Market Stats

There has been a very high level of expectation that we'll get an end-of-year rally. There are not many bears remaining who instead believe the weakness in the market will identify itself through selling into the end of the year as the disappointed bulls run for cover and protect profits. With the price pattern we've seen since mid November I'd say both sides have been disappointed lately.

Market sentiment is getting scary bullish. I constantly read how bearish everyone is but you wouldn't know it from the data that's collected by Their data shows a high percentage of bullish advisors vs. bearish ones. If the ones who are not committed are removed from the data you get a clear picture of those who are committed bullish vs. those who are committed bearish. As the following chart shows, the bull:bear ratio has climbed above 3:1 and hasn't been this high since October 2007.

InvestorsIntelligence Bullish vs. Bearish Advisors Survey, chart courtesy Elliott Wave International

Sentiment cannot be used as a timing signal for trading but it can certainly be used for a heads up. With the market pressing up against resistance levels with waning momentum and very high bullish sentiment (which means it's hard to find more bulls to help power the market higher), it becomes even more important to watch for signs of topping and breaking down. It's time to walk over to the other side of the ship so that you're on the high side when it rolls over from too many bulls on one side.

But we've had plenty of warnings of a market top for a few months now. The bulls simply laugh in the faces of the bears (after gorging them) and continue to press higher. Bulls will argue the fact that the economy is improving, the job picture is looking brighter (remember, even a candle burns brightly in the dark) and peoples' moods are improving. Well, scratch that last one.

The market rarely turns down on bad news. It's that wall-of-worry thing. Market tops are most often made on good news. Think of it as the ultimate sell-the-news event. Market bottoms are usually made when everyone is predicting Armageddon after citing how bad the economy is doing. Therefore, predicting higher or lower stock market prices based on good or bad economic news is not necessarily something you want to do. That's usually old news. Looking ahead is what the market reacts to and that's a much harder thing to do. So we look for evidence in the charts, and things like sentiment, to help provide some clues--ahead of economic numbers--as to where the market is headed next.

The first chart I want to look at tonight is the weekly chart of the NYSE. This gives us a very good perspective of where we were and where I think we're going. It has one of the clearest wave patterns and makes for a good reference for why I think the market's next big move is back below the March 2009 low. I can get into lots of arguments about why I believe the market is in a secular bear market, why the credit contraction (debt destruction) will cause more problems ahead, why we'll have an environment more similar to the Great Depression than most would like to admit, and a slew of other reasons why I think this year's rally has been built on hope, which is actually less stable than the sand under Dubai's buildings.

Many (most) don't follow Elliott Wave analysis and that's OK. We all need to pick the technical tools that work best for us--meaning we have to be comfortable with it to make trading decisions. Mine happens to be EW. And when I look at the EW pattern for the NYSE I see a major decline in front of us. All those arguments I mentioned above merely support what the chart pattern is telling me. The move down from the 2007 high is a 5-wave move which means it's an impulsive wave count which defines the trend direction. A 5-wave move down followed by a correction will be followed by another 5-wave move down, no ifs, ands or buts.

NYSE Composite index, NYA, Weekly chart

EW patterns are always subject to some interpretation which is why a room full of Elliotticians will be no less an argumentative group of people than any other group of market analysts. That's why it's important to use other technical indicators and to understand the underlying fundamentals to see if they support what the wave pattern is saying. I have little doubt about the supporting picture I'm getting from the other tools and fundamentals but I am constantly testing it to see if the picture changes.

This year's rally is a 3-wave move (actually a little more complex than a simple 3-wave bounce but on the weekly chart it's clearly just a 3-wave move and I've labeled it A-B-C). A 5-wave move down followed by an A-B-C correction will be followed by another 5-wave move down and oftentimes it will be the same size (or larger).

The 2007-2009 decline on the NYSE was about 6200 points. Another 6200 points from this month's high gives us a downside target of about 1100. That's a scary decline and seems a little excessive (although maybe not) so I like to look at percentage declines for equality when we get big moves like we've had. The 2007-2009 decline was 59.7% so the same percentage decline from the December 4th high near 7285 gives us 2936 for a downside target.

