Market Stats

This morning's economic news was considered good and the earnings reports from Government Sachs (GS) was strong (as long as you don't look under the hood) but futures had sold off before the open and the cash market followed it lower for the first hour. But then there was a concerted effort to lift the market back onto its feet so that it could continue its relentless climb higher. The DOW tacked on another 47 points to close at its high of almost 10,063.

The DOW outperformed the others and makes it look like there might be an agenda on that index (do you think?). As I'll show in tonight's chart it's getting very close to an upside target I've been eyeing for awhile so I'm hoping to see a little more upside tomorrow. It could be a mixed start to the day tomorrow based on opposite reactions in after hours as GOOG reported good numbers that beat expectations and the stock spiked above this morning's high. I've been looking for a high in that stock but might have to wait another day to see how it does on Friday.

But IBM reported after the bell as well and was not greeted with the same bullish enthusiasm. They beat last year's earnings, beat estimates and raised their earnings outlook for the rest of the year. But much of the improvement was again on cost cutting and that's not what the market wants to hear. It needs to hear increased revenue otherwise the whole premise of this year's rally is called into question (and Hoofy doesn't appreciate being questioned). Tomorrow morning's reaction to GE's earnings could be telling as well. Remember, this is the earnings cycle that the market needs to start hearing about increased revenue otherwise people are going to move into profit-lock mode.

News from the real estate market continues to sound dire. RealtyTrac ( is a leading online marketplace for foreclosure properties and today it released its "U.S. Foreclosure Market Report" for Q3 2009. It shows that foreclosure filings, which include default notices, scheduled auctions and bank repossessions, were reported on almost 938K properties in the 3rd quarter, a 5% increase from the 2nd quarter and an increase of nearly 23% from Q3 2008. This equates to one in every 136 U.S. housing units that received a foreclosure filing during the quarter.

The good news is that we're seeing a decrease in the percentage of foreclosures related to the lower-priced homes and subprime mortgages. The bad news is that the more expensive homes and pristine prime mortgages are now becoming the greatest percentage of mortgage defaults. As many of us have known, and I've certainly discussed all year, the next wave of defaults will be the option ARMs (adjustable rate mortgages), many of which were interest-only loans. The numbers of these mortgages in the past pointed to a high failure rate starting in the 4th quarter of 2009 and peaking around mid 2010. Currently 46% of option ARMs are at least 30 days past due. And so far only 12% of these ARMs have reset to a higher rate. So in other words the bulk of the housing problem hasn't even hit us yet. This does not sound like an economy that's recovering.

The unemployment situation continues to get worse and not better. The pundits would like us to believe that this is a lagging indicator and that unemployment always peaks after the end of the recession and therefore the stock market predicts its recovery. Unfortunately the market has a habit of predicting a recovery many times before getting it right (they're called bear market rallies). The reason it's fundamentally different this time is because we're into a fundamental shift in our economy. When we do recover it will be to a new, and lower, normal level. Jobs being shed today are permanent cuts. Many won't be coming back and people will need to find new fields of employment.

Much of the new employment opportunities will be in exciting new fields, many of which literally haven't been invented yet. My hope and desire for government stimulus spending (instead of pork barrel projects aimed at keeping the representative employed) is in job training. Get the unemployed the job training needed to enter new fields. It will be a slow process and in the meantime the credit contraction that the economy is going through will permanently downsize many organizations, including manufacturing (we will consume less on a global scale). Construction jobs will be slow to return as we build less. It's a necessary, albeit painful, process of deleveraging the huge increase in most everything in the past 20 years (we supersized everything, including our bodies).

When we consider the number of people who are unemployed or underemployed, which by the government's numbers (U-6) is close to 17%, and then add in the family members of these people it's not hard to imagine about a quarter of our population not able to spend like they used to. Covering the bare necessities (food, clothing and shelter) is difficult enough for many families right now. So the question we must ask is how can companies expect to profit on increased sales soon? Where's the extra income going to come from when most recognize could be at least another year before unemployment peaks?

The answer of course is that increased sales can't happen and the market will soon recognize this fact, potentially very soon in the current earnings cycle. Inventory has been cut for the 13th month in a row and each month the pundits greet this news with great cheer and declare what good news this is because those companies will now have to rebuild inventory for the coming sales increase. Hello!? What sales increase? Inventories are being reduced to a permanently new lower level. This is what I mean when I say we're going to have to get used to a new "normal". The stock market is behaving as if we're going to recover and drive to new highs. Many believe we've been through just a normal recession and that it's now over so let the good times roll. This is highly unlikely given the significant and fundamental shift that is occurring in our economy and financial structure.

