Market Stats

After the sharp selloff yesterday morning there was a steady effort to buy the market back up to the flat line and protect profits into the end of the quarter. It looked manufactured and manipulated. Today's selloff supports that idea--once the quarter was made we saw no desire to hold onto equities today.

We've been bombarded lately with lots of talk in the media about how overbought the market is and how much it needs to pull back, etc. So it sounded very bearish and from a contrarian perspective it meant it was a good time to be long the market. Looking back at the quarter I'd say that was a good move. A lot of the rally was attributed to too many people trying to short the market and then being forced to cover but in fact that's not really what was going on. There was simply a lot of money coming into the market as fund managers chased performance. It was a momentum drive, pure and simple. The bearish talk was more fear of the market dropping rather than many people playing the short side.

Thoughts of a falling market were not being played by the short sellers and therefore there's not much in the way of short interest to help prop up the market or drive it higher. And since the drive higher has been primarily a momentum play (very few are buying based on fundamentals) it's in danger of a hard reversal once that momentum peters out (and the negative divergences have been warning us that it's petering out). When the selling starts we'll have fund managers who become more fearful than greedy and will want to protect profits, so they'll start selling (or hedging, which adds selling pressure). The frustrated bears who have been forced to sit this out and wait their turn will be only too happy to start selling as well. The double selling pressure will show up on days like today (or worse).

Most of us are aware that the market is overextended to the upside, although we know that it can continue higher despite being overbought. In fact if it could drive higher into the end of the year it could help wipe out some of the decade's losses. Here's a sobering statistic for those who believed in, and got caught by, the buy-and-hold mentality: even after back-to-back +15% gains for the S&P in the two previous quarters, something not done since the first half of 1975, it needs to gain an additional 39% before the end of the year just to break even for the decade. I think even the most hopeful bulls would recognize the challenge of getting that kind of rally into the end of the year.

In an article today by Kate Gibson at MarketWatch, she also mentioned the fact that boring bonds aren't so boring after all. The S&P 500 would have to rally another 159% before the end of the year just to beat the return on 10-year Treasuries over the same period. But if you were good at picking sectors, those who invested in energy before the decade started fared the best--up +92%. But if you were unlucky enough to be in telecom you're down -66%. Speaking of bonds, I've updated the chart for the 30-year and I'll review later where bonds stand and what it means for the stock market and inflation worries.

The day started in the hole with equity futures down during the overnight session. This morning's economic reports were a mixed bag and probably had very little to do with the selling that took place.

Consumer spending got a shot in the arm in August, thanks to the government-sponsored cash-for-clunkers program. Spending rose at a rate not seen since October 2001, up +1.3%. Excluding durable goods spending (which includes cars), spending was up +1.0%, the first gain since February. The headline number for personal income was +0.2% but after accounting for taxes and inflation real disposable income was down -0.2%, the 3rd monthly decline in a row. Spending rose at a faster rate than incomes so the savings rate declined to 3% of disposable income. Higher spending than income is what got us into so much trouble so we know that higher consumer spending won't continue with that kind of trend.

The rally since March has been built on hope that the economy has seen its worst and the social mood swing to hopefulness has been reflected in the stock market. When the mood sours again, and historical patterns suggest it will (and we're seeing plenty of evidence of the divisiveness in our society and world), the stock market will suffer the consequences. It's just part of the cycle.

This cycle can also be seen in the savings rate. People tend to spend more during the good times because they feel confident about the future. But during bad times their fears cause them to save more and spend less. During the last secular bear market the savings rate in the U.S. climbed from a low of about 6% to a high of about 14%. The period averaged about 10% and many believe we'll see that kind of savings rate again. It could go higher as baby boomers try desperately to get some savings tucked away before retirement, which is fast approaching. The following chart shows where we were and how we "spent ourselves to wealth" during the previous secular bull market of 1982-2000:

U.S. Personal Savings Rate, 1960-2009

With an economy so utterly dependent on consumer spending it's no wonder the government has done the irresponsible thing and encouraged more of it. The government of course wants a more robust economy so that it will create jobs and get the wheels rotating again. After all, each one of their jobs is dependent on it happening. If you stop spending and the economy heads down the toilet you're not going to be happy with your representatives and they know it. You should do your part and drive yourself deeper into debt for the sake of the politician, er I mean, country. But a higher savings rate means it's good for the individual but bad for the country and by extension bad for job security for the politicians. Guess which way I vote.

