Market Stats

From the tables above you can see the techs and small caps had an even better week than the strong rally in the broader market. Santa Claus did not disappoint all the good boys and girls on Wall Street. He even took care of all the bad boys and girls. Other than gold, which at least recovered much of the week's losses from Tuesday's low of 1075.20, most everyone did well this past week (except the bears). Merry Christmas everyone!

What wasn't up was volume but we all knew volume would be much lower than usual. Typically we'll want to see volume behind new market highs but we instead saw volume dropping lower and lower as the holiday-shortened week progressed. Whether or not it has any bearish implications is too hard to tell, especially since we're into a typically bullish period, one that runs into the beginning of January.

The US dollar also pulled back from its high of 78.77 on December 22nd and looks like it's finally ready to rest a little after a very sharp rally off its November 25th low of 74.27. A $4.50 rise, +6.1%, in the dollar in 18 trading days is a monster move for currencies. As I'll review later on its chart, it rallied right up to predictable resistance so a pullback/consolidation would be typical over the next week or so. And that could be helpful to stock market bulls who would like to see at least a little more life to this rally without the bothersome dollar getting in the way.

December had been running flat for the month prior to last week so the month is now positive thanks to Santa. I found some data going back to 1988 that shows the average daily and monthly returns for December. This period encompasses primarily a secular bull market so it may be skewed toward the positive side, and it's by no means predictive of what each December will bring, but it does show the seasonal influence that many talk about.

S&P 500 December Returns Since 1988

The left column is the trading day, not the calendar day, of the month. It's interesting to see that the cumulative return in December is historically positive every day of the month. The typical return for the month is +2%. Last year, in the middle of a wicked bear market cycle, the cumulative return for the month was dismal and if it hadn't been for the rescue in the last day the month it would have ended down. This month was essentially flat coming into last week but the steady small gains each day has us up +2.8% for the month, better than average. If we were to end the month at the average gain of 2% we'll see the S&P settle around 1118 or about 8 points below Thursday's close.

But have you noticed, particularly last week it seems, how much of the gains have occurred in the overnight session with very little follow through during the trading day? If you are trying to trade this market to the long side, rather just buying and holding, it's been a real challenge buying the market after the cash market opens and making money. And this has actually been going on for the past three months. Equity futures have been manipulated higher by "someone" in the hope of sparking more rallies (especially from short covering). An interesting chart from shows what's been happening:

After Hours vs. Normal Hours Trading Gains, charts courtesy

The chart shows the cumulative returns since mid September, with the top line being the return measured from the close of the trading day to the opening of the next day (so from 4:00 PM to 9:30 AM, EST) while the bottom line shows the return for the normal trading day (9:30 AM to 4:00 PM, EST). As you can see, during the normal trading day the cumulative return since mid-September is zero while the overnight return is about 6%. To me this is a blatant example of the manipulation going on the futures market.

But that's our market now--not as free as it used to be and with a government that's convinced it knows what's best for us and will do everything in its power to protect us from ourselves (or more accurately, protect the banks). We just need to figure out how to trade around it and so far the ones who have been rewarded are those who have bought and held positions--exactly what "they" keep preaching what we're supposed to do. Forget about trading, just buy and hold because, well, because the market always goes up. In a secular bull market that's true. But as far as I know, the longer-term cycles haven't been repealed and I really don't think it's different this time.

The market does in fact cycle between bull and bear markets. A chart that was done by Elliott Wave International towards the end of last year was a very good one for showing the secular bull and bear market cycles. What they showed were cycles lasting a little less than 17 years on average. The current bear market cycle started in July 1999 (which was the top in many of the secondaries) and is expected to continue into 2016.

Bull/Bear Market Cycles since 1930, chart courtesy

The reason for the two graphs in the chart is to show the difference between current and inflation-adjusted dollars. Since 1999 Elliott Wave International has been using the price of gold rather than inflation to adjust the value of the DOW, which drops the line even further. But the major point I want to note from the chart is that the current secular bear market is not expected to end until early to mid 2016 if the 16.6 to 16.9-year cycle holds. That means another 6-1/2 years of a bear market lay in front of us still.

