Market Stats

The equity futures were pointing to an ugly start to the day and the market gapped lower at the opening bell. The DOW dropped about 70 points from its Friday close in the opening minutes but then the buyers stepped back in and rescued the market from itself. All in a day's work for the market controllers. Actually there are many fund managers who feel they're behind the 8-ball as compared to their competitors and that has them looking at dips as opportunities to do some catching up. They may have one foot in the door and looking to exit quickly (you can imagine how many are in that position and why selling could get out of hand quickly if this breaks) but for the time being it continues to help hold the market up. Most everyone knows valuations don't support higher stock prices but that's what momentum is all about--you keep buying them until momentum runs dry.

The volume today was less than each day last week so considering most of the day was spent rallying that's not a good sign. SPX continues to struggle against a pretty tough resistance zone of 1040-1050. I had mentioned last Thursday the 75-week moving average that did a good job supporting the pullbacks during the 2003-2007 rally. After breaking below it in December 2007 it tested it from underneath in May 2008 and this is the first time it's back up to it, currently at 1042. The October 2008 bounce high was 1044 and that's also an important Gann Square of Nine number. The broken long-term uptrend line from 1990-2002 is also sitting near 1041.

The good news for the bulls is that today's closing price was above all those resistance levels. Unfortunately, with the weakening momentum, as can be seen with the negative divergences on the daily charts, and the weekly chart showing overbought it looks like a good setup for at least a pullback. But we all know the market can stay overbought and display negative divergences for a very long time. Neither is a very good market timing tool but instead only offers a heads up to be careful.

While I much prefer to use charts and technical tools to do my trading I realize there are times when technical analysis has its deficiencies. Opex week is one of those times. Technical analysis measures the "normal" ebb and flow of trading (normal being highly questionable in this market now, what with government interference and all) but during opex we will often get some big buy and sell programs that were not telegraphed from the charts. I've found over the years that opex week can be one of the most difficult times to trade and I tend to hang back during this week. Some people have figured out how to trade it very well and make their bread and butter during this week. I think the trick is to always find what works best for you (style of trading, when to trade, even time of day to trade, timeframe for trades, etc.) and then focus on doing that kind of trading well. At other times it often pays to stay away.

I don't really know why the market was rescued this morning after another gap down open. It seemed to have another one of those relentless, and yet not aggressive, undertone of buying pressure. I wonder who could do that. Many hedge funds (and the big bank trading houses are very much like hedge funds) sell premium and in a bullish market they sell puts. Come opex there is a strong interest in keeping the market up so in order to collect all that premium. When volume is relatively light it's not that difficult to keep pumping buy orders into the market to overwhelm any selling that shows up. Multiply this by a few thousand funds trying to do the same thing and it's not hard to understand why the market won't go down.

Just as most of the banks got into so much trouble trading the same technique and in the same way (quants were in high demand) so too can we see the market swing violently to the downside if most everyone is leaning bullish and suddenly they have to cover and/or hedge their positions. If they have short puts (bullish trade) and the market goes against them they'll have to buy the puts back or short stock as a hedge. Both are bearish plays and add selling pressure to the market. So in a bullish market a down week during opex can be hard down. I mention that as a caution since it's possible we're going to get some hard selling this week (though you wouldn't know it by today's action).

So let's dive right into the charts and see what's changed since last Thursday. SPX looks like it's going to push up to its trend line along the highs since May, currently near 1053. If this continues to hold SPX down we could see the start of a pullback to the bottom of its rising wedge pattern (the uptrend line from March). Whether it breaks that uptrend line or bounces off it and heads higher again is something we'll just have to wait to see. I don't show it on the weekly chart but it's possible we'll get a blow-off top and see SPX rally up to its downtrend line from October 2007 and tag its 50% retracement near 1121. There's nothing I see that's pointing to that possibility but it's a scenario that needs to be respected if you're attempting to short this market.

