Market Stats

After some throat surgery (to remove a cyst on my vocal cord) on Tuesday I'm hurting a little more than I thought I would at this point. The pain medication helps but if I seem "not all there" tonight, I offer my apologies in advance (smile). Tonight's update may be a little shorter than usual but I'll get to all my usual charts since they really tell the story anyway. At least they tell the story if there's a story to be told. After this week's price action we're left hanging a bit as to what to expect over the next few days. But I think the story for the next week is becoming clearer.

As it turns out, it's really not a surprise to see the market held up into the end of the month. But after this morning's sharp decline following another gap-up opening, I thought we might have received our first sell signal. But the uptrend is intact and the bulls still control the ball. We've got an overbought market and the key levels to the downside are now getting close so if you're looking to maximize profits on long plays by dragging your stops up higher, or for an entry into a short play, we are now close to getting a reversal signal. The big question in my mind tonight is whether we'll see a push to a new high on Friday/Monday before we start a more serious decline next week.

Today was a bit on the wild ride with a fair amount of volatility. Tuesday had a gap-up open that was immediately reversed and in so doing it left some sell signals on a couple of indexes that I watch (and will show later). It looked like an exhaustion gap. And then today's gap-up open was again immediately reversed so there's clearly some interest in selling rallies at this point. That should be a big caution flag on the field for the bulls to pay attention to. When you look at the lower volume during rallies and then rallies getting sold into you know the market is moving more towards distribution rather than accumulation. So I think it remains the right idea to be looking for a top to short rather than dips to buy, especially now with a price pattern that's looking nearly complete to the upside.

There must have been a lot of confidence by more than a few people thinking the market would be heading higher into next week. The call buying went through the roof yesterday as can be seen on the ISEE call/put chart below. It hit 182 yesterday which nearly equaled the high on April 15th (185). This may not be a good timing index but it does provide a heads up that the bullish sentiment is getting a little frothy, which is when readings get above 150. The wall of worry is crumbling.

ISEE Call/Put Index

The bullish sentiment is coming at a time when the economy is not supporting such bullish enthusiasm in the stock market. We've been getting report after report recently that shows a significant slowing in just about everything, whether it's home building, durable goods orders, consumer sentiment, manufacturing, employment, etc. It's just not looking very good out there. The double-dip, or larger single-dip, recession looks more and more likely. The "Greater Recession", as it's been called, will soon be known as the "Greater Depression".

One indicator that has a 100% success rate when predicting recessions is the Weekly Leading Indicator (WLI) from the ECRI (Economic Cycle Research Institute). I downloaded their data from 1967 and plotted it to show when recessions have occurred. Without fail, every time the WLI dropped below -9% we have been in a recession. The WLI dropped below -9% on July 2nd and the most recent reading is -10.5%.

The raw data, or the actual number, is shown with the blue line and shows very steady growth during the 1982-2000 bull market. Even during the bear market that started in 2000 there was still a big jump up into the high in 2007. But the corresponding growth rate into 2007, shown with the brown line, was anemic and that's one of the reasons why the cyclical bull market into the 2007 high did not hold.

ECRI Weekly Leading Index, 1967-2010

Both the raw number and the growth rate spiked down into late 2008, with the growth rate dropping to almost -30% by December 2008, which was lower than at any time in the past 40 years. Then the Fed, Treasury and Uncle Sam stepped in and did everything in their power to stop the slide. Think cash-for-clunkers or the housing credit on steroids. Over a trillion dollars was pumped into the economy to avoid a slowdown. The growth shot higher to nearly +28% by October 2009, in less than a year following the significant decline.

But what happened after the cash-for-clunkers program? What happened to home sales after the tax credit to home buyers disappeared? Sales disappeared in both cases after the false buying was no longer supported. The government's stimulus plan is false (wasteful) buying and might work during brief recessionary times but not during prolonged recessionary times and certainly not during times of depression. Government borrowing and spending actually takes money away from businesses (people would rather buy "safe" Treasuries) and that's why it ends up making the economy even worse than if they had simply let the correction run its course.

