The strong selloff into Wednesday's low followed by an equally strong reversal back up into Friday gave us another v-bottom reversal off some important support levels. Strong follow through to the upside in the coming week, vs. a consolidation pattern, will be important for the bullish pattern. The jury is still out as to whether or not this week's low will be an important one.
Review of Major Stock Indexes
By early this past week there were several measures that showed the market was more oversold than any time since the 2008/2009 lows. The rubber band had been pulled back hard and now the rally off Wednesday's low has many thinking the correction to the rally is complete and we're now ready for the next leg up to new highs this year. As I'll review in the charts, there is bullish potential for the start of another rally but I think the higher-odds scenario calls for lower prices as the market works its way lower over the next few months before setting up a larger bounce correction. We'll have some price levels to watch to help guide our trading.
Helping the stock market was a strong bounce in oil, which also found a bottom on Wednesday. Cheap oil is great for those of us who buy gasoline for our cars, heating oil and other energy-related products. But weak oil prices are playing havoc with the earnings and finances of most energy-related companies. Because of the abnormally low interest rates over the years we had an abnormally large amount of debt taken on by oil drillers, especially the frackers. Now with lower earnings we're finding many drillers heading for bankruptcy, which means loans are going unpaid. That of course negatively affects those banks who were heavy lenders. It also negatively affects the bonds created out of packaged loans (as was done with subprime mortgage loans) and the decline in the junk bond index, such as HYG, especially the steep decline since April 2015, has been warning us for a long time that not all is well.
The borrowing problem is much worse than just the oil industry. Many corporations also borrowed heavily over the years to use it for non-productive purposes, such as stock buybacks and M&A activity. Instead of investing money in productive uses, such as capital equipment, most companies preferred to buy back stocks to help improve "earnings." The problem is this has been hiding the fact that the companies have actually been producing lower earnings while earnings per share increased.
Many analysts used the improved P/E ratios, as a result of these financial machinations, as justification for the higher stock prices, completely ignoring how and why those P/E ratios were improving (or at least not declining). But with declining earnings we're finding companies faced with less money to service their significantly larger loans so the result is going to be a double whammy from declining earnings and higher debt. The enormous amount of debt that has been accumulated far surpasses what we had in 2007 and the result is a far more leveraged financial market, which makes it much more vulnerable to a downside disconnect. The sharp decline last August might have been the shot across the bow and January's decline could very well be a small taste of what's to come.
But with oil's recovery this week, +23.5% off Wednesday's low at 26.19 to Friday's high at 32.35, it has many believing the worst is behind us and it was a reason for strong short covering. Short covering in a bear market can produce more powerful rallies than you'll see during bull markets. But they also tend to fail with v-reversals as the buying can quickly stop. If oil can get above 33.50, to climb back above strong support-turned-resistance, it would likely help lift the broader stock market and therefore it will be important to watch oil in the coming week.
As of the end of the past week we do not yet know if the market is at the start of a strong reversal that will take us to new highs. If we follow the multiple instances of strong v-bottom reversals that we've seen since 2009 then we're headed for new highs. But if the market topped out then January is merely the start of what will become a much more significant decline. We can't know for sure which scenario will play out and therefore simply need to let price lead the way, using some price levels and the price pattern to help identify the higher-odds scenario as early as possible so that we can get in on the move or at least avoid being on the wrong side. For this coming week I think it's important to stay more cautious than aggressive to either side.
A Look At the Charts
Because of the big moves in the stock market indexes this month (actually since last August), I think it's important to keep the big picture in mind. With that in mind I'll start this weekend's review of the indexes with a look at the Wilshire 5000 index (the granddaddy of the indexes) and a top-down view, starting with the monthly chart. As I've stated more forcefully in the past month, I think the market has topped and we've now started the next cyclical bear that should complete the secular bear.
Last week I showed a monthly chart of the DOW to point out the large expanding triangle and explained why I think a 3-wave move up from 2009 did a nice job completing the rally and now we're looking for a big decline back to the bottom of the triangle (so below the 2009 low). But I think it's also important to consider a more bullish option (at least for this year) and then test the price pattern along the way to see if it continues to be supported or gets negated. I'll use the W5000 index to highlight the bullish possibility and what to watch for as the price pattern develops further.
Wilshire 5000 index, W5000, Monthly chart
The monthly chart of the W5000 shows parallel up-channels based off the trend line along the highs from 2010 through 2014, with the parallel lines attached to the 2009 low (green) and 2011 low (blue). Using up- (or down-) channels like this are an excellent way to see when a trend has broken. You can see how often the bottom of the channel from 2009 (green) was tested during the multi-year rally -- it was broken only once in October 2011 but there were no monthly closes below that line. If January closes below 20300 (about 700 points above Friday's high), which is the current location of this line, it will be the first monthly close below the line. The blue line, attached to the October 2011 low, was also broken this month and the bounce off Wednesday's low is currently back up to the line, near 19600 (Friday's high was 19605).