As for yesterday's "good" news about retail sales (actually it was less bad as sales are still down significantly year-over-year), it must be acknowledged that the same-store sales came from stores that have been in existence for at least one year. Many of the stores that were losing money have been closed and therefore that data wasn't included. According to the Fed, nearly 8,300 stores have been closed this year. We've only completed 9 months of the year and already this exceeds the 6,900 tally for all of last year. But you don't hear the pundits talking about these points. It's called spin and right now the bullish spinsters have the microphone.

Companies continue to meet or beat (lowered) expectations but none of it is coming from increased revenue (except the government supported hedge funds called Government Sachs, JP Morgan,, which are doing it through their trading desks and assuredly not through normal banking operations). Cost cutting in these companies includes reducing employment and it's continuing. Once the stock market gets visible proof that their hope-filled rally has nothing but smoke and mirrors holding it up it could collapse quickly.

The hiring news from small companies continues to be dismal. Firms with one or more job openings remained at an all time low of 8% in September and those planning to increase employment fell another 4 points to -4, a 4-month low. Overall, small firms are still cutting jobs and very few are adding. This is the source of most of the hiring and there's no sign of abatement in the unemployment situation. There was a good article in the NY Times last weekend that highlighted the problem: Small firms face credit squeeze.

One problem the smaller firms are struggling with is the reduction in credit available to them. Meredith Whitney commented on this last week. Those who don't need to borrow can borrow all they want. Those needing to borrow have been cut off. The reduction in credit in the past year has been staggering and it's the biggest evidence of the deflationary pressures (even if the stock market has refused to acknowledge it this year). Just since the end of May total bank lending contracted by almost $400B which was a -17% annualized rate. Without credit the smaller firms can't make payroll and pay for other short-term expenses. They fold and more people are out of work. In the meantime the fat cats in the large banks, which are not lending money or laying enough money aside for loss reserves, are getting ready to pull down billions of dollars in bonuses. Grrr...

The bottom line this time around is that unemployment is a leading indicator and until employment numbers improve we will not have the economic recovery like we've seen in the past 30 years. This year's rally has been pinned on hope that that's not true. Only time will tell but right now I'm seeing a market that is toppy and only time will tell how much of a decline we'll get. I think it could easily test the March low if not worse. I think it's at least a good time to be protecting gains rather than looking for more. Speculative traders who understand the risks of shorting the market will have a very good opportunity soon, if not now. Let's start with the SPX weekly chart.

SPX continues to press up against its trend line along the highs since May and is now getting a lot closer to its downtrend line from October 2007 and its 50% retracement of the 2007-2009 decline (1121). One good push into next week could easily accomplish that level and I think it would be an excellent place for those who are long the market to take profits and even play the short side from there. Whether SPX can make it up to that level is the question in my mind this evening.

S&P 500, SPX, Weekly chart

The first resistance level that's a little less than 3 points above today's high is the gap left on October 6, 2008. That gap would be closed at 1099.31 (filled a little faster than many, myself included, thought possible back in March). With the continuation of the negative divergences at the new highs and considering the strong resistance levels between 1100 and 1130, I'd be very reluctant to enter any new long positions and would instead be looking to initiate new short positions. Note the expanding triangle pattern forming since August--this is a bearish reversal pattern and will have a 5-wave count inside it (shown as waves i through v). It's into its final 5th wave so bulls beware here as it could fail at any time (without reaching the top of the triangle.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1100 (up to perhaps 1120-1130)
- bearish below 1070, confirmed with a break below 1040

The final 5th wave up, which I mentioned above, is shown in more detail on the next chart. The move is creating a bearish rising wedge pattern and it too looks like it's now into the final 5th wave up. I show the first Fib projection for the move just shy of 1103 and then another upside target near 1113. The rising wedge pattern suggests 1103 is all we should see and that's only if the rally continues to chug higher on Friday (instead of a sharp thrust higher which would be more bullish). A break below 1080 would tell us it's all over.

S&P 500, SPX, 60-min chart

The expanding triangle is shown with the bold blue lines on the DOW chart. Like SPX it's into its final 5th wave for the pattern, the top of which is near 10150. This would also be a retest of its broken uptrend line from July. To say I like this setup for a short entry (longer-term play) would be an understatement. If the DOW manages to tag 10150, or 10205 for a throw-over finish, and then starts back down you'll want to protect/exit long positions and try the short side. Two equal legs up for the rally from March is at 10205 which is why I mentioned that level. Much above 10200 would have me backing off and watching for a bit, especially since MACD is hinting of breaking its downtrend line.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 9900 (up to perhaps 10150-10205)
- bearish below 9900, confirmed with a break below 9600

NDX is now very close to its 62% retracement of the 2007-2009 decline (1773) but it's starting to struggle. Techs underperformed in today's market and NDX is starting to look like a double top in the making (with negative divergence). But it's only 20 more points up to 1773 so watch for resistance if reached. The risk is it can start back down at any time now since the upside pattern can now be considered complete.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1773
- bearish below 1730, confirmed with a break below 1690

Another reason NDX may be topping right here is because of the time factor. Each rally leg off the lows since November 2008 have lasted a Fibonacci 13 weeks, +/- 1 week. Today is the 14th week from the July low. If the time cycle is to hold, next week will start back down.