So the market sold off today and we're left to wonder if it will mean much more than just a needed pullback before proceeding higher or if it's the start of something more serious to the downside. The weekly chart of the S&P 500 shows price remains inside its rising wedge pattern so no real harm done yet. I had mentioned the 89-week moving average last week (89 being a Fibonacci number and I noticed it did a good job supporting the pullbacks during the 2003-2007 rally) and that the last time it was touched in May 2008. The market didn't do so well after that. It touched it again last week and now we've started some selling this week. Could trading be that easy? Only time will tell.

S&P 500, SPX, Weekly chart

As noted on the chart, the upside target near 1121 may be too obvious, with the downtrend line from 2007 and the 50% retracement, and therefore will not be achieved (or may not stop the rally if it continues). When too many expect something you can expect the unexpected.

While the weekly chart shows the uptrend line from March still intact, the shorter-term view on the daily chart shows the uptrend line from July was broken with gusto today. This came after a bounce off that uptrend line last Friday so today's break is potentially very important, as would a recovery back above it. If the decline continues we should see support tested at the 50-dma near 1121 and the March uptrend line near 1015. A break below the uptrend line, confirmed with a break below the September 3rd low near 992 would be proof that the top is in place.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1070
- bearish below 1035 (broken today) and more bearish below 992

On the 60-min chart I've placed a parallel down-channel around the price action since last week's high. If the decline is to be just a pullback correction before proceeding higher into mid month (opex?), the bottom of the channel should hold as support (to complete an a-b-c pullback). A break below the bottom of a parallel down-channel is almost always confirmation that we're into a harder selloff instead of just a pullback correction. This will make the potential support zone of about 1015-1021 doubly important. Back above 1046 would negate the bearish wave count (dark red) and therefore use that as a stop level for short plays if you're hanging onto them in hopes of further downside.

S&P 500, SPX, 60-min chart

The DOW has broken below 9650, which was support yesterday, and in so doing it has confirmed the break of its uptrend line from July. The next support level is the 9420-9540 area (Fib retracement level, previous price high in August and 50-dma). If the DOW breaks below 9400 we could see a continuation of the selling down to its March uptrend line near its September 3rd low of 9250.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 9835
- bearish below 9650 and more bearish below 9250

One thing to point out on the DOW's daily chart, which is true for just about all tonight's charts, is the 3-wave decline from the high. Right now it looks like an a-b-c pullback and therefore maintains bullish potential. A 3-wave pullback that holds above the September 3rd lows can be followed by another rally leg to a new high (shown in pink). For those who are playing the short side of the market you need to respect this possibility. Do not get complacent and maintain good stop discipline. Take profits too early as Jim likes to say.

NDX is not quite as bearish as the DOW and SPX, even though it too broke its uptrend line from July. It's a relatively minor break so far and could easily recover back above it tomorrow. It held support near 1668 which is the August 28th high. A little lower it should find stronger support near 1645 where it has its 50-dma, uptrend line from March and broken downtrend line from October 2007. If that level breaks look out below.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1734
- bearish below 1668

As always, I like to keep an eye on the semiconductors since I believe they're a good canary for the techs and broader market. It too broke its July uptrend line but found support near its 50-dma. You can see from past price action that this moving average is not that influential but its broken downtrend line from 2000-2007 might be, which is currently near 303.

Semiconductor index, SOX, Daily chart

What I like about the SOX chart, from a bearish perspective, is the fact that it had a clean wave count finish to the upside, a throw-over above its rising wedge pattern, a drop back inside the pattern followed by a retest of the top of it, followed by a hard break below the bottom of the wedge. This is a pattern only a bear could love and the setup last week was the reason I was strongly recommending a short play on this index. These setups don't get much sweeter than this one. But as I mentioned under the DOW chart, don't get complacent here--the move down from the high is still only a 3-wave move and therefore could fit as just a corrective pullback that will be followed by another rally. I don't think it will but then it's not my money if you lose it because you didn't use protective stops.