The up-channel(s) could be important because it could be pointing to another rally leg this year that will take the indexes to new highs. If the pullback from last May is a correction to the bull market rally (green 4th wave correction) then we're due a 5th wave to new highs (green arrow). That would mean a rally leg could get started from here and it's a good enough reason to not get married to a short position. The bearish interpretation says the 3-wave move up from 2009 into the May 2015 high was the completion of an A-B-C rally that will now be followed by the next bear market decline (red arrow). And the bearish interpretation makes the downside risk MUCH greater than the upside potential.
Wilshire 5000 index, W5000, Weekly chart
By studying the weekly chart of the W5000 below, shown below, you can see how well price traded technically. Following the high last May price broke down in August and dropped below an uptrend line from October 2011 - October 2014. That uptrend line then became resistance when it was back-tested in November, along with price-level support/resistance near 22200. The bearish kiss goodbye from there led to the strong decline into this month, which has broken through the bottoms of the up-channels described above.
Wednesday's low at 18550 came very close to tagging its uptrend line from March 2009 - October 2011 (bold green line), currently near 18475, and the rally into Friday's high brought price back up to the bottom of its broken up-channel from the 2011 low (blue line), which is also its previous low at 19619 on September 29th.
From a bearish perspective this week's bounce is just a back-test of resistance that will be followed by a continuation lower, possibly after a week of consolidation between this past week's high and low and into the end of the month. The bullish interpretation is the bounce off the longer-term uptrend line from March 2009 - October 2011 with bullish hammer candlestick at support. You can see a bullish hammer at the October 2014 low and how it led to another rally to new highs. The bulls are clearly hoping for a repeat performance. A strong rally next week would be reason enough to think more bullishly for at least the next couple of months.
Wilshire 5000 index, W5000, Daily chart
From an EW perspective the bears have a lot more work to do before we'll see a tradeable bottom for something more than just a week or two. Starting from the May high we have a series of 1st and 2nd waves to the downside, which is what set us up for the strong decline off the December 29th high. That means we need to see the index stair-step lower to complete the wave count, which is why I'm showing a projection down to 16547 by June in the chart above (a typical wave pattern and down to the 38% retracement of the 2009-2015 rally). As depicted on the daily chart below, this stair-step pattern could mean a lot of whippy price action over the coming months. Strong short-covering rallies could be followed by steep declines and then back up again. You'll need to be a short-term trader in this scenario. The bulls need to see a rally above the December 14th low, labeled wave-i on the chart, at 20603 in order to negate the bearish wave count, in which case I'd turn bullish for a move back up to at least the downtrend line from July-October, near 21700.
Key Levels for W5000:
-- bullish above 20,603
-- bearish below 18,300
S&P 500, SPX, Daily chart
The pattern for SPX is the same as the W5000 (as is true for the other indexes as well, except the RUT). There were several layers of support that was broken this past week, starting with an uptrend line from August-September near 1888 and price-level S/R levels near 1885, 1867 and 1820. But those levels were recovered with the rally off Wednesday's low, leaving only an intraweek break of support. We could see price chop up and down in this area before finishing with a higher bounce but in reality it's next to impossible to reliably guess where price is going in the coming week. The bearish wave count calls for a 4th wave correction and those are very difficult to figure out in real time. Only with more price will the pattern clear up enough to then make a projection for the next move. Compounding the difficulty is the question about whether or not we're going to see the start of the next rally (above 1950 would better support that idea) or instead a continuation lower (below 1820 would be more bearish). There are some timing models that suggest February 1 will be a high for a bounce before heading lower again.
Key Levels for SPX:
-- bullish above 1950
-- bearish below 1820
S&P 500, SPX, 60-min chart
Thursday's rally stopped at the downtrend line from December 29th and Friday's rally was a break above the line, confirming the leg down from December 29th completed on Wednesday. So far the rally off Wednesday's low appears more corrective than impulsive and that supports the idea that we will get only a bounce correction to the decline and it will be followed by another drop lower. But it doesn't prevent the bounce from getting higher, such as up to the 50% retracement of the decline from December 29th, near 1947, and the bottom of a previous down-channel from November, near 1950. This is why I think it would be more bullish above 1950 but until then I would not get complacent about the long side.
S&P 100, OEX, Daily chart
As with many other indexes, OEX dropped down to its August 2015 low (809.57) on Wednesday with a low at 809.96, which was another intraday break below price-level S/R at 825-830. But like in August, support held on a weekly closing basis. The bearish wave pattern says that support level will eventually break for good but it might not be easy for the bears to achieve. The bulls would look stronger above 880.