Those who believe we've started a major bull market this year will have to discount the cycles shown for the past century (actually longer) and explain away things like why the P/E ratio never dropped below 10, which is the hallmark of an end to the bear market. There are many reported P/E ratios, some well above 100 while the lowest is above 20 but the point is that it never reached typical bear market lows. When people swear off ever owning stocks again we'll know we're finishing the bear market. The extreme level of bullishness (and near-record low level of bearish sentiment) says the bear market is not finished yet.

I collected data from 1870 that includes the stock market monthly closing prices and CPI data so that I could adjust market prices for inflation and then compare the charts (similar to what Elliott Wave International did for the above chart). I did this in a spreadsheet and then created my own charts with parallel up-channels for price action since 1929-1930, the longer-term bull market that we've been in.

S&P 500 in Nominal vs. Constant Dollars, 1870-2018

The first thing that jumped out at me when I looked at these two charts is how much more volatile price was when using constant (inflation-adjusted) dollars, which is the lower chart. Both charts use the log price scale otherwise the rally from 1982 makes the rest of the chart flat line near the bottom. In the bottom chart I also added yellow bands to show the secular bear market cycles. This is showing the same 16.6-16.9-year cycles referenced above. Notice that the 1966-1982 bear market cycle brought the inflation-adjusted price down to the bottom of the up-channel. As depicted on the chart, a similar move in the current bear market is expected to do the same thing. The top chart shows the same depiction for a continuation lower to the bottom of the channel.

The bottom of the channel in 2016 is near 475, which would mean back down near the lows in 1994, as I had mentioned in my last market wrap (Thursday, December 17th) when discussing the potential for another leg down equal to the first one when measured in percentage terms. The 2007-2009 decline was a 58% decline and a 58% decline from 1133 (let's just use that for a high for the year if it can push slightly higher next week) would have SPX down to 475. Funny how that works out to the same number.

Based on data, historical cycles and price patterns I firmly believe the current bear market cycle will finish playing out. My opinion is not based on feelings about the market or wishful thinking one way or the other. It's based primarily on the fact that we human beings are prone to repeating the same patterns of the past--it's what we react to. The huge credit bubble that was created, and its current collapse, is strong evidence of the cyclical nature of our markets which is reflective of our social mood swings and herding behavior. So if this is all correct, saying we should view this year's rally as simply a cyclical bull market within a secular bear, then I should be looking for where the current rally might end, or at least where it pays to get out of long positions and play the short side.

Since we're in a similar environment to the 1920s to 1930s (big credit expansion followed by a credit collapse and depression), I think it continues to be a worthwhile period to compare ourselves to. After the 1929 crash and then strong rally in 1930, it was important then to recognize that it wasn't the start of another bull market. A simple trend line break was all you needed back then. The chart below shows the 1930 rally in the bottom chart and this year's rally in the top chart. The declines for both can be counted as a sharp 5-wave impulsive move which were each followed by a 3-wave correction (labeled A-B-C). An impulsive move tells us the larger trend while a 3-wave move is a correction to the trend.

DJ Industrial Average, 2008-2009 vs. 1929-1930

I compressed the 2008-2009 time to more closely match the decline and bounce in 1929-1930. The decline was much faster in 1929 and the bounce relatively longer. The decline into the 2009 low was relatively longer as compared to sharp bounce back up. But both have retraced nearly the same percentage of the decline. In 1930 the retracement was 53.7% and a similar retracement would have the DOW up near 10620. In 1930 when the DOW broke its uptrend line for the rally off the low, it was all downhill from there into the 1932 low.

Has the DOW broken its current uptrend line from March? When drawn through the November low (with the same log price scale), yes it has and the current rally has it pushing back up for what could be a retest from below. In fact that trend line is currently near 10620, which would give it the same 53.7% retracement as back in 1930. It's also where the downtrend line from October 2007 is currently located (using the log price scale). That would certainly be an interesting setup.