The 1994 low, which is the low before the stock market started its parabolic climb, is near 2570. A parabolic climb will very often retrace back to its origin so as scary as those downside numbers seem, it would not be at all unprecedented for the market to drop back down to the 1994 lows. For reference, the 1994 lows for the DOW and SPX were near 3600 and 440, respectively. When you hear the real bears out there talk about their expectation for the DOW to get back below 4000 this is where it's coming from. I happen to be one who believes this will happen so I can be forgiven for constantly begging those who are long the market to get to cash. Just think of the buying opportunity down there if you've got the cash! :-)

For SPX its 2007-2009 decline was nearly 58%. That kind of decline from its December high of 1119 gives us 473, so once again, close to its 1994 low of 440. To those who think I've been smoking some whacky weed and that there's no way the market could get that low again, all I can say is go study the historical patterns following periods of "irrational exuberance". Look at the chart of oil after it went parabolic from its January 2007 low into the July 2008 high. It quickly retraced the entire rally and dropped below the January 2007 low. I could of course be completely wrong and we'll only know that in hindsight. It's merely a risk at the moment (or a money-making opportunity if you want to play the short side).

So after that bit of a sobering and bearish outlook, let's get on with our normal charts, starting with the SPX weekly chart. I'm sticking with the log price scale for the weekly chart to show the downtrend line from October 2007 that's just above the current price, near 1133. Because that lines up with the price projection at 1132.70, for two equal legs up from March, I would love to see that happen next week. In the beginning of this week I was thinking we would get it. Now I'm not so sure and that has to do with the market weakness following the FOMC announcement on Wednesday. For those who follow EW counts you'll see that I'm carrying a slightly different wave count for SPX than I showed for NYSE. Both call for lower prices below the March low but the longer-term pattern could be different. For the next year or two it shouldn't matter much which wave count is used.

S&P 500, SPX, Weekly chart

A closer view of the SPX chart shows the trend lines that are in play at the moment. I'm sticking with the log price scale on the daily chart below to match with the weekly chart above and you can see how the March-November uptrend line has been acting as resistance since last week's low. The drop off from Wednesday's post-FOMC test of that trend line looks like a bearish kiss goodbye. The shorter-term uptrend line from November is currently acting as support, near 1099, although today's close was below it. When this chart is viewed with the arithmetic price scale the March-November uptrend line drops to only slightly below the shorter-term one from November (shown more clearly on the 60-min chart below the daily chart) so the 1099 level is important for the bulls to hold (meaning it needs to be recovered quickly on Friday). I'm showing the possibility for a rally up to 1133 by early next week but the market must rally immediately on Friday to keep that upside target alive. For now the 50% retracement at 1121 (shown on the weekly chart above) has been playing whack-a-bull and hammers any bull who dares to stick his head above 1114.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1116
- bearish below 1085

Two uptrend lines, from March-November and November-December are both in play at the moment and you can see that the shorter-term uptrend line became resistance this afternoon after it was broken this morning. Closing below the uptrend line from March is bearish if it doesn't get back above it quickly. If we see a bounce on Friday and SPX is rejected at or below 1100 and proceeds to a new low then I think the chances of another rally are very slim.

S&P 500, SPX, 60-min chart

For the DOW's chart, I want to point out possible symmetry that's saying we may have seen the high for the rally from July and in turn from March. This gets into a little bit of corrective wave structure so I'll try to keep it from getting mired in the details. The count is considered a triple zigzag which simply means three a-b-c moves, each separated by an x-wave. The first a-b-c move is the rally from July to August and the c-wave was a small 38% of the a-wave. The middle a-b-c, the rally from September to October, achieved equality between wave-a and wave-c. The final a-b-c (there are no quadruple zigzag patterns and therefore this has to be the last one) is the rally from November to December. Achieving symmetry between the first and third a-b-c means the c-wave needs to be 38% of the a-wave and that projection is shown at 10525.70. The high on December 14th was just shy of 10515 or about 11 points shy of the target. Close enough? It just might be. It takes a break below 10235 to confirm we've seen the high.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10235

