Market Stats

With the European markets recovering somewhat from their selloff on Wednesday, it had our futures starting higher out of the gate this morning. It was then followed by a strong buy program and what few remaining short there are in the market, they were chased away again. The brief short-covering rally lasted about 10 minutes, getting the DOW up a little better than 100 points and that was it for the rest of the trading day. Another one-and-done kind of day.

To say this market has been difficult to trade during the past month, especially with quick morning moves like this morning followed by nothing, would be an understatement. The winners in this market lately have been premium sellers (naked options, cover calls, credit spreads, etc.). Anyone trying to make some money with directional plays, especially in options has only seen time premium bleed away. If you're good you've been able to make some money by day trading very fast--get in and get out (hopefully with a profit). This too shall pass but for many, not fast enough.

The big story for the past week has been the dollar and its rally. This in turn has caused some pain for commodities. We'll check the charts on all these to see what might be next.

I've been asked by a few to help understand why I've been bullish the dollar and bearish the commodities, including gold, and the stock market. Basically it has to do with longer-term cycles and the credit bubble that was created, especially in the 1990s and early 2000s, which led to the financial collapse in 2008. This credit bubble has been re-inflated by the Fed this year, I guess because they thought it worked so well the first time. As a side note, Bernanke has been getting some heat recently, as his term is up for renewal, because he did not see the financial collapse coming (he and his sidekick Hank Paulson kept telling us things would be contained). I'll go one step further and say Bernanke not only didn't see it coming, he helped cause it and now wants more control so as to prevent it from happening again. Watching the hen house is no longer good enough; he now wants the keys to it to make it easier to steal the hens. But I digress.

When a credit bubble collapses we get a credit contraction. It's call debt destruction because all the debt that was created is either worked off (paid down) or it goes away with a bankruptcy. CTI debt? Poof, written off ($2.8B of TARP money, down the drain). Dubai debt? Poof, written off. Home mortgages? Poof, written off. You get the idea. It's the reason all the money that the Fed is furiously printing is not resulting in inflation. The velocity of money, which is what the creation of credit increases, is in reverse and with that the money supply reverses. That's what's called deflation (or as the Fed likes to say, disinflation).

With deflation comes nasty things such as a drop in asset valuations. This means stock portfolios, home values and gold prices drop in value. You name the asset and you can bet it will drop. That's the bad part. The good part is that if your income can remain fairly steady you will pay less over time for the same stuff. Deflation is actually very healthy since it removes the excesses from the system. Central banks want inflation and have suckered all of us into believing inflation is a good thing. What's good about it? You get to pay off debt with cheaper dollars over time and the government lives on debt (as did a lot of people in the previous credit cycle).

A deflationary period makes cash one of the only assets that increases in value (you can buy more with the same dollar). It's why I've recommended getting out of all asset classes, including selling one's home if the situation is right. I've led a bit of a vagabond life for the past 5 years so it was an easy decision for me to sell my home and rent instead. I have no intention of buying for at least a few more years (renting has actually been more freeing than I thought it would be, since I've owned homes since the late 1970s).

With a disruption in asset prices, including the stock market of course, people become even more worried about what to do with their money. Bear markets are caused by a souring social mood. The previous good times were a result of happier moods and risk taking. That risk taking is taken to an extreme and then mood turns more cautious and then sours. This results in the cycles between secular bull and bear markets and they are as natural as the phases of the moon. When the mood turns sour and fearful we'll see people looking for safer bets for their investments (at least what's left after paying down their debts).

While we may think our country is headed for ruin and the dollar for the toilet, many others look to the US as at least a safer place to park one's money. This will add to the strength of the US dollar, which remember, is related to other fiat currencies. The dollar will be considered the safer place to be and that will result in a dollar rally. With a dollar rally will come a decline in value for dollar-based assets, which many commodities are priced in.

And that brings me back to why I'm bullish the dollar and bearish just about all other assets. Hopefully it makes some sense even if you disagree with the premise. It's what I base my "fundamental" analysis on and then look for technical indicators to either confirm or negate my expectations for the market. With that let's jump into the charts.