S&P 500, SPX, Weekly chart

In a correction, which is what I consider the rally from March to be, it's common to get an a-b-c type of bounce (leg up, pull back and then another leg up). I have this labeled as a w-x-y bounce on the daily chart because of the kind of corrective pattern it is but it's still basically a 3-wave kind of move. The common price relationships between the two legs of the bounce are for the 2nd leg up (the rally from July) to be 62% or 100% of the 1st leg up, which was the rally from March to June. The 1048.19 price projection on the daily chart is where the 2nd leg up would equal 62% of the 1st leg. Friday's high was 1048.18 and today's high closed marginally higher at 1049.34. If the oscillators roll back over from here they'll leave yet another negative divergence and considering the 1040-1050 resistance zone I think we've got a setup for a reversal. How the market will behave during opex is another question.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1044
- bearish below 992

A closer view of SPX as it approaches the trend line along the highs since May shows it could tag both that trend line and the broken uptrend line from July first thing tomorrow morning near 1053. Keep an eye on price behavior if that's tagged and then the market pulls back.

S&P 500, SPX, 60-min chart

The DOW's daily candle on Friday was also a doji (with a small red body which makes it slightly more bearish) at resistance. Today's candle is a hanging man, another bearish candlestick. They both portend topping action but again, this week has its own agenda. Assuming we'll see at least a slightly deeper pullback we should see the DOW test its uptrend line from July. currently near 9450. A break of that would be a bearish heads up although it takes a break of its September 3rd low near 9253 to indicate an important high is in place.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 9650
- bearish below 9250

NDX, like SPX (and the DOW but not shown on its chart), the leg up from July has achieved 62% of the 1st leg up (March-June) at 1686.28 and at the same level it's trying to push through the trend line across the highs since July. The fact that the various indexes, blue chip and tech alike, have achieved this Fib projection at the same time shows how much the market is in synch. They will need to keep rallying together otherwise we'll see bearish non-confirmation. As with the others I'm showing the possibility for just a pullback and then a final leg up to complete the rally in late September/early October to about 1710 (another larger pattern Fib price projection (pink). A break below 1585 would negate that short-term bullish possibility. Basically the rally from September 3rd is starting to go on life support (bearish divergences at new highs since September 9th on the 60-min chart) but remains bullish as long as it holds above 1660 and if that breaks then watch the uptrend line from July, near 1630.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1660
- bearish below 1585

The RUT continues to press up against its broken uptrend line from July through the August 17th low. On Tuesday this trend line crosses the one across the highs since June near 602. That could be tough resistance. To the downside there's support near 565-570 at its uptrend line from July through the September 3rd low. Then the 50-dma near 552 and uptrend line from March near 547.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 602
- bearish below 552

Wrapping all the indexes into one, the Wilshire 5000 index shows what this week might look like if it follows the patterns we saw at the tops in June, early August and late August. Before we got either a sustained selloff or just 2 days of hard selling, we got a lot of choppy price action at the high. June and late August in particular look very similar and left a lot of doji candlesticks before selling off. Now Friday's doji candle has been followed by a bit of an exaggerated hanging man doji (both potentially bearish where they're located). The risk for long players is that we could see a sudden breakdown (whether for two days or two weeks or two months) so play it carefully here. It's possible we'll see this choppy price action continue to the end of opex week (oh joy).

Wilshire 5000 index, DWC, Daily chart

I've been watching bond prices for some clues as to what we can expect into the end of the year but we don't have much of a resolution yet for them. It appears they're in a corrective pattern since the low in early June which has TLT looking like it will get another leg down to a new low this year. But it's not clear whether it will bounce a little higher in the short term (to a Fib target at 99.19) before heading back down again. Longer term it looks like the decline from December 2008 has not finished yet and of course if bonds do sell off some more that will raise the yields (and borrowing costs).

20+ Year ETF, TLT, Weekly chart

The banks, while weaker relatively speaking, also refuse to die. Since September 3rd the BIX has pushed up along its broken uptrend line from March. This is the big Kahuna of trend lines since a break of it will signify the rally from March has finished and that we'll get at least a larger correction of it. The banks are the first to break it and can't quite recover back above it. If and when it lets go to the downside it will leave a bearish kiss goodbye. If on the other hand it's able to gain some traction to the upside we should see it head for its trend line along the highs since May, currently near 133. That would be needed to confirm any additional rally in the broader market.

Banking index, BIX, Daily chart

The broker index had a strong day today and shot higher to a new yearly high. Unfortunately the oscillators are not as bullish and the rising wedge pattern for this year's rally looks downright bearish. XBD is nearly back up to the top of the wedge, currently near 118 and if we see a little throw-over followed by a move back down inside the wedge that would be our first clue that it's ending. The significance of this rising wedge pattern is that it will very likely get completely retraced in less time than it took to form. It's possible, if it tops out this week, that we'll see new lows before the end of the year. It doesn't seem possible now but it never does when things appear so bullish.