The RUT looks the same as the others. The break below 590 is bearish but watch for potential support at its 50-dma near 579 and March uptrend line near 566.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 617
- bearish below 590

The banking index trades well around its trend lines and one is broken and/or retested it pays to watch how it behaves. You can see how it has reacted to the uptrend lines from March and July. The bold trend lines outline a rising wedge from July within the larger rising wedge from March. The negative divergences shown on the chart support the bearish interpretation of these wedges. Today's break is a key break and there is a high probability that we've seen the high. Until the September 3rd low near 118 is taken out there remains the potential, like the major averages, for another rally leg to a new high this month. But I consider that a lower probability at this point.

Banking index, BIX, Daily chart

One of the differences in the price pattern of the banks vs. the others is that the wave count is much more bearish. The possible a-b-c pullback was the move down to last Friday's low (which found support at the bottom of the bold wedge). Now that it has proceeded lower than Friday's low it has the potential to be in a 3rd of a 3rd wave down. These are the strongest moves and today's long red candle confirms this is probably the correct interpretation. This pattern suggests continued selling as it stair steps lower and probably break below 118 soon. But back above 132 would negate that bearish wave count and suggest the new high scenario is back in play.

Other than the SOX index giving me a very bearish opinion on the market, the broker/dealer index also had a chart setup that had 'SELL' written all over it and was the reason I highlighted it last week. We haven't received a confirmation from this index yet but the follow-through selling today after tagging the top of its wedge pattern on Tuesday and Wednesday for a kiss goodbye continues to favor the bears here. Confirmation requires a break below 114.

Broker/Dealer index, XBD, Daily chart

The improvement in home sales hasn't been helping the home builders' stocks. After rallying above its 50-dma in July the index has firmly dropped back below it. It's reaching short-term oversold and the pattern of the decline calls for a bounce soon but I expect the decline to resume its relentless march lower into the end of the year.

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

After consolidating at its uptrend line from July and its 50% retracement level, the Trannies let go of that trend line and could not hold at the August highs. Both look bearish to me. The March uptrend line near 3620 looks to be next on the agenda.

Transportation Index, TRAN, Daily chart

The commodity related index also broke its uptrend line from July today. This is in keeping with the all-the-same market theme where most asset classes will sell off together again, as they did during the 2007-2009 decline. That decline had many fund managers complaining that there was nowhere to hide from the carnage once the bears took over. In a deflationary environment there is nowhere else to hide except cash, and some bonds as I'll get into in a bit.

Commodity Related index, CRX, Monthly chart

With all the talk out there about inflation getting out of hand and how the Fed's money-printing scheme is about to launch us into hyperinflation, there's very little evidence of it yet in the commodities. Nor is the bond market telling us it's particularly worried about that yet. I've been watching the TIPS market (Treasury Inflation Protected Securities) and they've been running sideways for most of this year. So there's no real fear of inflation driving demand in that market. The longer-dated securities, such as the 10 and 30-year bonds have also been suggesting something different.

There are a lot of opinions about what bond yields will do over the next few years because of concerns about what the Fed's easing policy will do to the dollar, bonds, commodities and inflation. Most are very concerned about hyper-inflation because of the crushing of the U.S. dollar and too much money being printed. Zimbabwe is used as the latest example of how well it works when you try to print your way out of financial troubles. And of course we all know what happened in Germany that led to their financial ruin and WWII. So the hyper-inflationists are claiming bond yields will have to increase dramatically in order to compensate for the risk of owning bonds. Gold prices would soar well above $2000 under this scenario. While I don't discount their argument I will argue that they're early at best because of the deflationary cycle that we first have to get through.