After the DOW broke its uptrend line in 1930 it was not a fun time to be long the stock market. Every bounce for the next two years was an opportunity to short it. Each uptrend line for the bounces, when broken, was a signal to get short. By the time it was finished in 1932, it had lost 90% of its value from the 1929 high. A similar fate would have the DOW back down to 1400 and not be historically precedent setting. That's not at all a prediction but simply stating what could happen. For the S&P 500 a similar 90% decline would have it dropping to 160. Scary to even think about that.

DJ Industrial Average, 1929-1932

But knowing what the potential is, even if all of us would clearly not want to even consider it (especially knowing the havoc it would create for our country, and globally), I wanted to project what a typical move would be when using EW (Elliott Wave) analysis. I use trend channels, Fibonacci time and price projections, previous price levels and time cycles to come up with an estimate of what could be. I do this for one reason only--to show you the potential for a nastier bear market ahead of us. I can sleep at night knowing I've done what I can to show people why they need to at least consider getting into a position of safety.

S&P 500, SPX, Monthly chart

Sticking with the log price scale, which is typically better to use on longer-term charts, especially with large price changes, the uptrend line from 1973-1982 supported the decline to the March 2009 low. That's an extremely important trend line to hold if and when price drops back down to it. Currently SPX has almost made it up to its downtrend line from October 2007, near 1130, and what I'm showing is an end to the rally and a continuation lower into 2011. When one considers the huge spike in home mortgage defaults about to hit, which peaks in 2011, it's not unreasonable to think it will be a contributing factor to the next wave of foreclosures and a further contraction in consumer spending. I'm depicting a much larger drop in the chart above than the earlier charts showing a downside projection to 475. Regardless of which chart could be correct, I think we'd all agree neither one is very pleasant to think about.

We at OIN have very different opinions about the market. Jim and I, all by ourselves, will make a market with our different opinions. Jim wants to buy a pullback in January and I want to short all rallies, including the current one. I think it's very healthy that we have different opinions since it presents both sides of the argument. Based on your temperament and style of trading you can then use the information to make your own trading decisions.

Even if you go with my opinion and go to cash, it's a great time to trade while the bulk of your capital is safely out of harm's way. If you buy and hold the market you will make whatever the market makes. If the market goes sideways you can still make a lot of money by trading the up and down moves. We've just experienced a lost decade (similar to Japan's two lost decades) where the market went nowhere and in fact lost money. Thanks to John for sending me the following data points for the stock market's closing prices on December 31, 1999:
DOW -- 11,450
SPX -- 1,475
NDX -- 3,800

For those who followed the "professional" advice to buy and hold, especially considering inflation, you've lost money for holding long the past ten years. An interest-bearing checking account did better and would have been a lot less stressful. But those who held for just the bulk of the two rallies and then got out could have doubled their money, or more, over the same period. And if you trade the short side in addition to the long side, you have an opportunity to double your money, or more, in each direction. That's what we at OIN hope to be able to help you do.

So that's my longer-term view as we wrap up 2009 and head into 2010. My sincerest hope is that first of all you don't lose money, or at least not more than you make (stop losses are a necessary part of doing business). In a secular bear market the protection of one's capital is job #1 and then the 2nd goal is to make some money by trading. If you can accomplish only half that you'll be ahead of the majority of people out there, especially those in retirement accounts who simply ride the market lower. So with one more week left to the trading year, let's see what the shorter-term charts look like.

For now and until proven otherwise, I think SPX will have trouble getting above the 1133-1138 resistance zone (trend lines and Fibs) and the pattern is looking very good for a finish. The end to its rally could come literally at any time and in fact I'm a little worried that it could start with a downside surprise (gap down and run lower as panicked fund managers scramble to protect positions). That's just a worry, not a prediction. Right now it would look better with a small consolidation this coming week and then a final push to a minor new high, possibly into the first day or so of January.