Broker/Dealer index, XBD, Daily chart

The home builder index has a similar wave count (a-b-c-d-e) as the broker index but in a parallel up-channel instead of a rising wedge. On the weekly chart this parallel up-channel from November looks like a bear flag pattern. The outcome from it should be the same as the broker index--a complete retracement.

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

The Trannies are looking strong. The nearest price-level resistance, not shown on the daily chart, is the January 2008 low near 4033 so within spitting distance at this point. Near 4063 is the level where the 2nd leg up in the rally from July will equal 62% of the 1st leg up. And then slightly higher again is the November 2008 bounce high near 4094. That gives us a potential resistance zone of 4033-4094.

Transportation Index, TRAN, Daily chart

I'm showing some Fib projections and the 62% retracement of the decline from May 2008 to March 2009 at 4237-4366. Slightly lower is the October 2008 bounce high at 4217. So that gives us an upper resistance zone for the Transports at 4217-4366.

I continue to keep a close eye on the U.S. dollar because I believe it's close to bottoming if it hasn't already done so. Friday's low took it below the bottom of the descending wedge pattern and today's rally brought it back up inside the wedge. That's a buy signal and a very early bottom call. Obviously the rally must continue from here and break above 23.50 to confirm the break of the wedge and downtrend line from March.

U.S. Dollar ETF, UUP, Daily chart

Many people feel that the Fed's rampage to print more money is creating a nightmare situation from an inflationary perspective. Think Zimbabwe. The problem is the velocity of money is shrinking (basically this is a measure of how much the money growth rate increases from things like lending and leveraging). What we're actually experiencing is a deflation and even M1 contracted 1% in the final week of August and is down -6.5% annualized over the past 4 weeks. M2 has also contracted over the past week at an annualized rate of -12.2%. MZM is down -15.8% annualized over the past month. Bank credit is contracting at a -9% annualized rate and this credit contraction is what's deflationary. The huge credit expansion must be followed by a credit contraction (reverting to the mean, or below it and then back up to it over time). This is what the Fed is fighting with all its money creation and they have not been able to keep up with the contraction. If they accelerate their efforts they'll crush the US dollar even further and tick off our major foreign investors. Between a rock and a hard place is where the Fed has placed itself.

Commodities, including the metals, and stocks have been running in the opposite direction as the dollar and therefore if the dollar is getting ready to rally that could put some pressure on stocks and commodities. Gold has been stuck more or less in a big sideways pattern, which it recently broke out of, since the beginning of the year and it tends to march to the sound of a different drummer--primarily inflationist worries (worries that fiat money around the world will become worthless). I've said many times I think deflation will be the bigger concern for at least the next year and that could take away some of the buying pressure for gold. Add in a rallying dollar (assuming it will) and we could see the kind of decline I'm projecting for gold--down to 650 to set up an outstanding long-term buying opportunity for the shiny metal. But until proven otherwise the gold bulls are in control. I just wish they could break that broken uptrend line from October 2008. Gold has now tested it several times since the July low and hasn't been able to break back above, which remains bearish.

Gold continuous contract, GC, Weekly chart

I show an upside price projection at 1031.90 and the previous high in March 2008 was 1033.90. That could be tough resistance if reached. In the meantime it's possible it has already completed its corrective bounce from April and is now ready to head lower. It takes a break back below 941 to increase that probability.

If the dollar rallies it will be just enough to kick oil off the ledge it's been sitting on since July. The uptrend line from February has supported each pullback since that time but it's now threatening to break that line and its 50-dma (68.06). As shown on the chart, a break could see increased selling pressure take oil down to a projection just below 51 (or to its 200-dma at 55). A break below 67 would be a confirmed breakdown from its rising channel. It takes a rally above 74 to confirm the oil bulls have control.

Oil continuous contract, CL, Daily chart

Tomorrow's economic reports could move the market if there are any surprises to the CPI, retail sales or Empire Manufacturing survey. The market is looking for anything that will support the outsized rally we've had since March. So far there hasn't been enough to support the rally and any news that starts to put some serious doubts into money managers' heads could spell trouble.