The longer-term downtrend line for NDX (using the log price scale) has been holding it down since November. It's possible it will get one more leg up within a shallow rising wedge pattern but it will need to hold above 1773 for that to happen. Any break below the December 9th low near 1759 would negate any further upside potential, at least in the rising wedge pattern. As with the others, the significant bearish divergence at the December highs vs. the November highs, especially following the bearish divergences for much of this year, is a clear warning to bulls that it's getting ready to break down.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1773
(perhaps up to 1820-1825) - bearish below 1759

The small caps have been the recipients of those who believe we'll see an end-of-year rally and new-year rally, where the small caps typically outperform. Even today, while the RUT pulled back, it found support at its broken downtrend line from September 2008. If the rally can continue on Friday and into next week I see upside potential to about 620. If instead the RUT is forced to follow the broader market lower and drops below 592 it will have broken its uptrend line from March and its 50-dma. When the market starts to break down I suspect the RUT will lead the way lower again.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 613
- bearish below 592

Before moving on to some of the other sectors I wanted to take a look at the granddaddy index, the Wilshire 5000 (DJ Total Market Index) because of the pattern it's showing from Wednesday's high. Using the log price scale, its downtrend line from October 2007 was tagged on Wednesday and then sold off into the close, leaving a shooting star doji for the daily candle. That turned into a sell signal with today's red candle. This followed price sliding up underneath its broken uptrend line from March through the November low so it now looks like a kiss goodbye sell signal as well. DWC found support at its shorter-term uptrend line from July through November but this afternoon's bounce looks more like a correction than the start of another rally leg. We'll know more on Friday since a continuation of the rally would support at least one more push to a new high while a break of today's low would be a confirmed breakdown signal.

Wilshire 5000 index, DWC, Daily chart

The downtrend line from September 2008 has kept the bulls down in the KBW banking index. The December 3rd and 14th rallies were both rejected at this downtrend line and today it closed a penny below the November 4th closing low of 41.71. It looks like it's ready to head on down to its 200-dma at 39.51. I suspect the banks, which are not at all healthy and in fact have leveraged themselves worse than before, will once again lead the broader market lower into next year.

KBW Bank index, BKX, Daily chart

One reason why the stock market is likely to struggle next year is because of the continuing struggles I expect to see for the homeowner. As the largest asset that most of us have, not to mention the emotional value we tie to it, our house and its value greatly affects how we feel. And right now our houses are making us (collectively) feel poor. With about one third of homeowners now owing more on their house than it's worth, it doesn't take a great imagination to understand the depressing influence that has on the masses. We're not going to be in a spending mood when we know our houses have dropped so much in value and especially if they drop further in value, which I think they will.

We had a spike in mortgage defaults back in 2007 which resulted from too many people not being able to pay their resetting mortgages. They were people who couldn't afford a regular mortgage but instead got adjustable mortgages with no down payments (and they were told not to worry about it since home values always go up and they could then remortgage). This type of mortgage peaked in 2005 and 2006 and the resets peaked in 2007. People couldn't pay the increased payment and they couldn't refinance like they thought they'd be able to so they started a wave of defaults. The subprime problem was "credited" with the collapse of the mortgage market which in turn, to the dismay of Bernanke and Paulson, took down the rest of the credit market and in turn the stock market.

The subprime problem was only a symptom of the real problem and unfortunately the real problem hasn't gone away (too much easy credit). The subprime problem has steadily declined since 2007, except for a brief spike back up in late 2008. While job losses have caused a continuation of the mortgage defaults, we have been in a relatively quiet period of mortgage defaults due to mortgage resets. That is unfortunately about to change.

Mortgage Loan Resets, 2006-2012, chart courtesy of

What's about to change is that we're going to go through about two years of seeing an increase in the number of mortgages that will reset, specifically the option-ARMs. These were the loans taken out by many people with better credit ratings than subprime borrowers but who still couldn't afford the skyrocketing home prices without interest-only and teaser-rate ARMs (adjustable rate mortgages). The peak in these mortgages resetting doesn't occur until next year and then a higher peak in 2011. Each one that resets will likely be met with a homeowner who can't afford the increase, can't remortgage because of today's higher lending standards and can't sell the home for even the value of the mortgage. It's a no-win situation and will result in a huge spike in foreclosures.

