Market Stats

The techs have been the strongest index in the bounce off the March low and recaptured the January high back in May. The S&P 500 and small caps (RUT) followed in June and now the DOW has achieved the same in July. The DOW's January high was 9088 and today's high was 9096; 8 points to spare. Now the big question of course is whether there's more where that came from or if that was the last hurrah. I'm thinking there might be a little bit more to the rally but the rally has clearly gone too far too fast and that raises the risk level for the bulls now. We'll have to see how the market deals with the disappointing earnings that came in after the bell.

The break above the June 11th highs has many feeling bullish about the breakout. Not only have the major indexes now broken above their January highs but they also negated the H&S top that everyone with a charting program saw unfolding and then negated. A negated pattern often moves quickly in the opposite direction and the more recognizable the pattern the more people are trying to play it. The reversal from a pattern that fails can be swift and fast. The rally from the July 8th low certainly fits that category.

So the combination of technical factors on the charts is leading many to believe we'll get another strong rally from here and they could certainly be correct. We all know the market moves more on emotion than logic. Therefore the upside from here must be respected no matter how illogical it may seem. The rally from July 8th looks like it should be finishing soon both from a wave count perspective as well as thinking about a move that has stretched the rubber band to the upside.

While I recognize the ability of the market to thwart all efforts to figure it out, both technically as well as fundamentally, I will of course do my best to figure out where it could turn and based on that where we can trade. As most of you know I am bearish the market because of the longer term factors and wave pattern. We're only in the 2nd or 3rd inning of a 9-inning game called credit contraction and we unfortunately have a lot of unwinding to do. The economy is still not well and "less bad" is far different than "improving". The economy is not improving and the strong rally off the March low has been built on more hope than anything else. And I think it's gotten away from even the bulls.

Today's rally pushed the number of NYSE stocks that are above their 200-dma to more than 80%, a level that has not been achieved since 2007. And it did this in one fast spike up off the March 2008 low. This is begging for at least a pullback as the rubber band has stretched to the snapping point.

NYSE stocks above 200-dma, Weekly chart

The chart of the NYSE is at the top and price hasn't even retraced 38% of its decline and yet the number of stocks above their respective 200-dma has now exceeded 80%. This is a classic overbought indicator. When we look at the same chart of the stocks over their 50-dma it's naturally more volatile with the faster moving average. I've drawn in vertical dotted lines to show previous peaks in the percentage of stocks above their 50-dma and you can see the corresponding peaks in the NYSE (or in the case of September 2008 when price was about to let go to the downside).

NYSE stocks above 50-dma, Weekly chart

The last peak in this indicator was about 96% in May and with today's rally the reading is almost 76%. The significance of this is that not only is the reading at the level of previous turns in the market but also that the reading is lower today than in May. We have higher prices with fewer stocks participating. This is a very good example of lack of market breadth when I keep harping about the waning momentum and lack of market breadth in support of higher index prices. Underneath the hood the market is not as healthy as it looks to the outside world.

Let's take a look at a stock that's considered one of the best bellwether stocks as it's a good representation of the industrial as well as financial economy. In the chart below the dotted line is the S&P 500 while the solid black line is General Electric (GE). As you can see, GE has been underperforming the SPX.

General Electric (GE) vs. SPX, Daily chart

GE was actually holding up a little better than SPX during the decline in the latter part of 2008 but then caught up to the downside into the March 2009 low. It ran neck and neck with SPX during the rally into May but then things changed. GE is not looking so hot from there and has significantly underperformed the SPX. Should we be listening to GE or is it just yesterday's stock? To those who say GE has become more of a financial company instead of an industrial company I say "and your point is?" If a financial company is lagging the major indices should we be listening? In my mind we have a total disconnect between what the major indices are doing and what the "real economy" is doing. That disconnect won't last much longer and I highly doubt it will be the economy that recognizes the stock market is correct.

The last time our country faced a serious credit contraction was the 1930s and the lead up to that period (in credit expansion) pales by comparison to what we've recently been through. The correction should make the 1930s also pale by comparison. People are tired of hearing comparisons to the last Great Depression but I think it's likely we're headed for a Greater Depression and it at least behooves us to pay attention to the possibility. It didn't happen overnight in the 1930s and it won't happen overnight this time. These things are often recognized in hindsight but the stock market tends to get a whiff of the problem sooner (after another one of its hope-filled bear market rallies--just look at Japan's numerous rallies followed by new lows).