The weekly candles on the SPX chart are getting a little crowded after having the market go virtually nowhere over the past month. SPX has stalled beneath its 50% retracement of the 2007-2009 decline (1121.44) and after breaking its uptrend line from March through the July low (not shown) it is now threatening to break the uptrend line from March through the November low. Bulls are looking at the sideways consolidation as a bullish consolidation while the bears are looking at it as rolling top that is getting ready to sell off. While I do see the possibility for the market to be held up, with a little more rally, into the end of the month, there are many signs that the rally is topping.

S&P 500, SPX, Weekly chart

On this chart I'm using the log price scale to show where the downtrend line from October 2007 is located when using the log scale. Using the arithmetic price scale, that downtrend line has already been broken and sits lower near 1083. In fact it was tested on Wednesday and held. But using the log price scale, that trend line is higher near 1133. One price projection I've got on the chart is at 1132.70, which is where the rally from March would have two equal legs up if I use the 1st leg up to the May high and the 2nd leg up from the July low (with the sideways consolidation between those two points separating the rally legs). That price projection crosses the downtrend line, using the log scale, on December 21st. This scenario supports the Christmas rally so bulls can hang onto that hope.

But the bears have something to hope for as well. The daily chart, also using the log price scale to match the above weekly chart, shows the uptrend line from March through the November low is currently where SPX has stalled. A resumption of the selling on Friday would suggest the bearish price pattern is going to play out, which calls for a move down to the 1060 area by mid month (in which case we can kiss the Christmas rally goodbye). A continuation higher on Friday, especially if it can above 1111, should be a good sign for the bulls and their Christmas rally. In other words, price action tomorrow could tell us how next week will go.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1111
- bearish below 1079

Moving in closer with the 60-min chart shows what to watch for on Friday. If the bulls rule we should see today's sideways consolidation resolve to the upside. But watch for resistance near 1110-1111, a pullback to correct the leg up from Wednesday morning, and then a continuation higher into next week. Bears have it easy--watch for a break below 1095 and then hop aboard and hang on for the ride down.

S&P 500, SPX, 60-min chart

The DOW has the same setup as SPX--an immediate selloff Friday morning will be bearish whereas another push higher above today's high will be bullish (watch for a pullback after the new high and then get long, for a trade only). The upside potential is to about 10700 where it would hit its trend line along the highs since May (again) and a Fib projection for the a-b-c move up from November (where the 2nd leg up would equal 62% of the 1st leg up).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10230

When looking at longer-term charts it's often a good idea to flip back and forth between arithmetic price scale and log price scale, especially when using trend lines. The larger a price move the more appropriate it is to use the log scale. If we look at this year's rally in the DOW we can see the difference in the trend lines. Using the arithmetic scale, shown in the top chart below, the uptrend line from March through the July low has not been tested yet and is currently near 10090, which is the location of the 50-dma. An uptrend line from July through the November low also has not been tested yet, although it came close on Wednesday. The downtrend line from October 2007 is where price has been stalled since mid November and DOW closed slightly back above it today.

Dow Industrials, INDU, arithmetic vs. log price scale, Daily chart

When looking at the same chart and trend lines using the log price scale we see the uptrend line from March-July was tested at the October 2nd low, broken with the move down to the November 2nd low, recovered and then broken again on November 27th. It has been acting as resistance since then, with the last test on Friday, December 4th. Now it has dropped down to the uptrend line from July-November which is acting as support. If that trend line (red one) breaks then the next test will be the uptrend line from March, using the arithmetic scale, down near 10090. Using the log scale, the downtrend line on the lower is currently near 10700, the same place as I identified on the daily chart above.