So do I think it's a good thing the home builders are building more and permits are on the rise? Uh, no. Adding to an inventory problem that's about to get much worse is not my idea of fixing the problem. And with a spike in foreclosures you can guess what it's going to do to home prices. And with a further drop in home prices you can imagine what it's going to do to consumer sentiment. And with a drop in CS you can imagine what it's going to do to their spending, and in turn GDP, and in turn the stock market. It's all connected and the connections point to a lower stock market over the next two years. It fits the EW count calling for lower prices.

The home builders got a big bounce on Wednesday after some positive numbers on construction starts and permits but the bounce stopped at the broken 200-dma. This moving average was tested on November 2nd and then broken on December 3rd and is now being retested from below. There's a good chance the retest will fail but if the index can push a little higher it will then find resistance at its downtrend line from September, currently near its 50-dma at 256. The home builders, for as much as they've lost already, still haven't seen their lows yet.

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

Yesterday's rally in the transports took the index right into Fib resistance and left a shooting star. Today's red candle is a sell signal following the shooting star. The Fib resistance comes from price projections based off the wave pattern for the rally leg from July--one at 4205 and the other at 4189. Wednesday's high was 4199. Today it found support at its broken downtrend line from May 2008, which will be near 4190 Friday. A break back below resistance-turned-support at 4060 would be bearish and confirm the top is in. Until that break there remains the possibility for one more minor poke higher into next week.

Transportation Index, TRAN, Daily chart

The dollar's rally off the November low has been sharp and looks like a short-covering rally. There have been virtually no pullbacks but instead only small flat corrections. This has made it difficult for dollar bears to get out and bulls to get in. Each flat correction has been followed by another spurt higher. It has already made it through several layers of resistance and doesn't appear ready yet to pull back. This has put a lot of pressure on commodities but surprisingly little pressure on stocks (I expect stocks to soon pay the price but the seasonal bullishness in the stock market has been holding it up). Eventually the dollar is going to pull back a little deeper to correct the initial rally leg and when it does it will be a very good opportunity to get long the dollar. The dollar will likely rally strong next year and easily exceed the March 2009 high.

U.S. Dollar contract, DX, Weekly chart

With the dollar rallying, and expected to rally higher, the commodities are getting hit. With the stock market holding up for now, the commodity stocks have also been holding up. This year's rally in the commodity stock index was able to retrace 62% of last year's decline but that Fib level has been strong resistance and now it's threatening to break the uptrend line from March. This year's rally pattern is a correction to the 2008 decline which means a new low, below the November 2008 low, will be the next big move for this index.

AMEX Commodity Related Equity index, CRX, Weekly chart

After the sharp decline from its early-December high, gold did not bounce as much as I thought it would and today's sharp drop lower makes it look like the bounce correction is already over. This is very bearish and supports the idea that we'll see a very sharp and deep decline following its blow-off top into the December high. If a small bounce off its uptrend line from August is followed by a break back below $1100 there's a good chance gold will be below $1000 before the end of the month.

Gold continuous contract, GC, Daily chart

Oil bounced sharply this week but banged its head on resistance near 72.80 where it retested two broken trend lines--one was a trend line along the lows since mid October and the other an uptrend line from July-September. As long as the broken uptrend line from July remains resistance we should see oil continue to sell off.

Oil continuous contract, CL, Daily chart

There are no major economic reports Friday morning.

Economic reports, summary and Key Trading Levels

This year's rally has been helped by the Fed's liquidity push. I don't think there are many who would argue that point. Many also believe the government had a direct hand in the market this year (the PPT or President's Working Group, was overtly discussed by Hank Paulson last year) and many are complaining it's not a free market anymore. But I don't think the government is particularly concerned about those of us who whine about the loss of our free markets.

Ben Bernanke is admittedly one of the most knowledgeable people about the Great Depression. He knows how important it is that we don't repeat the same mistakes that occurred during that period. He also knows how important social mood is during this time.