One comparison between then and now is to look at capacity utilization. At 68% we're already well below the levels reached in previous recessions. The Fed has been keeping records since 1967 and the previous low was 70.9% in December 1982 and there's little indication that it's improving. Industrial production on a worldwide basis (we're a worldwide economy now) has slowed to levels not seen in past recessions. Two economists, Barry Eichengreen and Kevin O'Rourke, put together a chart showing the slowdown in production from June 1929 measured in months from that date. They then plotted industrial production from April 2008 and put it on top. It's scary how close we're following the pattern after about 15 months into it.

World Industrial Output, comparison between Great Depression and Now

World trade, a well recognized factor in the Great Depression as protectionism reduced trade, is also on a tear to the downside. World trade is slowing faster than it did in the 1930s. So unfortunately we seem to be following the same economic patterns as the last credit contraction only this one will probably be worse. Bear market rallies are to be traded but not believed. In other words if you can catch a quick ride back up to the top of the hill, great. Just be sure to get off before it slides back down and crashes at the bottom. As Eichengreen and O'Rourke concluded, "To summarize: The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the U.S. leads one to overlook how alarming the current situation is even in comparison with 1929-30."

So if you're wondering why I'm a stubborn bear look no further than the data. Forget about what you hear on CNBC or even read in any of the well respected financial magazines and papers. They're filled with hopeful human beings who want to believe Goldman Sach's economist when he says the worst is behind us (not that GS has any hidden agendas). Many are coming out with rosy outlooks for the rest of the year and this is another sentiment indicator--it's very common to get upgraded economic forecasts at the top of a stock market rally and dismal forecasts at the bottom of a stock market decline. There's a reason economists are almost universally wrong at the turns.

The problem we have now is figuring out when the euphoric expectations for the economy, reflected in buying in the stock market, meets reality that shows the economy continues to worsen. Then the selling will start and it could drop strongly. That's what I'm trying to figure out. The weekly chart of SPX shows additional upside potential to the 1000-1050 area where there are some Fib projections, the 38% retracement of the 2007-2009 decline and the broken uptrend line from 1990-2002. Whether it can shoot straight up from here or after a pullback (shown in pink) it remains a possibility into August. The other possibility, shown in dark red, is for a stronger decline to start at any time. Whether it will be part of a larger sideways consolidation, as depicted in dark red, or lead to new lows (dashed red), it's too early to tell.

S&P 500, SPX, Weekly chart

The daily chart is getting a bit messy but I'm trying to show some trend lines that could be important. I've drawn a parallel up-channel off the March and July lows and attached a parallel to the May high. The centerline of this channel is the blue dotted line and you can see how price remained in the upper half from March to June and is currently in the lower half since June (poking marginally above it today). I've often found price will bounce back up to the mid line of an up-channel and then drop below the bottom of it. Slightly higher, near 989, is a trend line along the highs since May. Whether that will be resistance, if tagged, can't be known but it's a level where the rally could stop.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 944
- bearish below 900

Using that trend line along the highs since May I can see the possibility it will be the top of a rising wedge pattern. A pullback into early August followed by another rally leg (pink) up to the Fib level near 1010 in August is a good possibility. A break below 900 is needed to tell us a more important high is in place.

The leg up from July 8th is shown on the 60-min chart and I've drawn a parallel up-channel for it. Notice the same thing is occurring as I described for the daily chart--the initial part of the rally stayed in the upper half and now it's in the lower half (with a little poke above it today). I show the possibility for a small pullback on Friday and then a final push higher to the trend line along the highs since May, near 990 by the end of the day. A break below 952 would be a heads up that the leg up from July 8th has finished and that in turn could indicate that we're going to see a deeper pullback as shown on the daily chart.

S&P 500, SPX, 60-min chart

Using the same trend line along the highs from May for the DOW shows it's currently near 9275 so that would be the upside potential by that trend line. There are a few possible wave counts for the March-July rally and I'm showing one that fits particularly well (a double zigzag so two a-b-c's with an x-wave in between). A Fib projection for the completion of the 2nd a-b-c move up from late May is at 9150 and today's high was 9096 and therefore has another 54-point potential if the bulls can limit Friday to just a pullback before pressing it higher again. Right now the January 2009 high of 9088 is acting as resistance with the DOW unable to close above it.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 8700
- bearish below 8400

Nasdaq-100, NDX, Daily chart

NDX punched above the top of a rising wedge pattern as I had it drawn (from the January high across the May high). Whether that ends up being just a throw-over finish will be determined on Friday. If the cash market follows the futures down, as they are this evening, we could be left with one heck of a bull trap by today's move. NDX stopped right at its trend line along the May-June highs that I showed for SPX and the DOW. RSI is as overbought as it's been since October 2007. How's that for scary?