Nasdaq-100, NDX, Weekly chart

The semiconductor index is another one that looks to be giving us a double top. At the same level it was testing its September high it was testing (again) its trend line along the highs since January. It too sports a nasty looking negative divergence against that test. It also closed back below its broken uptrend line from July. The intraday chart pattern supports the idea that we've seen the top. If it starts down immediately Friday morning it will confirm a trend change to the downside (small 5-wave move down from the high). A new low on Friday should be followed by a bounce which would then be an excellent shorting opportunity with your stop at a new annual high.

Semiconductor index, SOX, Daily chart

The RUT has been slightly weaker relative to the other indexes. It hasn't quite been able to test its September high and is leaving an even more bearish looking negative divergence. There's just no momentum in the rally effort from October 2nd. A break below 606 should be a heads up that the rest of the market should follow it lower (I think the RUT will be a leader to the downside).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 606, confirmed with a break below 590

The granddaddy of the indexes, the Wilshire 5000, is showing an interesting setup this evening. Today's candle looks suspiciously like a hanging man doji right at resistance (its downtrend line from October 2007). This is one of those charts that's screaming at you "SHORT ME!" Tomorrow should tell us plenty in this regard. I do have a price projection to almost 11640 (two equal legs up from March) so that's the level to watch if we get a throw-over above its downtrend line (for a bull trap?) and then drop back down below it.

Wilshire 5000 index, Daily chart

If the banks drop back down on Friday it will create a sell signal. Today's candle is an even more bearish dragonfly doji after a little throw-over above the top of a rising wedge pattern. If that rising wedge pattern is correct and the throw-over finish is followed by a move back below the top line (so below 137) it could be the kickoff to a much stronger decline. If it continues higher instead then the rising wedge pattern would be negated and that would be bullish.

Banking index, BIX, Daily chart

We got the expected bounce in the home builders and that sets up a stronger decline as the next move. The 50-dma at 283 provides a little more upside potential if it can push a little higher. If it rolls back over from here we'll have a sell signal on MACD (bounced back up to the zero line to "reset" itself).

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

Showing the weekly chart for the transports, I want to keep its rally in perspective and show the upside potential if the rest of the market cooperates. Its downtrend line from May 2008 and 62% retracement of the decline from October 2007 (which was a lower high than May 2008 but was the end of its rally from 2003) coincide at 4206 next week. That would be a good place for this index to take a rest. So far it's testing its September high with negative divergence.

Transportation Index, TRAN, Weekly chart

The argument between inflationists and deflationists will continue for some time to come. I happen to be a deflationist and it's not because I want to be but because I think I have history on my side. Past incidents of a severe credit contraction (1930s being the last one) have been accompanied by a deflationary cycle. Credit contraction is by definition deflationary.

One of the biggest arguments of inflationists is what's happening to the U.S. dollar. It's been getting crushed and that's because the Fed is hell bent to destroy it (by creating massive amounts of money out of thin air). While inflationists are right technically (more dollars than goods creates an inflationary problem) I continue to think they're early from a timing perspective. The velocity of money is the missing component and this comes from leveraging the money.

The leveraging typically comes from lending where banks lend out 90-95% of their money and keep the rest for reserves and then banks down the line do the same thing, and on down the line, the result being the original $100 is leveraged to a much higher amount. But we know banks aren't lending and instead they're sitting on the cash. It's not multiplying as fast as the Fed would like and therefore the velocity of money is declining and that means the growth in the money supply is declining. That's deflationary and while the Fed is fighting it for all they're worth they can't make the banking officers lend if they're too scared to lend or for borrowers to borrow if they're scared and maxed out.

The following chart shows the growth rates in M2 money supply and you can see the significant drop in its growth rate in 2009:

M2 Money Supply, 1980-2009 chart

The above chart shows rate of growth grew steadily from 2005 to the start of this year, with a spike up in 2008. The spike back down in 2009 means the rate of growth is slowing (to about +5% from +10% last year). Who knows if the recent trend will continue but if the deflationary cycle persists, which I believe it will, that line should continue lower.

Now take a look at bank credit. This is where the velocity factor for money growth comes from. It has nosedived within the past year. This is what the Fed is trying to fight.

