Market Stats

The market was green across the board for most of the day and it looked very bullish. By the end of the day, after some selling, the only major sectors in the red were the semiconductors and biotechs. All other sectors finished in the green and the total advancing issues beat out declining issues by 3:1. But look at the up and down volume in the table above--down volume beat out up volume on what looks like a very bullish day. That's one chink in the bull's armor.

The EW (Elliott Wave) count for the rally from July 8th now counts complete and as I'll show on the charts it's a clean count which gives me more confidence than I've had in a while to call a top for now (we might only get a pullback to correct the July rally before heading higher again). Several sectors and indexes also tagged some potentially important resistance levels which I'll cover in the charts as well. So my number one caution tonight is for the bulls--we're at a point where we could see a minimum of a deeper pullback to correct the July rally. More bearishly we could start a more serious decline into the fall.

On Monday we got a sell signal from VIX and in the live Market Monitor I showed a 60-min chart to point out the bullish descending wedge that had been building since the July 15th low. Once it gapped out of the wedge pattern it was a bullish signal for VIX. Of course a bullish VIX is bearish for the stock market. It was only a warning but considering how far the rally had run it was a warning that required we watch carefully for signs of topping in the stock market.

Volatility index, VIX, 60-min chart

As you can see, the VIX has continued to "rally" since its low last Friday. As the stock market made new price highs today the VIX was clearly not confirming it by making new lows and that sets up a negative divergence against today's price high.

When we look at the weekly chart of the VIX there's another longer-term bullish descending wedge that's been building since the November 2008 low. The VIX has dropped close to its uptrend line from early 2007 and the point I want to make from this chart is that it calls for a break out of the wedge and a complete retracement of it (back to the January high at least). That would clearly be associated with a big move down in the stock market. For now we have no such sell signal for the stock market but it's what I expect to see sooner rather than later.

Volatility index, VIX, Weekly chart

Most people have turned bullish the stock market so I'm beginning to feel, again, like the lone wolf out here. But I'm going to present some evidence (instead of hope) to show why I've turned particularly bearish at this stage of the rally.

One--sentiment. Bullish sentiment is running at an extreme again and of course from a contrarian perspective that's bearish for the stock market. The crowd is always wrong at the turns, which includes economists by the way. AAII (American Association of Individual Investors) reports the Bull Ratio (Bulls divided by the total of Bulls + Bears) shot up to 61% from a low of 33% earlier this month. This marks the highest net bullishness among individuals since May 2008. If you've forgotten what happened after May 2008, let's just say the market took a little dip.

Two--insider selling. Despite a near 50% rally in the stock market and "better than expected" earnings across the board, since the March lows we've seen an increasing amount of insider selling (these are the leaders of the companies that investors are buying in hopes of a recovery and the leaders are bailing en masse). At the same time we're seeing record low levels of insider buying. The buyers in recent weeks bought just over $26M in stock ($16.5M of which was just one buyer). But the sellers have sold over $300M. That’s a staggering 30:1 ratio of sellers to buyers if you back out the one larger buyer. When they talk about smart money, these are the people to follow.

Three--earnings/revenue (this is the big one for fundamentalists). According to S&P, about 60% of the companies who have reported earnings have beaten their profit estimates, which as we all know have been lowered to the point where snakes can barely crawl under. Speaking of snakes...hmm, never mind. We also know that the profit objectives are being met with cost cutting rather than increased revenues. The staggering unemployment lines are testament to that fact. With over 50% of the S&P 500 companies having reported earnings now, revenues are down about -10% Y-o-Y but we haven't even heard from the companies in the most trouble still--the retailers and homebuilders. Those little green shoots are withering faster as we move into the middle of the 3rd quarter (and in Seattle with the record heat wave I think the remaining green shoots have died). Without an increase in revenue there's just so much cost cutting that can be done. Cutting the fat is one thing but cutting to the bone is when companies are in a position of survival. To put the current recession into perspective, when the 2001 recession ended, sales were running at -1.0% Y-o-Y but currently, supposedly with the recession ending if you listen to most of the economists out there, the current sales are worse by a factor of ten. And when the last bull market was confirmed in the spring of 2003, sales had already swung well into positive territory on a Y-o-Y basis. Believing that the recession is ending and that we've entered a new bull market is that slippery slope of hope thing.