Key Levels for NDX:
- cautiously bullish above 1500
- bearish below 1450

The RUT continues to look very similar to the DOW and SPX and like them I see the possibility for a little more upside (perhaps 555) before rolling back over. Whether from here or a little higher on Friday/Monday we should see the start of at least a larger pullback before heading higher again (pink) or break down and head for new lows (dark red).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 520
- bearish below 496

The banks were not participating in today's strong rally, or this week's rally for that matter. Even when the DOW was up over a 100 points this morning the BIX was still in the red (the semiconductors too and both of those had me doubting today's rally). The daily chart of the BIX shows the past week it has struggled to push through its down-sloping 200-dma. So while the major indexes enjoyed a good week the banks were struggling just to get into the green. Bullishly it looks like BIX is consolidating below its 200-dma and getting ready for a move up. Of course it will have to immediately do battle with its downtrend line from September 2007 and then the top of a parallel down-channel (bull flag?). That's why I've still got 116 as the key level to the upside--follow it higher if it can get up there. Otherwise follow the money if the banks break down.

Banking index, BIX, Daily chart

The home builders got a boost today with a good report on existing home sales improvements. Sales of single-family homes and condos rose +3.6% in June to a seasonally adjusted annual rate of 4.89M which is the highest level since last October. But the previously reported increase of +2.4% in May was revised lower to +1.2% as a result of sales not going through. The sales numbers reported are for contracts to buy but then buyers need to come up with the funding and many are not being funded. The good news is that sales have improved for three straight months and obviously everyone is hoping the trend continues (instead of being just a summer blip helped by first-time-buyer incentives). Most sales are in the lower price category where the first-time buyers are focused.

Inventories of unsold homes are still relatively high and that's putting downward pressure on prices. The good news is the number fell to a 9.4 month supply at the June sales pace, down from 9.8 months in May and a high of 11.3 months in April 2008. A balanced supply of existing homes on the market is about 5-6 months and there continues to be the threat of more homes coming onto the market as foreclosures tick higher (mortgage defaults continue to rise). The median sales prices fell -15.4% in the past year to $181,800 with distressed properties accounting for nearly a third of the June sales. Adding more foreclosed homes into the market will very likely continue to put downward pressure on prices for some time to come. This will continue to dampen consumer's appetites for risk (spurring them to save rather than borrow and spend).

The Wall Street Journal reported "For the third straight month, option adjustable-rate mortgages are generating proportionately more delinquencies and foreclosures than subprime mortgages, the scourge of the U.S." My daughter's neighborhood outside of Seattle is made up of about 3/4 of the homes with these option adjustable-rate mortgages and most of the homes were sold about 2-3 years ago. They're now starting to reset and unfortunately for my daughter and husband (who purchased their home the old fashioned way with a fixed loan) many of those homes are now coming onto the market. Prices are down about 20% in the past year as foreclosure signs start popping up.

Because the loans only require a partial payment each month (negative amortization loan), the combination of a higher loan balance and lower home value is killing people. Most are unable to refinance. The WSJ article mentioned that as of April 36% of these homes are at least 60 days past due. The two largest banks most susceptible to losses from these loans are Wells Fargo and JP Morgan Chase. Many other smaller banks are exposed. Wells Fargo has a huge share of the loans--about $115B. Guess who will be the next bank to get bought out with government support.

But this is all in the future. Home builder stocks enjoyed a nice rally the past two days in particular and the index nearly tagged its downtrend line from July 2005-February 2007. A small push higher on Friday could tag it at 253 (today's high was 251.51). Considering how overbought it is (on RSI), I think it's safe to assume it will at least consolidate before pushing over a major downtrend line. The bearish wave count calls for a resumption of the selling to new lows once the current bounce finishes, whether from here or eventually up to the 300 area.

U.S. Home Construction Index, DJUSHB, Daily chart

James reported today in his OIN intraday update that UPS and FedEx reported less than positive news about their businesses. They are of course tightly linked to the economy since so much of what we do is shipped by them, or the railroads who have also been reporting shrinking shipments. Both UPS and FDX have now issued warnings about the 3rd quarter and threats of more layoffs. But traders were in the mood to buy (or shorts were pushed out) and the transports rallied anyway. This is a classic example of rallies based on emotions rather than data. And the idea that the stock market looks 6-9 months out is pure nonsense. Bear market rallies exist because people hope the bottom is in and try to get in early on a rally. Then disappointment sets in and the process starts all over again.