So now with the punch bowl (stimulus) taken away the crowd starts to sober up quickly. We collectively have too much debt and need to work it down. Some can't pass up a good deal (a new car or a house) even if they can't afford it, but the majority of the people know full well it's time to conserve. Hence the steep drop back down in the WLI growth rate.

There's a very good chance the WLI growth rate will drop much lower than the 2008 level as the "normal" course correction continues in the economy. The Fed can delay this needed correction but they can't stop it. The only thing they can do is make it more volatile and prolong the process.

Speaking of volatility, this week's volatility is making it more difficult to determine the short-term pattern but it does reinforce the idea that the market is in an ending pattern (topping). On the SPX weekly chart I've added a price depiction with a dashed line so that I can show the possibility for a very choppy pullback this year instead of a hard decline as I've been showing (with the bolder lines). The way the market has been coming down since April has frustrated a lot of traders, myself included, and it's either getting ready to really let go to the downside or else it's going to continue to whip up and down over the next year as the Fed continues to do battle with the economy.

S&P 500, SPX, Weekly chart

The very bearish wave count, in the bold dark red, calls for a strong drop in the next few months, one which could see the March 2009 low tested by October. I consider that the most likely path for the market because of several factors I see lining up (cycles, EW pattern, astrological, economic, sovereign debts, etc.). But considering the possibility that we'll see large swings down and up, it's going to be important for traders to take profits often rather than sit and hope for a home run. Coming up is an opportunity to take profits on long positions (think safety and protect your long positions) and get ready to play the short side.

Because of today's bounce off this morning's low I think there's a reasonably good chance we'll see the market make a stab at one more new high before the rally is finished, so that's what I'm showing on the daily chart below. The price pattern is getting very choppy and whippy and that tells me we're likely in an ending pattern and one more push higher would do a nice job finishing it. I've got an upside target zone of 1130-1140. But if this morning's lows are taken out (SPX 1092.82), that would be the first indication that the top is probably already in. Today SPX once again found its 200-dma at 1114.25 to be resistance.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish to 1130-1140
- bearish below 1088

The move up from July 1st should be an a-b-c bounce and looking closely at the move up I've been watching for the c-wave, which is the leg up from July 20th, to be a 5-wave move. I thought this morning's gap up was going to give us that 5th wave but it got immediately reversed. It's possible it is the 5th wave as a truncated move (it's the tail sticking up on this morning's first candle) but at this point that's a stretch, especially on the NDX and most especially on the RUT charts. So that's why I'm leaning towards seeing another push higher on Friday/Monday to finish the pattern. But if the uptrend lines from July 20 and July 1st start breaking and SPX drops below 1088 then the wave count will be finished and the top will be in.

S&P 500, SPX, 60-min chart

While SPX found its 200-dma to be resistance today, the DOW used it for support, near 10409. Because this morning's high for the DOW was a new high above Tuesday's (marginally), it fits better as the completion of it’s a-b-c bounce off its July 6th low. Therefore I'm showing an expectation for a breakdown from here. But obviously it's not going to do that by itself so if the others have a new high to finish their patterns then the DOW will do the same. The most likely upside target will be near 10650 with higher potential to 10800. A drop below 10265 would say the high is already in place.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish to 10,650-10,800
- bearish below 10,265

Another thing that has me alert to the possibility this morning's high may have been the last one is the behavior of the DOW around its parallel up-channel from its July 20th low. As you can see below, yesterday afternoon's pullback found support at the bottom of the channel and then this morning's spike up failed just below the midline of the channel, common for the 5th wave, especially if it truncates. Price then fell out of the channel and found the bottom of it to be resistance on the bounce back up. This is all typical price behavior for the end of the rally. It takes a break below 10265 to confirm a high has been made but a break of this morning's low at 10387 would be a bearish heads up.