Economic reports, summary and Key Trading Levels

The stock market continues to rally in the face of reality and since price is king that's all we need to care about. We trade the charts and we use technical analysis to judge what we think will happen next. But it always pays to keep your ear on the railroad track and listen for the train that's coming. That would be the southbound train. You don't want to be walking on the tracks with your back to it and not hear that one coming. The biggest problem as I see it is that the banking problems have not been fixed. The Fed and other government agencies have stuffed bubble gum in holes, they've put Band-Aids across deep gashes and they've refilled coffers with mark-to-market valuations and electronically-created money. The man behind the curtain does not want us to look behind it.

There are several articles popping up in business publications that are referring to the fact that the banks are actually in worse shape now than when the crisis started in 2007. This is because they're lending less (so less income generation) and their portfolios are worse. The housing problem continues to get worse, not better, and now the commercial real estate market is rearing its ugly head. The number of defaults in this area is rising dramatically. The banks are more leveraged than ever and they don't have the reserves to handle even a 5% decline in their asset base.

The FDIC is continuing to close banks at a record pace and probably hasn't even scratched the surface. They'll be out of money before the end of the year and borrowing from the Fed to pay off depositors. Bank credit contracted by $32B during the 2nd week of September which brings the total credit contraction to more than $200B just since the end of July. This is the definition of deflation and the economy will not do well without a continuous supply of new credit. Instead, it's being removed. Businesses are struggling to get new financing (bankruptcy filings in August were 22% above year-ago levels). Home owners who thought they would be able to sell their home back to the bank using a short sale (have the bank accept a payoff of a lower amount than the mortgage balance) are finding banks that are balking and walking away. That means more foreclosures and depressed housing values to come.

There were 250 companies in the S&P that cut their dividends in the 2nd quarter. That's the highest number in 50 years. Do you think that the stock market rally might be a touch overdone when the 'E' part of P/E is dropping (for you non-math majors that makes the P/E ratio higher, especially with a stock market rally that makes 'P' larger while 'E' gets smaller). We are way overpriced at this point.

Now we have an administration who panders to unions and slaps a 35% tariff on Chinese tires. Did anyone in his administration study history and understand that protectionism worsened the global Great Depression? China has already said they will now retaliate with their own tariffs and trade restrictions. Here we go.

I could go on but you get the point. "Less bad" is not an improving economy. Have you seen the video of a jet during an air show pull out of dive too late and belly into the ground? As the pilot was pulling out of his dive and decreased his rate of descent, but still dropping, he didn't say to himself, "Self, this is now less bad so I think I'll hang around for the conclusion." He ejected just before the plane hit the ground which erupted into a fireball as he got one swing in his chute before safely landing on the ground. Less bad is not good; it just means we're dropping slower to the ground but impact is still inevitable.

If all of this sounds pessimistic so be it. I consider it realistic when you think about the plethora of problems still facing us. History shows us that the massive credit creation, and all the bubbles spawned from that, results in years of pain as the credit expansion is unwound. There's just no easy way to pull out of the dive. The Fed merely prolongs the ride down and now we have an administration that is ignorant of history. I'd rather just get the pain over with and get back to healthy growth but politicians will never ever let that happen. Their jobs depend on spending our money on ourselves.

So we're into opex week and that means the market can do anything with little warning. Moves related more to opex settlement will not be "normal" price swings that we look for on the charts. So be aware of the increased risk in that respect. I see a market that is topping but it may happen slowly. In the review of the daily Wilshire 5000 chart I pointed out the choppy consolidation patterns that have led to quick (even if not sustained) declines. We could see a similar pattern this week, especially if there will be an effort to pin SPX to the 1050 area.

The other thing to be fully aware of is that we could see a big effort to hold the market up into the end of the month in order to get the highest closing prices possible for month/quarter end (and fiscal-year end for many). That's what happened in 2007 and this is reminding me of that period. While I see vulnerability to a breakdown at any moment I understand the forces that can keep the market held up longer than I thought possible. Therefore trade carefully this week and for the rest of the month. The charts may not help as much as they normally might.

Good luck and I'll be back with you a week from Thursday.

Key Levels for SPX:
- cautiously bullish above 1044
- bearish below 992

Key Levels for DOW:
- cautiously bullish above 9650
- bearish below 9250

Key Levels for NDX:
- cautiously bullish above 1270
- bearish below 1096

Key Levels for RUT:
- cautiously bullish above 602
- bearish below 552

Keene H. Little, CMT