But the trannies have had a stellar rally since the low on July 8th and today broke above the top of its trading range marked by the May high and low. If it can hold above 3500 we could see a rally up to the 3800 area where it will run into the top of a parallel down-channel from its 2008 high (not shown on the daily chart). Higher potential exists up to the 4100 area. But if it flips around and drops back down from here then today's rally will have set a bull trap. If that happens we'll have a good indication that the rest of the market is probably also in trouble so watch this index over the next few days.

Transportation Index, TRAN, Daily chart

Gold and oil are looking very similar lately and they're each on the verge of a potentially big move. Gold has been trading in a big sideways range since March and could be building a bullish sideways triangle continuation pattern. A rally above 970 would be bullish and above the downtrend line from March 2008, currently near 993, would be a confirmed breakout to the north. But if the current bounce fails to get above 970 and makes a new low below its July low near 905 it would be a signal to me that some strong selling is about to kick in (this would likely be accompanied by strong selling in the stock market as well). Follow price once a key level breaks.

Gold continuous contract, GC, Daily chart

Oil has been more bullish than gold where it rallied from March while gold traded sideways. The pullback from its June high is only a 3-wave move and therefore fits as just a correction to the rally. The bullish wave count calls for a continuation of the rally to a new high. It may only make it up to the 38% retracement of its 2008 decline (76.77) or it could make it to the top of its parallel up-channel (above 80). Once that leg up completes we'll then get a larger pullback to retrace some portion of the rally from February. But another rally leg would make for a longer-term bullish wave pattern with a pullback into the fall followed by a new rally into next year.

But if the current bounce off the July low fails below 70 and then drops back below 58 we should see some hard selling kick in. It would mean we'll probably see oil drop to new lows below the January low of 33.20. As with gold, follow the break of a key level but beware there may not be much more upside before getting a bigger pullback correction.

Oil Fund, USO, Daily chart

Today's economic reports were only the unemployment numbers (still dismal but people keep trying to put a positive spin on them) and existing home sales. Friday we only have the revised Michigan consumer sentiment.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, it looks to me like we could see a pullback on Friday and then one more stab higher to complete a 5-wave count from Tuesday which in turn would complete a 5-wave count from July 8th. That would then call for a larger pullback to at least correct that rally leg (watch for a 38%-62% retracement). Beware that we might not get that one last push higher (and of course the "last" push higher could extend) but if we do then I'd keep an eye on SPX 989-990/DOW 9150 (maybe as high as 9275) for resistance.

Next week should see the pullback in force. If it becomes very choppy and more of a sideways/down correction then we'll get a good sense that another leg up (shown in pink on many of the charts) into August is in store for us.

But if the decline becomes sharp (impulsive 5-wave moves down) we'll start to get some clues that the decline may be much deeper in which case the key levels to the downside could break sooner rather than later. A break of those levels would usher in the probability for a deeper correction of the entire March-July rally. And stay aware of the larger wave count which calls for the possibility of the start of another leg down in the bear market (which will take us well below the March lows). If you look over historical patterns from the 1930s and Japan in the 1990s you will see we're in a very similar pattern. Just as I showed on the industrial production chart at the beginning of the report, it's quite possible we'll see more than a 50% haircut from current price levels before the next significant bounce.

Because the price pattern remains elusive, leaving multiple possibilities, I continue to stress a shorter term trading mindset. Bear markets are to be traded and certainly buy-and-hold should be banished from your vocabulary. For the next many years those who make money in the stock market will be those who trade it. This of course makes it particularly challenging because it means we need to do our best to identify tops and bottoms. I had a pretty good sense when the bottom was approaching in March but it's been more challenging figuring out the top of the bounce.

I suspect a lot more money has entered the market through Uncle Benny and the Feds than I had appreciated. But sooner, rather than later, we'll get another mass psychology shift that will overwhelm even the mighty Fed and Treasury. The bulls have been climbing the slippery slope of hope and doing a good job at holding on. Once the leaders (banks, semiconductors) slip it will be like bowling pins as we watch them all come tumbling down. I'd like to position us for the move down and that's what I'm watching for. Then when the market tags an important bottom again we'll try to hitch a ride back up, ready to bail at a moment's notice.

Being ready to bail is something I think those of you who are long the market need to be serious about now. You might be able to ride out one more pullback and new high (into August) but the risk for longs has increased significantly. Remember, pigs get fat, hogs get slaughtered. Be happy with a chunk out of the middle and be ready to position yourself for the next trade. That next trade is going to be to the downside.

Good luck in the coming week and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 944
- bearish below 900

Key Levels for DOW:
- cautiously bullish above 8700
- bearish below 8400

Key Levels for NDX:
- cautiously bullish above 1500
- bearish below 1450

Key Levels for RUT:
- cautiously bullish above 520
- bearish below 496

Keene H. Little, CMT