People like Larry Kudlow on CNBC tell us revenue and earnings per share (EPS) are both increasing. I don't know where he gets his data but he's flat out wrong. I'll be kind and not say he's lying to the viewing public in order to keep his job. In Q1 the Y-o-Y EPS drop was -31.49%. As of right now the drop is -32.41%. And the drop in revenues is much worse--the quarterly drop is actually accelerating. In Q3, 2008 earnings were +8.6%, Q4 they were -9.2%, Q1 2009 they were -11.6% and Q2 they're -15.1% (the one that's being reported on now). I don't see a positive trend there. And yet economists and analysts, as they've done each quarter, keep forecasting revenue and earnings growth for the coming quarters (or worst case, "less bad"). That's what the spring rally has been built on--lots of hope that "less bad" will turn into "more good". As the old Wendy's commercial used to say, "where's the beef?"

As far as the increased revenue and earnings for the banks, well you know where I stand on those. If not for the tax payer recapitalizing the banks' trading accounts and the accounting ruling change allowing mark-to-model (which allowed banks to "earn" money on the increased value of their toxic holdings), the banks would be reporting far less rosy results. The bulk of the capital is now being made in their trading accounts, including the sale of assets. They've gone right back to the high-leverage ways that got them into trouble the first time. What's that definition of insanity? Doing the same thing over and over again and expecting different results? The market will soon be reporting the Emperor (the king banks) is wearing no clothes.

Four--home foreclosures, consumer sentiment, saving vs. spending. We've been hearing about increased home sales numbers but this is a smoke screen. High-end homes are now entering the foreclosure process which may be helping to drive up (less down?) the recent home price numbers. Foreclosed homes are seeing the highest level of activity and account for a solid share of total sales. And yet the banks are still sitting on a record number of foreclosed units that have yet to hit the market, with more landing on their books every month. And the government-imposed moratorium on foreclosures just ended.

Of the 131M housing units in the U.S., nearly 19M (15%) are vacant. With net household formation running barely above 800K annually, there is a 20+ year supply of real estate units on the market. In the coming 1-2 years we can expect a higher mortgage default rate (not to mention the commercial mortgages that are in more trouble), more foreclosures than the market can currently absorb and an unemployment rate that will worsen in the coming year. These will continue to depress the consumer who is retrenching and saving vs. spending (boomers alone are expected to remove some $400B in spending in the next year). Is it reasonable to assume we're coming out of a recession? At best I think we'll have a double dip--if we come out we'll drop right back into another one.

Five--the credit contraction continues. Lending continues to slow as bankers and borrowers refrain from taking on any more risk and the credit contraction remains bearish for the economy. Total bank credit contracted $41B (20% annual rate) for the week ending July 15th, making for the 4th weekly decline. According to an article that recently ran in the Wall Street Journal, the total amount of loans held by the 15 largest U.S. banks shrank by 2.8% in the second quarter, and more than half of the loan volume in April and May came from refinancing mortgages and renewing credit to businesses, not new loans. Commercial & Industrial loans dropped $1.7B and is down over $50B in the past three months, or a -13% annual rate, which is unprecedented. These kinds of numbers are simply not present in a recovery from a recession.

I haven't even touched on unemployment, which will worsen, but I think that's enough. It's depressing enough as it is. But the point I want to make is that you need to be careful about getting sucked up in the bullish euphoria that's out there. While we all want to feel good and I'd certainly prefer to talk about how the little green shoots are sprouting beautiful flowers, when it comes to my portfolio (mine and what I manage for others) I need to stay realistic. History, cyclical studies and wave patterns are my guide, not CNBC or economists who didn't see these problems coming in the first place (including Bernanke) and now tell us all is right with the world.