NDX has been very gappy lately. Looking at its daily chart reminds me of overseas symbols. Price is stuck between a trend line along the highs since September and its uptrend line from March. It could literally go either way here and I don't have enough clues to help me lean one way or the other. Follow the blue chips.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1816
- bearish below 1742

Maybe the semiconductors will be able to provide us some clues for the techs. Right now we've got a bearish setup but it needs to reverse back down now in order to stay bearish. The rally from November 2nd achieved two equal legs up today by tagging 341.54 (today's high was 342.12). That move can be considered the completion of its longer-term rally but again, only if it starts back down on Friday. If that happens then I would be suspect of any bullishness seen in any of the other indexes. We've already got relative weakness in the banks and small caps so weakness in the semis would be icing on the bear's cake.

Semiconductor index, SOX, Daily chart

The RUT has a slightly different pattern than the others and has two downtrend lines to consider. The first is the one from October 2007 through the September 2008 high, which is quite a bit higher than the current price. The 2nd one is from September 2008 through the October 2009 high, which is where price is currently trapped under. Any continuation of the rally above 607 would be bullish and I have some upside potential targets between 610 and 620. It's been holding onto its 50-dma (you can see the little bird feet sitting on it this week) so a break of that level (on a closing basis), near 594, would likely be bearish. But the uptrend lines and price support between 589 and 577 will give the bears a lot to worry about.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 607
- bearish below 577

Taking a look at the bigger index, the NYSE, for additional clues leaves us with the same kind of setup. The NYSE is fighting to get back above its broken uptrend line from March-July. The break of the trend line is bearish so far and a kiss goodbye after today's test would be a sell signal. A rally back above 7200 would be bullish for a run up to a price projection near 7330.

NYSE Composite index, NYSE, Daily chart

I mentioned earlier the weakness in the banks is not giving me any bullish feelings about this market. Could the broader market get manipulated, er I mean, pushed higher? Sure. But unless the banks participate I'll stay suspicious. Follow the money. And right now the money is fleeing. After hanging on by the skin of its teeth to its H&S neckline this week, the BIX gave it up today and closed below it. It could turn into just a one-day break, especially since it's still above its November 5th low near 122, and rally back up for a save. This is another reason buying or selling on Friday will provide some much needed clues for next week.

S&P Bank index, BIX, Daily chart

The other banking index, the KBW, was also clinging to support this week with little dojis on its price-support line near 43.50. It also gave that up by closing below it. It could be just a minor break for the banks but all major declines start with minor breaks.

KBW Bank index, BKX, Daily chart

While the banks gave up support today the Trannies hung on. Like the banks the TRAN had little dojis on its support line (resistance turned support near 4055) and today closed slightly above it. But notice it rallied back up to its broken uptrend line from March-July and sold off--bearish kiss goodbye. At today's high of 4099 is its downtrend line from May-August 2008 so the bulls have some work to do while the bears just need some selling tomorrow to get the TRAN back below support.

Transportation Index, TRAN, Daily chart

The US dollar finally did it--it found its bottom. Once its bottom was firmly grasped with both hands it leaped out of its parallel down-channel that it's been stuck inside of since August. With the strong rally in the dollar has come some pain for commodities and while the stock market has shown some stoicism, relative to the commodities, any continuation of the rally in the dollar is going to hard on the stock market.

So far the dollar looks to be developing an impulsive rally, meaning the trend has changed from down to up. My best guess at the moment is that the dollar needs another leg up to complete a 5-wave move up from its November low and preliminarily I have an upside target around the November 3rd high of 77.50. Following that move should be a pullback to correct the leg up and then a continuation higher into January (and well beyond).

U.S. Dollar contract, DX, 120-min chart

With the dollar rallying it has had a negative effect on commodities and commodity related stocks. The commodity related equity index, CRX, shows traders clearly paying attention to the uptrend line from March-July, which was tested and held at the November 2nd low and most recently at Wednesday's low (731.52). It looks like it could bounce a little higher, especially if the broader market does (and if the dollar pulls back some more), in which case I'd watch for a Fib target near 764. Any turn back down from this bounce that then breaks its uptrend line and Wednesday's low will be a confirmed sell signal.