Bank Credit, 1970-2009 chart

Again, this shows percent of growth in credit and just recently it dropped into negative territory. This is the empirical evidence of all the stories we read about how difficult it has become to get a loan. The banks prefer the carry trade where they borrow the money from the Fed at dirt-cheap rates and then invest it in Treasuries paying 4%. It's a can't-lose trade in their minds vs. the risk of lending it out to a struggling small business (which they're forcing to struggle even more). And of course the big investment banks need the money to continue their risky speculative trades in the market so they can pay themselves royally. When they blow up again, and they will, they'll come hat in hand back to the Fed who will bail them out again (mark my word on that). The only way to stop the Fed is to support the bill being sponsored by Ron Paul, and cosponsored by many, to get the Fed audited.

If we're going to head further into the deflationary spiral it will bolster the value of the dollar and crush just about all other assets. Looking at the dollar's chart I see it's now very close to a downside target I've been eyeing at 75.23. Whether it gets there (today's low was 75.40) or drops further will only be known in hindsight but I continue to like the setup for a long play in the dollar. UUP is the ETF that can be used as the proxy.

U.S. dollar contract, DX, Daily chart

Did you hear the bell at 1071 for gold? That was the upside target based on its sideways triangle that ran from June through August and is shown on the chart. The setup is good for a reversal back down now and the downside target is well below 900. The fact that gold looks ready for a reversal down at the same time the dollar looks ready for a reversal to the upside is mutually supportive. The only thing I'm wondering about is silver which looks like it could give us one more new high to about $18.50 (so another dollar higher from today). But silver needs to rally right away to keep that potential. Below 16.78 would negate the upside potential for silver and confirm the reversal for gold, especially if gold drops below 1025.

Gold continuous contract, GC, Daily chart

I have no update for the chart on oil since at the moment I can't make much sense of it. Today's strong rally (+$2.40 to $77.58, +3.2%) certainly looks bullish but in light of what the metals and the US dollar are doing it's not making much sense at the moment. I think oil could make it to about $80 but if the dollar starts a rally I'm not so sure it can do better than that. I'll see if next week's chart pattern is making any more sense.

The economic reports today showed the inflation data picking up a little but it's all in the noise category. The market pretty much ignored the report. The Empire Manufacturing number was very good but the Philly Fed index showed a contraction. More noise. Tomorrow we've got some potentially market-moving numbers coming out. The capacity utilization rate has been steadily dropping lower so a good number there could boost the bulls' drive to higher highs. Same thing with industrial production. If those numbers, or the consumer sentiment, scare the bulls at all, especially since many are on pins and needles about the current rally getting a little stretched, we could see a knee jerk reaction with a sell now, ask questions later (many are going to quickly move into profit protection mode, otherwise known as bonus protection).

Economic reports, summary and Key Trading Levels

Summarizing, the various charts look like they're ready to reverse at any time. While I see a little more upside potential, such as the DOW to 10150-10200, we could see a reversal start at any time. This is one of the best setups I've seen since monitoring the rally for an end point. The bearish patterns and negative divergences, along with strong resistance levels being reached, all point to the end of the rally here or slightly higher. I consider the long side to be very risky now.

Trying to short the market has been an exercise in frustration for the bears while every dip has been a very good buying opportunity. Just off the October 2nd closing low for the DOW would have netted you a 6% gain. Not bad for two week's worth of work. At this point though I consider the upside to be very limited and a quick decline back below the October 2nd low could net you more than 6% and in less time. At least that's the potential out of the ending patterns it appears we're in.

So I'm trying to pick a top here and this one (or slightly higher on Friday) is about the best one I've seen for the whole rally from March. It doesn't mean we'll head lower from here but I sure like the odds for that happening.

One last chart, since I referenced a short play on GOOG last week, which got stopped out on Monday with a new high, I want to see how it's looking now. I had mentioned that if stopped out, look for another entry at a new high. I had thought today looked like a good setup and mentioned it on the live Market Monitor, again with a stop at a new high above today's (536.90). The after-hours reaction to GOOG's earnings took care of that one this evening with a move up to 547.90 and a close at 546.25. If the bulls can hold this and rally it further on Friday there is the 62% retracement of the 2007-2008 decline near 556. But if this week's throw-over above the top of its rising wedge pattern is followed by a collapse back inside the wedge (so below 525) it will be a good sell signal. Finding the top is proving elusive on this one, but I continue to think it's very close.

Google, GOOG, Weekly chart

Good luck tomorrow and remember its opex Friday, a typically slow day. I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1100 (up to perhaps 1120-1130)
- bearish below 1070, confirmed with a break below 1040

Key Levels for DOW:
- cautiously bullish above 9900 (up to perhaps 10150-10205)
- bearish below 9900, confirmed with a break below 9600

Key Levels for NDX:
- cautiously bullish above 1773
- bearish below 1730, confirmed with a break below 1690

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 606, confirmed with a break below 590

Keene H. Little, CMT