the sharp up and down moves will lead to another strong breakdown, in which case we could see DOW 15340 in a matter of days, not weeks. But if support at 16K holds I see upside risk for bears with at least a strong short-covering rally and therefore shorts should be playing more defense here.
Key Levels for INDU:
-- bullish above 16,900
-- bearish below 16,000
S&P 500, SPX, Daily chart
SPX dropped down to price-level S/R near 1885 on Wednesday, held it for a day with Thursday's rally but then gave up that support and dropped down to the August low at 1867. The August low was broken intraday, hitting a low near 1858, but then closed above 1867 for the weekly close. However, it wasn't able to close above 1885 or back above its broken uptrend line from October 2014, near 1888. This is a trend line that lines up the spikes to the downside in October 2014 and the August/September 2015 lows. It held the line on Wednesday but Friday's break is showing us the current decline could be a lot more significant than the flash crashes back then. I show a little lower and then a bounce/consolidation into early February before it stair-steps lower into March. Below 1867 the next support level is 1820 (the October 2014 low) and then 1738 (the February 2014 low), which is where I think we'll see SPX by March before it sets up a larger bounce correction into mid-year. However, as stated above, there is still the risk for a new rally, or at least a strong short-covering bounce, and therefore a sell-and-hold strategy could be just as dangerous as buy-and-hold.
Key Levels for SPX:
-- bullish above 1963
-- bearish below 1885
S&P 100, OEX, Daily chart
OEX almost made it down to price-level S/R at 825-830 and I suspect that level will be tested in the coming days if we do not get a short-covering rally on Tuesday. I'm looking for that level to hold as support but only for a bounce correction into early February before heading lower into a mid-February low around 800. Another bounce and then lower into March is the way the bearish pattern should play out. If we get a strong rally in the coming week I'll be watching to see if the bottom of its previous down-channel from November, near 880, will be reached. It would be more bullish above that level but until that happens I would look at bounces as shorting opportunities.
Key Levels for OEX:
-- bullish above 880
-- bearish below 825
Nasdaq Composite, COMPQ, Daily chart
The Nasdaq almost made it down to its uptrend line from October 2014 - August 2015, which again are the spike lows. The current selloff could be just another one of those and the market will resume its march higher. For the reasons I showed with the DOW's monthly and weekly charts, I strongly believe the bull has been put out to pasture and we will not see last year's highs for many years (decades?) to come. It doesn't prevent some very strong counter-trend rallies but the bears would be in a stronger position once the uptrend line from October 2014, near 4380, is taken out. I show a drop to that level in the coming days and then a bounce/consolidation before heading lower but obviously we'll know more after Tuesday's price action.
Key Levels for COMPQ:
-- bullish above 4715
-- bearish below 4270
Nasdaq-100, NDX, Daily chart
On Friday NDX dropped below its uptrend line from June 2010 - November 2012, which is the bottom of a parallel up-channel from 2010, currently near 4150. It broke below this uptrend line back in August but it was only an intraday break, which was followed by the strong v-bottom reversal and big white candle seen on its chart below. This time it closed below the line but it did hold above its uptrend line from March 2009 - August 2015, near 4100. If the market drops a little lower on Tuesday I'll be looking for support at its September low, at 4053, to hold and launch a bigger bounce/consolidation into the end of the month. Another drop in February for perhaps a retest of the low would then set the pattern up for a bigger bounce. If the bulls can get NDX back above Wednesday's high near 4360 it would at least be short-term bullish.
Key Levels for NDX:
-- bullish above 4360
-- bearish below 4050
Russell-2000, RUT, Daily chart
On Wednesday the RUT dropped below the bottom of a parallel down-channel for its decline from last June. It was back-tested on Thursday and that was followed by another selloff on Friday, leaving it with a bearish kiss goodbye against support-turned-resistance. But Friday's low was a test of the price projection at 987 for two equal legs down from June and often these measured moves result in strong support. The long tail below Friday's candle body says bears should be careful here and if the RUT can get at least a decent bounce going it's likely to lead the broader market. But if the RUT heads lower on Tuesday keep an eye on the trend line along the lows from February-October 2014, near 967, especially since there's a Fib support level near 971 (not shown on the chart, it's the 127% extension of the previous rally, which was October 2014 - June 2015). It would be much more bearish below 967 whereas the bulls could have a fighting chance back above the bottom of its down-channel, near 1027. It would be more bullish above 1040 and then above Wednesday's high near 1057 would be reason enough to back away from the short side and maybe play the long side for at least a larger bounce.
Key Levels for RUT:
-- bullish above 1057
-- bearish below 967
SPDR S&P 500 Trust, SPY, Daily chart
The SPY chart below shows the increasing volume this past week, spiking into the highest volume for the week on Friday, which raises the question as to whether or not we saw some capitulation selling. The volume is not as heavy as it was in August and price can always continue to push the lower BB lower but it's looking like bears would be better not to press their bets here. It might be early to try to catch falling knives but it's also late to chase it lower. There is the possibility we'll see a sharp v-reversal with strong short covering, even if it's only for a day or two.
Powershares QQQ Trust, QQQ, Daily chart
The QQQ looks like SPY except that it hasn't yet broken its September low and is nowhere close to testing its August low. But the selling might not be over yet so the bears still have a chance. Volume is spiking but it hasn't yet doubled its normally-high reading of 50M shares, which it did in August. But we're seeing some bullish divergence on the Williams %R since January 7th and while it doesn't mean we'll see a rally from here it is hinting of bottoming for at least a bounce correction.
The strong selling over the past two weeks has buried many indicators into deeply oversold and bullish sentiment has quickly reversed into bearish sentiment. All of this warns bears not to press their bets to the downside since anything could spark a short-covering rally and we know how strong those can be. In fact the strongest rallies, albeit short-lived, are found in bear markets. Wannabe bulls jump on a rally and shorts cover -- all that buying can create 500-point rallies for the DOW before lunch time. But one thing to keep in mind is that a strong short-covering rally, especially on dying volume, is the kind of rally you want to sell into rather than pile into long.
The bearish pattern calls for the market to stair-step lower into March but that means we'll see intervening bounces and the first one should be arriving within days if it doesn't start on Tuesday. I'm expecting a 2-week bounce/consolidation before heading lower into mid-February but that's if we don't crash lower in the coming days. Crashes come out of oversold and we certainly have that condition right now. If enough investors panic after seeing how much their accounts are down this month we could see a low-liquidity event where lots of sell orders are met with no buy orders. I don't see that as a high-probability event but it's certainly a risk if Tuesday's selling becomes strong. Otherwise the market is looking like it's setting up at least a bounce correction and counter-trend trades on the long side could work nicely. Just keep them short-term oriented (day trades) and on a short leash (tight stops).
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