So let's get to the charts and discuss why I think today made a potentially important high. I've discussed several times before how the weekly chart of SPX does not look bearish and as I look at today I'd have to still conclude that it does not look bearish. In fact it looks bullish. I see the potential for a rally up to the 1014-1040 area where it would tag the 38% retracement of the 2007-2009 decline or broken uptrend line from 1990-2002. The November 2008 high near 1007 also makes for a good target. But if Friday turns to be a down day we could see this week's candle become a doji. If next week turns down then the doji would be the middle candle of a 3-candle reversal pattern called an evening star.

S&P 500, SPX, Weekly chart

Today's rally had SPX tagging the trend line along the highs from May-June and also the Fib projection near 990 for what could be the last leg of the rally from March. The dark red count and depiction calls for the start of the next leg down in the secular bear market. The pink wave count calls for a pullback (which might not go as deep as depicted and could instead find support around 950) and then a new high into August before the rally tops out. Only after the decline gets going will we be able to identify key levels to test it each and every step of the way.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1010
- bearish below 918

The 60-min chart shows why I'm feeling confident that today's high was it for the rally from July 8th--it has a clean 5-wave count and while the 5th wave could extend higher (if it does I suspect it will head for at least the 1040-1050 area), the pattern calls for at least a pullback to correct that 5-wave move. But the bears need confirmation that the final 5th wave has finished and that requires a drop below Wednesday's low near 968. Until that happens I think bears need to continue to respect the possibility that the rally will extend higher. While I don't think it will, price has a way of slapping me silly when I don't listen to it.

S&P 500, SPX, 60-min chart

The DOW came up a little shy when it comes to the trend line along the highs from May-June so by that measure there's a little more upside potential (to about 9320 tomorrow). A drop back below 9000 would tell me the rally from July 8th finished and from there I'd short the bounces while determining some downside objectives. Using a 38%-62% retracement of the July rally will provide some targets to keep an eye on. They're not shown on the chart but they are 38%--8804, 50%--8667 and 62%--8530.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 9400
- bearish below 8500

Like SPX, NDX pushed up to the trend line along the highs from May-June and also tagged the 50% retracement of its 2007-2008 decline (the March 2009 low was a higher low than November 2008). Today's candlestick is a bearish shooting star (actually a more bearish gravestone doji) against that resistance level so at this point it looks like we have a reversal pattern in the making. A down day on Friday would confirm the reversal pattern.

Nasdaq-100, NDX, Daily chart

As with the others, RSI is as overbought as it was at its 2007 high. Referencing its 200-dma, at today's high it was 337 points above its 200-dma whereas at its October 31, 2007 high it was "only" 319 points above the 200-dma. But what's really astounding, because of the lower level it's at today, the percentages above the 200-dma is eye-popping. In October 2007 it was almost 17% above its 200-dma whereas today it was 26% above. In the second half of 2003, after the strong rally, it was about 23% above its 200-dma before pulling back to it. Even a relatively small pullback to the 200-dma by October would likely have NDX pulling back to the 1400 area and taking away the July rally leg.

The NDX is a rubber band that's ready to snap. The market has gone beyond "too far too fast" and the resulting correction could be a nasty one. But as shown in pink on the chart, we could see a pullback to relieve some of the overbought conditions (and allow the 200-dma to catch up a little) and find support at its uptrend line from March for one more rally leg after that.

Key Levels for NDX:
- cautiously bullish above 1630
- bearish below 1470

This morning, seeing that we were going to gap up and knowing it would fit well as the 5th wave in the wave count for the rally from July 8th, I was feeling more confident that we were seeing the top put in. The end of the wave count was right at important resistance shown on the daily chart. On the live Market Monitor I posted a 5-min chart of the NDX to show its clean 5-wave move from Wednesday afternoon which was completing the 5th wave of the larger July rally. This chart also shows the 3rd of a 3rd wave up this morning, often accompanied with a gap move as this morning's was. It should be the exhaustion gap for the move as well. But as advised this afternoon, if the market rallies early on Friday and gets back above this afternoon's highs it will leave today's pullback as just a 3-wave correction and indicate higher prices are coming. I don't foresee that but that's what stops are for if you shorted today's high.