S&P 500, SPX, Weekly chart

The daily chart is getting very busy with multiple trend lines and Fibs, all congregating around the 1120-1140 area. As mentioned above, it would look best for a minor consolidation this week and then a final high. The two Fib projections of importance are 1133 and 1138. The downtrend line from October 2007 (using log price scale) is near 1130 on Monday, as is the trend line along the highs since October (which could be the top of a bearish rising wedge pattern). The broken uptrend line from March-November is now close to the 1138 Fib projection. One more upside Fib projection to watch, if it gets above 1138, is 1146.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1121
- bearish below 1094

The bottom of the rising wedge for SPX is the uptrend line from November 2nd and a break of it would signal a breakdown in progress, which is shown more clearly in the 120-min chart below. So a break below 1105 would be a bearish heads up. Any pullback this coming week should find support in the 1115-1120 area and if that's then followed by another new high as depicted it will be a very good setup for a reversal so watch for it as an opportunity to pull stops up much tighter on long positions and try the short side.

S&P 500, SPX, 120-min chart

The DOW has been running weaker than the others. This can be considered bullish in that traders are running into the riskier high-beta stocks rather than play defensive in the much larger blue chips. But there's no question that the DOW is painting a bearish picture here as it tests the highs since November again and with very large negative divergences. If fund managers start getting defensive again and run back into the DOW from the others (in expectation for profit taking in January) we could see the DOW change places with the techs and small caps and make a final stab higher (that kind of reversal would be another good heads up the rally is coming to an end). Upside potential for the DOW is near 10620-10630. A break below 10264, the low on December 18th, would say the rally is finished.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10264

The techs have been on fire and NDX left everyone else in their dust last week. Thursday's close had it poking above the top of a potential rising wedge pattern so a down day on Monday would create a sell signal following the throw-over. But as with the others, we could see a small pullback this coming week and then a final push higher into the first part of January. A Fib projection at 1877 could be its upside target. It doesn't mean it will stop there (or get there) but any failure from there would be a good setup to try the short side. A drop below 1814 would tell me the rally has finished.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1877
- bearish below 1814

The small caps also had a very good week. Actually they've had a very good month. The short-term uptrend line from November 30th and the previous highs coincide near 625 so that should be strong support for any pullback this week. A break below that level would be a bearish heads up and below 613 would say the rally has finished. In the meantime there is upside potential to the downtrend line from October 2007 near 640.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 613

The banks continue to run relatively weak as compared to the rest of the market, even as compared to the relatively weak DOW. The BIX almost made it up to its 50-dma and downtrend line from October 2007 (log scale), both near 128 last week. A rally above that level would be potentially bullish, or at least remove the immediately bearish scenario in front of it, especially since it recovered back above its H&S neckline last week and then used it as support. A drop back below 121 would likely be followed by strong decline, one that should treat its 200-dma near 114 as merely a speed bump.

KBW Bank index, BKX, Daily chart

In late November the home builders index broke its uptrend line from March-July, bounced back up to it for quick test in early December and then peeled away from it. It has now bounced back up to it but found it to be resistance on Wednesday and Thursday. A failure here would clearly be bearish with a kiss goodbye against previous support-turned-resistance.

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

For the transports, the two Fib price projections near 4200 has kept a lid on the rally since December 16th. These Fib projections are based on wave relationships for the move up from July and November. And now its downtrend line from May 2008 is coming down to pressure it, which will be near 4220 on Monday. Notice too that once the uptrend line from November was broken it became resistance. Wednesday's and Thursday's candlesticks are a hanging man followed by a shooting star, neither of which is bullish. It takes a break below 4055, previous resistance and now support, for the bears to claim victory and above 4220 to open up the door to at least 4400.

Transportation Index, TRAN, Daily chart

The weekly chart of the US dollar shows the sharp spike off the bottom, retracing about three months worth of selling in less than a month. It stopped at previous lows in December 2008 and March 2009. It was also just shy of a 62% retracement of the decline from the high in March. Last week the dollar's rally did not stop the stock market from rallying as it seemed to be following its own agenda. I do not think the dollar and stocks will stay disconnected the next time the dollar makes a big move up (probably in the 1st or 2nd week of January). They've been joined near the hip, in an inverse relationship, for a long time and I don't think that relationship is broken.