Commodity Related Equity index, CRX, Daily chart

That pop you heard last week was gold's bubble getting pricked. The rally came very close to its Fib price projection at 1231 where the final 5th wave would have achieved 162% of the 1st wave, a very common occurrence in commodities, especially when the 5th wave extends in a parabolic blow-off move like gold did. Now the question is whether we'll see gold simply pull back before launching higher still (that's what I'm reading by a lot of analysts) or if instead gold will follow the path of oil after it's bubble popped in 2008. I think the latter but only time will tell.

Gold continuous contract, GC, Daily chart

If gold is heading lower and the stock market is heading lower (either now or in another week or two) then the gold miners must be heading lower, and they are. GDX has dropped sharply out of its rising wedge pattern and these are typically retraced faster than it took to build them. That would mean back below the November low before the end of December. Right now it's finding support at its 50-dma but it should be good for only a bounce before it presses lower again.

Gold Miners, GDX, Daily chart

The bullish flag pattern that oil was in turned out to be a head fake. When price patterns fail, like flags, they tend to fail hard because too many traders are caught leaning the wrong way. You can certainly see the result of that in the selloff in oil. If I've got the wave pattern correct we should see a steep selloff into January, potentially getting it below $60 by then before we can expect a bigger bounce to correct the decline.

Oil continuous contract, CL, Daily chart

Note that I'm using the log price scale on the chart above because it shows how the February-September uptrend line was tested in mid-November, showing traders were using this line and price scale, broke it on November 24th and then retested it the next day and then again on December 1st. Once that last test failed it was bombs away.

Today's economic reports were not market movers, especially since there were no major surprises.

Economic reports, summary and Key Trading Levels

The initial unemployment claims ticked back up and started some chatter about last week's job numbers being more of a fluke than anything else. But it didn't stop "someone" from ramping the market higher out of the gate this morning. The trade balance number showed a slight improvement, attributed to the slowing demand for oil.

The next chart is a little scary when you see how much Federal tax receipts have slowed down vs. how much the government is spending. What most people seem to forget is that the government doesn't make any money; they only waste it. The government deficit problem would be bad enough with the loss of revenue but that hasn't stopped Congress' profligate spending. They've added a huge debt burden to future generations (unless we default on our loans sometime down the road) and this chart says it all.

Federal Receipts and Outlays, chart courtesy

The bad news is that revenue continues to drop sharply, as can be seen at the bottom right. The good news is that spending has come down a little, circled at the top right. Congress is talking about another stimulus package (since the first one has worked so well, cough) and they want to prevent further job losses (their own) so I think it's safe to say the divergence in those two lines will continue, especially as we approach elections next November.

So a quick summary of what I've shown tonight is that we're on the cusp of knowing how next week, and possibly this month, will go. Tomorrow holds the key and any further rally has the potential to push the market to new highs next week (just not sure about some of the laggards like the banks). But if the sellers take over we could see some hard selling instead. Because the sideways consolidation over the past month looks bullish on the charts, I think it has a lot of traders leaning to the long side. As I mentioned for oil and its failed bullish pattern, any failure to rally would be a failed bullish pattern and failed patterns fail hard.

At this point, I'd say any further rally would be more a gift to the bears rather than the bulls. While it would be great for the bulls to hang onto their gains a little longer, I don't see enough upside potential to make new trades on the long side worth the risk. But a new high will make for a better setup to get short. If the rally continues it's a very good time to draw an uptrend line from November through Wednesday's low and use that as your guide--once it's broken we should see the start of the next major bear market leg down.

If the bears are not given the gift of a new high into next week (which could go longer than next week, such as the December 21st date I discussed with the SPX charts) and instead we see selling on Friday, the risk for longs increases since the selloff could become intense into next week. A drop down to SPX 1055 by next week would mean the DOW will drop below 10K. For now use Wednesday's lows--if those break then the bears rule.

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

Key Levels for SPX:
- cautiously bullish above 1111
- bearish below 1079

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10230

Key Levels for NDX:
- cautiously bullish above 1816
- bearish below 1742

Key Levels for RUT:
- cautiously bullish above 607
- bearish below 577

Keene H. Little, CMT

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