Nasdaq-100, NDX, 5-min chart

Another look at the techs shows the NASDAQ achieved an important level today as well. It rallied up to its downtrend line from the October 2007 high and came close to the July 2006 low near 2030 (today's high was almost 2010). I don't think I'd want to do any more buying right now even if I was bullish the stock market.

Nasdaq, COMPQ, Daily chart

You can see where the NASDAQ first ran into resistance at the April 2005 low near 1890 so a drop below that level would be the first indication of trouble for the rally. Its uptrend line from March is near 1820.

The semiconductors continue to be a good index to watch because of the leading-indicator aspects of chip production. The fact that it was practically the only sector to finish in the red today is not a good sign. The SOX ran back up to the trend line along the highs from January-June but so far with a bearish divergence against the oscillators. The shooting star candlestick at resistance, if followed by a down day on Friday, will be a reversal pattern.

Semiconductor index, SOX, Daily chart

The RUT's daily chart shows it sitting in no-man's land at the moment. It's above the mid line of its parallel up-channel so that's potentially bullish. And today's candle is not bearish. If it were not for the others I could almost feel bullish about this chart.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 565
- bearish below 500

For those of trying to do some planning around what interest rates are doing, I'll offer my opinion and what to watch for in helping us figure out if rates are going to climb higher or drop lower from here. The inflation vs. deflation and dollar vs. commodities arguments have many wondering what's going to happen next. Me too.

The monthly chart of the 30-year yield shows a nice parallel down-channel from the 1994 high with the lower parallel line attached to the 1998 low. The low in December 2008 found support at the bottom of the channel and it's a complex corrective wave count that calls for a rally now out of the parallel down-channel, which is what I'm showing with the green depiction. Another small leg up could find resistance at the top of the channel, pull back into early 2010 and then rally higher. Rallying yields would of course mean dropping bond prices.

30-year Yield, TYX, Monthly chart, 1994 - present

But the current bounce off the December 2008 low is only a 3-wave move so far and therefore fits as just a correction to the longer-term decline. Therefore we could see a continuation lower from here and I show the two possibilities in a closer look at the rally leg from December. We have a parallel up-channel for price action from the December low and "price" is currently bouncing around on the bottom of the channel. If yields break down from here, confirmed with a drop below 4.15%, we could see yields head for lows below last December's 2.52%. That would tell us deflation is a greater concern.

If instead of dropping we see yields rise above Monday's high of 4.6% then a rally to new highs can be expected, either to the top of the longer-term down-channel near 5.0% or up to the Fib projection at 5.4% (where the 5th wave = the 1st wave in the rally from December). Then we'd see a pullback to correct the rally leg before heading higher into the end of next year (potentially much higher). So we'll let the next move tell us which of the longer-term scenarios will likely play out.

30-year Yield, TYX, Daily chart

The current yield curve is steep (higher on the long bond and low on the shorter-term bonds) and that enables the banks to make money. They can borrow from the Fed at next to nothing and lend it out at the higher rates. They're paying peanuts on savings accounts. Now all they need to do is lend it out (wink). There's been a lot of bullish talk about the banks and how well they're doing, what a great quarter they've had, blah, blah, blah. But it's not showing up on the charts. The BIX made its high in May and hasn't come close to challenging it since. Meanwhile we've got the stock market making new highs based on the assumption (you know how to spell a-s-s-u-m-e) that the improving banks and economy is going to catch up with the stock market.

The BIX tagged the top of a parallel down-channel from the May high. My first thought when I look at the chart is that it's a bull flag pattern and we should see a rally out of it. That's clearly possible and it's why I say a rally above 116 would be bullish. But when I include the analysis of the broader market I have trouble seeing the banks making that kind of rally. Therefore I'm expecting the decline to continue.