Dow Industrials, INDU, 60-min chart

NDX has strong moving-average support in the 1836-1850 range where its 20-ema, 50-dma and 200-dma are all located. Today's low was in the middle of the range at 1841. Add to that mix its uptrend line from July 1st, near its 50-dma at 1836 and you could say it's got strong support just below. Obviously a break below 1835 would be bearish, which would be confirmed with a break below 1784. In the meantime, if the market rallies Friday/Monday, watch for an upside target near 1925.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish to 1925
- bearish below 1784

Tuesday evening on the Market Monitor I noted the strong reversal signal from the semiconductor index. The SOX had left a dark cloud cover (gap up to new high at the end of a run, followed by a close below the halfway point of the previous day's white candle) and that candle does not require confirmation with a red candle the following day, which it got anyway. So we've got a strong topping and reversing signal on the SOX followed by strong selling. It bounced off its 200-dma today and closed on its 50-dma. It could be good for a bounce back up but not likely to a new high. The next big move should be a break well below its May-June-July lows near 326. An initial downside target is just below 300.

Semiconductor index, SOX, Daily chart

The RUT also found support today at its 200-dma near 640. Just below is its 50-dma, which has now crossed below the 200, at 639 and then its 20-ema at 638. If the 638-640 support area is broken, with confirmation below 629, we'll know the top for its bounce is already in place. Otherwise another push higher could see the RUT at least test Tuesday's high near 672. If the small caps get a lot of attention by the buyers in the next day or two (in a blow-off move, sucking in those who are feeling most bullish) we could see this index tag its 62% retracement near 685.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 670
- bearish below 629

I've been keeping an eye on the VIX as the stock market appears to be putting in a top to see if I am getting any kind of confirmation from the VIX. So far I'd say we're getting the needed confirmation. After the spike up in VIX to the May high it has formed a descending triangle, which is a bullish continuation pattern. The final leg down of the triangle, wave-e on Tuesday, did a little throw-under below the bottom of the triangle and then closed back up inside the pattern. That was a "buy" signal for the VIX on Tuesday. It also came down to its broken downtrend line from January 2009, which supported the pullback in June. So the VIX, on a buy signal, supports the idea that the stock market has peaked or is within days of doing so. The next move should be VIX over 50 within the next couple of weeks.

Volatility index, VIX, Daily chart

The banking index, BKX, was another index that gave us a reversal signal on Tuesday. It left a shooting star against its downtrend line which was followed by a confirming red candle on Wednesday. That looked like a good finish to a 3-wave bounce off its July 21st low which should lead to a very strong decline that takes it well below 40. At the moment it's finding support at a grouping of its 20-ema, 50-dma and 200-dma, all at 48.17-48.59, so a break below 48 should usher in some strong selling. Follow the money if it does.

KBW Bank index, BKX, Daily chart

The TRAN was another index I had pointed out on the Market Monitor as having met an upside target for its bounce off its July 6th low. At 4490 it achieved two equal legs up for an a-b-c bounce correction which was followed by selling. As with the broader averages, I see the possibility for one more poke higher but the risk from here is for the market to start down right away.

Transportation Index, TRAN, Daily chart

The U.S. dollar has dropped a little further than I thought it would and this is increasing the chances that the pullback from the June high is going to be all of the correction to the November-June rally rather than just wave A of a larger A-B-C pullback correction. It has now retraced 50% of its rally which is a very typical correction. As depicted on the chart below, it could drop a little lower to the bottom of its parallel down-channel from June but it's not necessary. A rally could start at any time and if the pullback correction is finish then the rally could become very strong and into the end of the year.

U.S. Dollar contract, DX, Daily chart

Gold has been pulling back since its high in June, in spite of the fact that the dollar has been pulling back as well. If the dollar is getting ready for a strong rally it's likely going to put further pressure on gold, as well as other commodities. On Tuesday gold broke its longer-term uptrend line from October 2008 and it did so convincingly. There were obviously a lot of trailed stops parked just underneath that trend line. Gold should be in the very early stages of a deep retracement of its rally, one that could ultimately take gold back down towards 600. It now takes a rally back above 1204 to negate the bearish wave count.

Gold continuous contract, GC, Daily chart

Last week I pointed out the gold miners index, GDX, had bounce back up to its broken uptrend line from February and to watch for a kiss goodbye. That's exactly what we got (against its 20-ema as well). It bounced off its July 19th low but I expect it to break. Today it found its 200-dma to be resistance (closed just below it).

