Market Stats

Today had some bad news/good news to deal with and good news won the day. While today's trading volume was a little less than yesterday's selling it was respectable. The bulls are doing an excellent job thwarting the bear's attempt to take over the market. There are a couple of indexes showing their intent to turn but so far traffic is not allowing them to make the turn. The caution to the bears is to wait for the right opportunity and don't cross in front of traffic. The bulls can still stampede you.

Overnight futures got hit with selling in Europe over more concerns about the sovereign debt issues. The European indexes recovered in their afternoon sessions once the U.S. markets started rallying on some favorable economic news. The U.S. markets gapped down at the start but did an immediate recovery and went on to rally to new highs (DOW, SPX and NDX but not many of the other indexes, including the NYSE and Wilshire 5000).

But has been the way of this market for the last week or two, rallies are getting sold into (lift the market, sell into, rinse and repeat) as more stock is distributed from fund managers to the late-to-the-party Mom and Pop retail crowd. The good news we're hearing about the economy convinces many that everything is getting better (and it is, for now) and that it's time to get back in the market. We hear every financial firm's pundits declaring we're headed for the moon this year and it gets the bullish juices flowing. Meanwhile the distribution of stocks continues by the same firms declaring we're heading for the moon. Grr...

Please make note that tops in stock market rallies occur on great economic news just as bottoms occur on the worst economic news. Don't fall into the trap believing that the two are always in synch.

But this morning's economic reports were good and it got the stock market rallying in the morning and into the afternoon. The first report out was the Challenger Job Cuts and employers announced plans in December to eliminate 32K positions for December, which was down -29% from December 2009. It was also a 34% decline from November. For all of 2010 employers announced plans to eliminate about 530K positions, closing out the month and year with the lowest number of job eliminations since 2000.

The ADP Employment report, out at 8:15 this morning, gave us a very nice positive surprise, showing the private-sector employment increased by 297K, with the service sector getting the bulk of that (270K). This makes for the largest monthly increase on record and while much of it (most?) may have been due to holiday temporary hiring, which will be reversed in January, it's still an outstanding report. The only surprise was why the stock market didn't rally even more, especially if the belief is that this report portends good things for the nonfarm payroll report on Friday. The nonfarm payrolls report includes government hiring/firing and current estimates are for a gain of 143K and a steady unemployment rate of 9.8%.

The positive ADP report continues a string of improvements since September's addition of 29K jobs. We've since seen October adding 79K, November adding 92K and then December's addition of 297K. No complaints there.

According to the ADP report, the manufacturing sector added 27K jobs, the largest increase since February 2006 and that's very positive. I'd sure like to see the unemployment rate start coming down instead of increasing. Whether that would have a positive effect on the stock market is debatable (there are many previous cases of the bear market returning in the face of improving economic conditions) it would be nice to hear about more people getting off unemployment.

The next report was the ISM Services report which was also positive, coming it at 57.1 for December, up from 55 in November and better than expectations. There were parts of the report showing some concerns (non-manufacturing employment) but overall it continued to show growth rather than contraction. Again, with all of the positive economic reports I was a little surprised we didn't see a stronger rally effort. Is it possible the market might be a little tired? It has run a marathon, or more like a triathlon, since July and I think it could use a rest.

Tonight I want to start with the big index, the Wilshire 5000. While it could be said the smaller big cap indexes might be more easily manipulated (futures, ETFs, index options) it's a little harder to manipulate the DWC without buying all 5000 stocks. So we'll see what this index is telling us. The weekly chart below shows price is up against potential resistance near 13500, which is price-level resistance based on price highs and lows going back to 2000, 2006 and 2008. It has also been pushing up underneath a trend line along the highs since the end of July. As noted on the chart, it's interesting that the 5-wave move up from July (indicating we should be looking for an end to the rally rather than an extension of it) has formed a rising wedge pattern, the same as it did for the 1st rally leg from March 2009. It's a fractal and we'll likely see a quick breakdown from it similar to what we saw from the April high (another flash crash perhaps?).