Yields have been dropping during this decade while the Fed has been printing money at a furious pace. But total money supply continues to drop as deflationary pressures overwhelm the Fed. During the Fed's quantitative easing campaign gold has remained below its peak in March 2008. The scare talk is not being backed up by the selling of bonds and buying of gold. If instead we're going to experience another couple of years of deflationary pressures then bonds will rally as they will be one of the few asset classes where you can protect your money (and in a deflationary environment you don't need a higher rate of return on your bond investment). Cash is the other place you'll want to "invest" (it becomes more valuable as asset prices drop).

A monthly chart of TYX shows the possibility for the 30-year yield to drop to an unprecedented 2% before the bull market in bonds finishes. That's when I'd then short bonds and buy gold but not before. However, as shown on the TYX chart, a rally in yields above 4.67% would look more bullish for yields (bearish for bonds) and I suspect at the same time we'd see gold rallying.

30-year Yield, TYX, Monthly chart

Another reason I like to watch bond yields is because they've been acting as a good canary for the stock market. Yields have been leading the stock market as shown in the chart below. The high in yields in 2007 was in June while the high in the stock market was October. The low in yields was December 2008 while stocks bottomed in March 2009. Yields peaked again in June of this year and it's quite possible stocks have peaked as of September 23rd (but still have a chance at one more new high in October). I fully expect the stock market to follow yields lower.

SPX vs. 30-year Yield, 2007-2009, Daily chart

The other thing I pointed out on the chart, since it's pretty glaring, is the declining volume since May as the stock market has rallied. The declining volume along with a divergence between the stock market and the bond market is a clear and present danger to the stock market.

With gold not reflecting hyper concern about the hyper inflation scare, might it be possible there are too many talking about the need to own gold? From a contrarian perspective gold has way too many bulls on its side. I'd rather take the opposite side of that trade and I continue to recommend not holding gold here (unless you own gold for a longer-term investment regardless of its price) and even look to short it. But there is still the possibility we haven't seen the final high for the bounce in gold so I'm watching it closely here.

Gold continuous contract, GC, Daily chart

Gold held its broken downtrend line from March 2008 and looks like a bullish setup--a kiss goodbye against resistance-turned-support. The green wave count supports the idea we'll see one more push higher to complete the bounce off the March low. But if gold turns back down and breaks its recent low near 985 I think we'll see a hard selloff in the shiny metal and it could coincide with a selloff in the stock market.

Oil continues to consolidate in its trading range that it's been in since June. I see the possibility for a little more consolidation through this month and then a continuation of its rally into the end of the year (shown with the green wave count). If the dark red wave count is correct the next downturn, with a break below 65, should be accompanied by strong selling and a downside target near 50.

Oil continuous contract, CL, Daily chart

The payrolls number tomorrow morning could goose the market but as always it's hard to determine what kind of reaction to the news, whether it's good or not. Just be aware that there could be some early volatility.

Economic reports, summary and Key Trading Levels

We had a good setup last week to short the stock market and this week we got some follow through confirmation. But we've seen so many times where the bears get too complacent, thinking for sure the market is finally ready to recognize a little reality and sell off some. They then get blindsided by new buying that comes rushing back in. There is still a vested interest in keeping the market up until the end of this month.

But we can only trade what the charts give us and right now they've given us a bearish picture so that's how I'm trading it. The bears rule unless and until Tuesday's highs are exceeded. Use the new downtrend lines from last week to help manage your plays if you're short and looking for a reasonable way to trail your stops.

If you're long the market and wondering where your line in the sand should be located I would use the March uptrend lines. The market has no business below those lines if there's to be another leg up for this rally. The fact that some have already broken their March uptrend lines, like the banks, is your canary signal. Only you can decide how much you're willing to give back while letting this market bounce around without whipsawing you out of your positions.

For tighter control at this point I'd say you want to be short below SPX 1046, flat between 1046 and 1063 and long above 1063. Now we'll let the market show the way.

Good luck and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1070
- bearish below 1035 (broken today) and more bearish below 992

Key Levels for DOW:
- cautiously bullish above 9835
- bearish below 9650 and more bearish below 9250

Key Levels for NDX:
- cautiously bullish above 1734
- bearish below 1668

Key Levels for RUT:
- cautiously bullish above 617
- bearish below 590

Keene H. Little, CMT