Gold Miners, GDX, Weekly chart

After another corrective climb back up from its July 6th low, oil broke its uptrend line on Tuesday and bounced back up to it today. A drop back down on Friday would leave a bearish kiss goodbye. It should be setting up for a hard decline that takes it well below 60 in August/September (especially if the dollar starts to rally).

Oil continuous contract, CL, Daily chart

This morning's report on unemployment claims showed some mixed results but generally poor. Friday's pre-market reports include GDP, which the Fed has been warning us will start to slow down. After the opening bell we'll get the Chicago PMI and University of Michigan Sentiment. Better or worse than expected could jolt the market--the market feels like it's on pins and needles and is using just about anything to spark buying and selling. Follow through in either direction is currently missing so the volatile price action is making it difficult for traders.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, some indexes are saying we've already seen the high for the bounce off the July lows while others are pointing to the possibility we'll get one more new high within the next 1-3 days to complete the correction to the decline from April. I think it's clearly too late to be thinking about grabbing anything to the upside. I'd be looking for a shorting opportunity or at the very least where to place your stops on long positions. While we could see a choppy and volatile decline over the next couple of months, without a lot of deep selloffs, there is the risk for a very significant decline.

I see a few things coming together that warn of the possibility for a strong decline next month. My favorite tool, EW (Elliott Wave), is showing a setup for the possibility of either a strong c-wave or 3rd wave to the downside. These are the stronger of the waves so the setup should be taken seriously.

Last week I showed a chart of SPX and a 67-day cycle that pointed to a turn date on July 30th. If we get another push back up tomorrow then the turn will be to the downside (even if it's just a bounce to a lower high).

The astrological event of 10,000 years, the Cardinal Climax, peaks July 30-August 1. How or whether it will affect traders' moods and therefore the stock market will only be known in hindsight. Many think it's going to have drastic consequences for the stock market (or worse, in which case we won't care about the stock market).

Buying momentum has been waning while we approach these indications of a coming market turn. Trying to get cute with your exits from long positions or entries into a short position could leave you behind if the market suddenly takes a spill (gaps down), leaving your stop untouched or without an entry on the short side. Think about a longer-term put option position to take home over the weekend and we'll see how the beginning of next week plays out. Without getting hung up on the scarier aspects of what could cause a strong market decline, let's at least try to take advantage of it as traders and make a little money. If we can trade with the cycles and get in synch with the market's moves, we can become more successful traders.

Speaking of cycles, it's a good time to reprint something I found interesting. This is a list of 10 things that someone wrote for the leaders of our country and are important for all of us to think about:

You cannot bring about prosperity by discouraging thrift.
You cannot strengthen the weak by weakening the strong.
You cannot help little men by tearing down big men.
You cannot lift the wage earner by pulling down the wage payer.
You cannot help the poor by destroying the rich.
You cannot establish sound security on borrowed money.
You cannot further the brotherhood of man by inciting class hatred.
You cannot keep out of trouble by spending more than you earn.
You cannot build character and courage by destroying men's initiative and independence.
And you cannot help men permanently by doing for them what they can and should do for themselves.

This is a list that was first published in 1916 as "The Ten Cannots" and credited to Rev. J. H. Becker who gained attention as a motivational speaker. You can see how we run in cycles over time. We overcame difficult times back then and we'll do it again. The government's efforts to stop these cycles is what makes it worse but we will get through this and get back on a growth path once it's concluded, whether the government likes it or not.

Good luck in the coming week and I'll be back with you next Thursday to see if the bearish setups proved fruitful or not.

Key Levels for SPX:
- cautiously bullish to 1130-1140
- bearish below 1088

Key Levels for DOW:
- cautiously bullish to 10,650-10,800
- bearish below 10,265

Key Levels for NDX:
- cautiously bullish to 1925
- bearish below 1784

Key Levels for RUT:
- cautiously bullish above 670
- bearish below 629

Keene H. Little, CMT