U.S. Dollar contract, DX, Weekly chart

The inverse relationship between the dollar and gold continues to hold (even if not on a daily basis) and the dollar's decline last week gave a boost to the metals. Now is when it will be interesting to see what happens. I'm thinking the dollar has further to pull back next week but gold is up against its broken uptrend line from August and near its broken 50-dma at 1112. If the dollar consolidates sideways to work off some of its overbought conditions, we could see the metals start back down again. If the metals sell off further I think it's going to be very hard for the stock market to ignore it for much longer.

Gold continuous contract, GC, Daily chart

Oil has rallied very sharply off its December 14th low and has now made it back up to its downtrend line from October and its broken uptrend line from February. The two trend lines cross near 78 on Monday.

Oil continuous contract, CL, Daily chart

This coming week is another holiday-shortened week and will be another quiet one from a volume standpoint. As for economic reports it's also going to be a quiet week. There are no significant reports on Monday and then Tuesday we'll get updates on housing prices and consumer confidence. I'm not so sure either number will be as good, or less bad, as is expected so it could cause a little trouble Tuesday morning.

Economic reports, summary and Key Trading Levels

Since October I've been thinking the market has been topping and while it's been another frustrating experience feeling like I've been early to the bear's table, similar to 2007, I can't say the bulls have had an easy time of it either. Until this past week both sides were simply marking time. Now that we have a break of the trading range to the upside there are many who believe it will carry far and much higher. They could certainly be correct but I'm wondering if the brief breakout will be followed by an even faster price collapse as it catches the bulls flat footed.

There's no way to know how it will play out over the next week, or certainly next year, but the setup remains a good one for a reversal of this year's rally and a quick failure of the breakout would likely result in a quick decline below the November/December consolidation lows.

However, the trend is your friend and it remains up, especially with the breakout of the trading ranges. Therefore until the trend is broken, with a break of the uptrend lines from November as a heads up for that, it is risky to short this market. While I don't like the upside potential for new trades on the long side (risk:reward is not good enough for me) it is obviously not a good time to get aggressively short the market. If you're a longer-term trader then getting short the market is not a bad idea since you won't have to worry about a sudden decline which would make it difficult to get aboard the short side. But you'll have to live with some pain if the market chugs higher for a little more.

The seasonal factor and new-month/year money coming in on January 4th means there will be an underlying bid to the market (not to mention the government's efforts to keep things up in hopes of creating some more speculative juices among the public to buy the overly inflated and exorbitantly priced (IMHO) banking stocks) this coming week and into next week. As discussed with a few of the charts, a pullback and then new high into the first of next week would look like a good finish to the wave counts so that fits the scenario of seeing a rally into the first part of January.

What I don't like about the bullish scenario is that everyone is expecting it. The market hates to accommodate what everyone expects and therefore the risk for downside failure is not insignificant. Watch for it and be at least ready to get out of the way. If the futures have the market gapping down instead of up one morning it might not turn around. There is a lot of profit to protect and fund managers would love to be able to capture that profit and reload at lower lows. That urge to take profits could start to overwhelm any buying efforts by others.

So enjoy the rally for a little longer if it plays out but don't get complacent. Each rally high is an opportunity to try a short play and if you do it with options with money you figure is the value of getting stopped out on an index/stock play then you can just let it run to either success or total loss. You could start legging into a short position while letting your longs run, raising stops on your long positions along the way. When stopped out of your longs you can then let you short play work. If you don't get stopped out of your longs because the market keeps rallying then you'll have made money to compensate for the losses on your short play.

Good luck this coming week and be careful of low-volume volatility. One of these days a futures led gap up is not going to hold so be careful this week and I'll be back with you Thursday, January 7th as there will be no market wrap this coming Thursday either and Jim will be doing his usual weekend wrap. I wish everyone a Happy and Prosperous New Year.

Key Levels for SPX:
- cautiously bullish above 1121
- bearish below 1094

Key Levels for DOW:
- cautiously bullish above 10500
- bearish below 10264

Key Levels for NDX:
- cautiously bullish above 1877
- bearish below 1814

Key Levels for RUT:
- cautiously bullish above 625
- bearish below 613

Keene H. Little, CMT

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