Wilshire 5000 index, DWC, Weekly chart

The daily chart below shows the leg up from July and the 5-wave count. The 5th wave of the rally from July would equal the 1st wave at 13557.60, the most common relationship between these two waves. That projection crosses the top trend line tomorrow so a quick pop higher on Thursday would do a perfect job finishing off the rally. At least that's the setup for a reversal but as we well know, there have been more than a few previous bearish setups that simply morphed into another rally leg. All I can do is show you the setups and watch for confirmation from there (with a break below 13265, which is last Friday's low). Notice too that the move up from November is another smaller rising wedge. A rising wedge to finish a rising wedge? Look out below if it's the correct pattern since the break is likely to happen fast (a retracement of the rally from November faster than the time the rally took).

Wilshire 5000 index, DWC, Daily chart

Next, because the small caps might be giving us a heads up (the first turn signal) I want to review this index. The parallel up-channel on the weekly chart is a bit unorthodox because it doesn't catch all the highs that poke out the top of it but the mid line of the channel shows it was in play and therefore the top could be a good guide for price action (channels show the "rhythm" of the market). The fact that the top of the channel is at previous price-level resistance near 800 could also be important. A break of the uptrend line from August near 778 would be a signal that the leg up from August has completed.

Russell-2000, RUT, Weekly chart

The leg up from August is shown more clearly on the daily chart below and price action has formed another rising wedge within a larger rising wedge. The bottom of the smaller wedge is the uptrend line from November and it was broken yesterday but price climbed back above it today so there's still hope for the bulls. A break below 778, near yesterday's low and the uptrend line from August, would be a much more significant breakdown. Back above Monday's high near 801 would be bullish (not sure for how much more but it clearly would not be bearish).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 800
- bearish below 778

Since the DOW is watched by so many, let's drill down from a weekly chart to the 15-min chart to see what the setup looks like and why I think we're looking for a top near the current level (coinciding with what I see in the charts above). There is a resistance band of about 11650-11850 based on previous price support/resistance going back to 2006 and 2008. We have a 5-wave move up from July and therefore should be looking for a top rather than an expectation for a further rally. As labeled on the chart, the coming high could be the completion of an A-B-C bounce off the 2009 low which calls for at least a very deep retracement of the 2009-2010 rally. But first things first, we need to figure out where the current rally is headed or where it will make a turn.

Dow Industrials, INDU, Weekly chart

The daily chart is a bit messy but I'm trying to show the trend lines, as well as the resistance band, that should show us where price may stall out. We're there but as shown with the dashed line there remains the possibility for a final fling up to 11860 or so. It's a little bit of a stretch to get up there but a final little blow-off move could do it. Maybe after Friday's jobs report? It takes a break below 11530 on the daily chart to declare we've seen the high.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 11,860
- bearish below 11,530

The small parallel up-channel shown on the daily chart above, in December, is shown more clearly on the 120-min chart below. It has done a good job catching the highs and lows of the move, including the high on Monday and today. Will it break up or down? The answer to that question will tell us what direction to trade. The wave count says we might get a small pop higher tomorrow morning but that we should be looking for the end of the rally. The end will not be confirmed until it breaks below 11635 and the up-channel. It may be shallow but it's still an uptrend so know what you're dealing with if you want to try the short side from here--it's a good play since your stop can be kept very close (just above the top of the channel).

Dow Industrials, INDU, 120-min chart

Now we'll look at the move up from the end of December, which should be the 5th of the 5th wave as labeled above. It too needs to be a 5-wave move and while it's a little ugly (with a much larger 4th wave than 2nd wave) no EW rules have been violated (the 4th can't overlap the 1st). The very last 5th of the 5th of the 5th is the move up from Tuesday's low and as shown on the chart we'll ideally get one more leg up to finish off the rally. Upside targets are 11755-11779 as shown on the chart. The top of the channel in the chart above is near 11750 tomorrow morning. A break below 11700 would be your first heads up that the high got put in.