Key Levels for OEX:
-- bullish above 880
-- bearish below 825
Dow Industrials, INDU, Daily chart
Last week the Dow broke below price-level support at 16K (August and September lows) and 15666 (August closing low) and almost made it down to its February 2014 and August 2015 lows at 15340 and 15370, resp. The rebound off Wednesday's low had the Dow recovering back above those support levels and like the other indexes, it left a bullish hammer on its weekly chart. If the 3-wave move sideways since May is a bullish consolidation we could see a rally back up to the downtrend line from May-November, near 17750, before dropping back down in a continuing sideways consolidation. But that's a lower probability pattern and for now I'm looking for a consolidation through the coming week before heading lower again, which should result in at least a test of support at 15340-15370 before consolidating again.
Key Levels for INDU:
-- bullish above 16,900
-- bearish below 15,300
Nasdaq Composite, COMPQ, Daily chart
The Nasdaq dropped below its uptrend line from October 2014 - August 2015 and almost made it down to its August low at 4292 (Wednesday's low was 4313) before rallying back up and closing well above support by Friday. It's no different from the other indexes -- it could continue rallying but if we get something like depicted in bold red (a 3-wave bounce up to the 20-dma by the end of this coming week) I think it would be a good setup to get short. Watch for potential chop and whipsaw in the meantime.
Key Levels for COMPQ:
-- bullish above 4872
-- bearish below 4270
Nasdaq-100, NDX, Daily chart
NDX was relatively stronger than the Nasdaq in that it made only an intraday break of its September low on Wednesday and then recovered. On Monday and Tuesday it had been trying to hold its uptrend lines from June 2010 - November 2012 and March 2009 - August 2015, currently near 4160 and 4120, resp. (log price scale). These values are using the log price scale, shown on the chart below. Using the arithmetic scale, the uptrend line from March 2009 - August 2015 is currently near 3970, about 23 points below Wednesday's low. A 3-wave bounce up to its 20-dma, perhaps near 4325 by Friday, would be a good setup for a short play but as with the other indexes, keep the bullish potential in mind as we wait for further price action to provide more clues.
Key Levels for NDX:
-- bullish above 4478
-- bearish below 4050
Russell-2000, RUT, Daily chart
On Wednesday, January 13th, the RUT broke support at roughly 1030-1040, which included price-level S/R at 1040 (October 2014 low), the bottom of a parallel down-channel from June's high and its uptrend line from March 2009 - October 2011, the latter being an important break by the bears. In my mind this was a very important support zone that the bulls needed to defend. The next day, January 14th, it was only able to back-test broken support with a high at 1033.57 before dropping lower. Of all the indexes I think it's the RUT that deserves the most attention right now. If the bulls can get the RUT back above 1040 I would at least be more neutral the market and watch to see if it can continue to rally in a sharp impulsive pattern. If it did that I would then look for pullbacks as a buying opportunity. But if the RUT continues to chop around in the coming week and stalls in the 1030-1040 area I'll be looking to short it. The RUT is likely to lead the way from here and following it like a lost puppy could make it easier to stay on the right side of the market from here.
Key Levels for RUT:
-- bullish above 1109
-- bearish below 967
SPDR S&P 500 Trust, SPY, Daily chart
The SPY chart below shows a bullish reversal from the penetration below the lower BB, similar to what was seen off the August low. It was another good example of why you can't be looking to get long just because price pokes below the bottom of the band -- it can continue to press lower and trying to find a bottom is like catching falling knives. The volume spike on Friday, January 15th was followed by a further price drop into Wednesday's low but on a lower spike in volume, which set up a bullish divergence. But there is one message from MFI here -- notice the difference in behavior at the current low vs. the v-reversal back in August and even in November and December. At the moment it's a reason for caution while we wait to see if price can make it back up to the midline, which is the 20-dma and currently at 196.33 but coming down fast.
Powershares QQQ Trust, QQQ, Daily chart
We have a similar picture for the QQQ as for SPY -- the reversal up from the lower BB makes it probable we'll see a bounce at least back up to the midline of the BB, at 106.81 but coming down. The volume spike on Friday, January 15th, was followed by a lower price low on Wednesday but on slightly lower volume. Williams %R also showed bullish divergence following its low on January 7th and this was telling traders not to press their bets to the downside. Now we watch to see if the 20-dma holds as resistance if it's tested in the coming days.
While there are some minor differences between the indexes, the price patterns since the November highs are remarkably similar. There is a way to consider the setup into Wednesday's lows as bullish, for at least a return trip back to the December highs, but I believe it's a lower probability scenario. It would become a higher probability if prices can above the December lows, which I marked as key bullish levels on my charts. The higher-probability pattern calls for a continuation lower but probably not until after another week of consolidation or a higher bounce. Watch the 20-dmas, if reached, for shorting opportunities (turn more neutral above the 20-dmas).
The RUT has been a good canary index and I think it deserves special attention in the coming week. Stay bearish below 1040, neutral above, and then cautiously bullish above its September low near 1079 and more bullish above its December 14th low near 1109.
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