Banking index, BIX, Daily chart

The transportation index has rallied despite the less-than-rosy outlook from the shippers. The numbers of rail, air and truck shipments is down across the board and down big. But there has been this persistent hope that the shippers will soon reflect the kinds of shipments that comes with an improving economy. Now if the economy were only improving... The TRAN almost reached the top of its parallel down-channel from 2008 and slightly higher is a Fib projection for the rally leg near 3737, should the rally continue (and shown in pink). Otherwise if the broader market starts a pullback it's doubtful the trannies will hold up by themselves.

Transportation Index, TRAN, Daily chart

The U.S. dollar got a pretty good rally this week (but pulled back today) and that helped put the commodities in the hurt locker. Gold and silver, and oil, dropped fairly hard this week but bounced today. There's been little change from last week when I mentioned gold should be ready for a big move but I'm not sure which direction yet. I'm still waiting to see if it rallies above its bullish key level, now at 963, or below its bearish key level at 905. Follow whichever way it breaks.

Gold continuous contract, GC, Daily chart

Oil is in the same position as gold. So far it remains bullish in that it found support again at the bottom of its parallel up-channel from January, especially with today's strong rally (it's hard to see but today's white candle reversed yesterday's long red candle). Back above 69 would be potentially bullish (but only for a run into the 80s before reversing back down into the fall) while a drop below 58 would be bearish (for a run back down to, or below, the January low).

Oil continuous contract, CL, Daily chart

Tomorrow's economic reports include a few potentially market-moving ones and I think the GDP could be the most troublesome if it disappoints (comes in worse than the expected -1.5%). The Chicago PMI could also be trouble if it comes in less than expected. By the same token, if the reports are deemed positive and stoke the little-green-shoots fire of hope, we could see today's pullback get erased in a heartbeat. That's why short players need to keep their stops just above this afternoon's highs.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, I see the distinct possibility that the market made its high today. The EW count and potentially significant resistance levels, along with confirming candlestick patterns, tell me the market topped. The July rally leg is due for a correction at a minimum and that means a 38%-62% pullback correction. I provided numbers for the DOW and the equivalent numbers for SPX are 38%--948 (near the breakout level of 950 that so many traders (too many?) are talking about), 50%--933 and 62%--918. Following a pullback correction, lasting perhaps a week or so, we could then see another rally leg that takes SPX up to the 1050, perhaps 1100 area and lasting perhaps into the end of August. I don't see that happening but I'll let price lead the way and part of the determination will be the pattern of the pullback.

The more bearish potential from here is that the March rally has ended and we're about to resume the bear market selling. It takes a break of the uptrend lines from March, e.g., near SPX 918, to tell us a more serious decline is unfolding. A more serious decline would likely take us into the typically bearish months of September/October. I've looked at some cyclical studies that point to a bottom in November before rallying into 2010.

How low a more serious decline could be is the more difficult question for me at the moment. I certainly see the possibility for a decline to new annual lows (below March's) before the end of the year. But there's also a larger pattern, shown on the SPX weekly chart, for a deeper pullback as part of a large A-B-C upward correction against the 2007-2009 decline. That says a pullback into the fall to around 750 and then a rally into the spring of 2010 with an upside target around 1136 (an important Gann number).

This is obviously all speculation at the moment, especially since the market hasn't even started back down yet. Let's see if we get some follow through to the selling that started from today's high. Based on the pattern of the decline, especially if it's an impulsive 5-wave move (it's only a 3-wave pullback so far), I'll then be able to declare more emphatically that we'll get the larger pullback. It will take the next week or so to help determine whether or not it will be just a relatively quick pullback (SPX 950-ish) or something deeper (below SPX 900).

Until we gather some more clues I'll continue to suggest short-term trading strategies. I'm recommending the short side of the market as of today's high but at this point that's a day-to-day call. As always I'll do my best to keep everyone up to speed on the Market Monitor.

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

Key Levels for SPX:
- cautiously bullish above 1010
- bearish below 918

Key Levels for DOW:
- cautiously bullish above 9400
- bearish below 8500

Key Levels for NDX:
- cautiously bullish above 1630
- bearish below 1470

Key Levels for RUT:
- cautiously bullish above 565
- bearish below 500

Keene H. Little, CMT