Affecting social mood is very difficult but I believe Bernanke thinks it's one of the keys to his success in turning the credit crisis around. He knows he could force bankers to lend (although he'd rather they build up their capital base right now) but he can't force people to borrow, either personally or for their businesses. But if people are feeling more confident in the future they'll be more likely to take the risk and borrow more money.

In light of this, Bernanke & Co. have been hell bent on creating the idea that the market is recovering and one way to do that is to flood it with money and hope that peoples' moods will shift and take the ball and run with it. So this year's rally has been aided and abetted by the Fed and Treasury. Direct manipulation of the market has been one of their many monetary tools.

If we accept this idea then it may sound strange to consider why the government would now step aside, well before the economy has really healed. It has to do with the election cycle. Most everyone knows this year's rally, as sharp as it's been, is unsustainable. It needs to correct and the waning momentum tells us it's very close to doing that. If the government players let the market sink now, in the first part of the new year, and get the test of the March low out of the way, they can then help the market rally again into the summer and fall to help with the election cycle. In turn it would break the cycle seen during the Great Depression.

This is of course conjecture on my part. I may in fact be giving the government way too much credit for having much if any control over the market. But it at least makes sense (to me) as to why they might step away from the market come the new year and let it correct. Most believe that the March 2009 low needs to be tested, hopefully with a higher low, so that the next rally will have more believers behind it. I happen to believe the March low will not hold, not by a long shot, but we can worry about that later. For now we've got a price pattern, waning momentum and a rising dollar that support the idea that a major stock market correction can be expected soon. Adding to that the possibility that the government will stand aside only adds to the potential for a severe correction at least into this coming March.

Therefore, the appropriate question for those who are long the market, is whether or not you're wearing protection? Protect your capital by selling and going to cash, buying puts and/or shorting the market through any number of ways, including purchasing inverse funds. Particular in the first part of the year we could see some strong selling and likely a lot of volatility, including a big bounce back up in January and then harder selling into February for example.

As far as what to expect on Friday, RIMM reported earnings after the close and spiked higher on the news, taking the NDX futures (NQ) with it. It spiked up to 72.08 after closing at 63.46 and looked to be pulling back just under 71 by the late afternoon. When the stock gapped down on September 25th its high was 71.42 that day. It then dropped lower into early October, bounced back up to a high of 70.57 on October 9th and then sold off into the November 2nd low. So you can see that the after-hours bounce has only been able to get back to the bottom of the gap. It remains to be seen whether or not the stock can do better than that tomorrow, and whether or not that will drag the rest of the techs with it.

If RIMM can lead the way on Friday and the market rallies immediately out of the gate and SPX gets back above 1100 I'll feel better about the upside potential to 1133 (or at least 1121) next week. But without an immediate rally on Friday, that holds, the current price action is looking bearish. If we get a bounce on Friday that then leads to another drop below today's lows I think it will be lights out for the bulls. The price pattern will have turned too bearish at that point to have much of a chance to turn it around again and rally into the end of the year.

If money managers start to sense the market is losing it, and could therefore cost them some of their profits, they will likely start taking profits now rather than wait until the new year (for the tax advantage of selling next year rather than now). One can only imagine how many money managers are all thinking the same thing here and that's why selling could get out of hand quickly. If the market continues lower on Friday or Monday, either immediately or after a bounce, I would not be looking to buy the dip but instead look to sell rallies.

Who knows, maybe tomorrow, being opex Friday, will be a very quiet trading day and just get pinned to strike levels. That's pretty typical. But when it's not quiet it can be pretty volatile.

Good luck on Friday and into next week, which should be relatively quiet as we head for Christmas. But again, if it's not quiet it could be quite the opposite. I'll be back with you next Thursday, the day before Christmas.

Key Levels for SPX:
- cautiously bullish above 1116
- bearish below 1085

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10235

Key Levels for NDX:
- cautiously bullish above 1773
- bearish below 1759

Key Levels for RUT:
- cautiously bullish above 613
- bearish below 592

Keene H. Little, CMT

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