Dow Industrials, INDU, 15-min chart

On Monday SPX stopped just shy of the 127% extension of the April-July decline, a common Fib reversal level, at 1276.62. Today it poked marginally above it and essentially closed at it. There is upside potential to about 1292 to hit the price projection for the 5th wave of the rally from July where it would equal the 1st wave, maybe even 1300 to tag the trend line along the highs from August, so it remains bullish until it breaks below last Friday's low near 1254 (with a bearish heads up if it breaks below 1262.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1277 to 1292
- bearish below 1254

NDX has also returned to a price level that could be resistance to any further advances--the 162% extension of the November decline at 2271.16. Only slightly higher, at 2281.82, is the 162% extension of the April-July decline. That's very close Fib correlation between the two moves since it's the extension of the last decline before each up leg--the April-July decline leading to what could be the last leg of the rally from March and the November decline leading to the last leg (5th wave) of the rally from July, both coinciding near the same level. It might be nothing, or it could be very important, especially if it turns back down here. Bullish above 2282, bearish below 2237.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2282
- bearish below 2237

Speaking of tight Fib correlation, I've been watching the BKX to see if price would rally up to the 153 area where there are multiple price projections based on the wave relationships of the move up from August and November. It has created a potential resistance zone between 152.96 and 153.65. Today's high was 153.38. It has also tagged a trend line along the highs from November and December 22nd (not sure yet whether this trend line is important). With a wave count that can now be called complete it makes for a very good setup for a reversal. Now all the bears have to do is pounce on it and take advantage of it. If the A-B-C pattern is correct for the rally off the August low, it will be completely retraced.

Banking index, BIX, Daily chart

Following up on the debt concerns in Europe that I mentioned at the beginning of tonight's report, there is increased worry about how the governments are going to be able to sell more debt, including the ECB (European Central Bank). Governments have been able to slow down the process of dealing with the debt crisis but they have not been able to make it go away. Eventually the can that keeps getting kicked down the street will have to be picked up and thrown away. The issuance of new, or different, debt is still debt and it needs to be funded through the sale of bonds, just as the U.S. Treasury must fund the government through the sale of Treasury bonds (which the Fed is currently buying but even that will have a limit).

The concern therefore is the amount of debt that must be funded and eventually there will not be enough buyers of all the debt. That's when you will see failed auctions, which then results in a collapse in bond prices and yields climb rapidly higher (to attract buyers who want to be compensated for their risk with higher yields). And of course higher yields means more difficulty for countries to pay off their existing debt, never mind the additional debt that continues to accumulate. This second crisis in banking will be much more difficult to solve because at that time the market will not view the central banks' efforts to create more money to sell more debt as the solution but in fact the problem.

Europe is looking at refinancing about 400B euros ($500B) of its debt within the first six months of this year. In addition it will need to replace another 500B euros during the same period. And then it must replace/refinance hundreds of billions of euros of mortgage-backed securities. Italy and Spain alone could require another 400B euros this spring. It's simply an overwhelming amount of debt that must be funded and the concern is that there will be chaos in the credit markets soon. Most economists say not to worry but that's what they said about the coming crisis due to the subprime slime that was spreading in early 2007. In its latest financial stability review the ECB warned that there is a risk of "increasing competition for funding". Ya think? The problems have not gone away with all the credit/debt issues we've been facing--the can has only been kicked down the road. This goes for the U.S. as well.

Bonds sold off today and one reason is because many are very concerned about the coming credit crisis, which will result in a collapse of bond prices. Many fund managers are likely to begin shedding bonds from their holdings in an attempt to get out ahead of the pack. This could help the stock and commodity markets if money rotates out of bonds and into stocks. In fact that's been one hope of the Fed--they want to see the stock market rise so that the "wealth effect" will get more people freely spending their money and helping the economy. Their other effort of course is to hold down yields which requires buying, not selling, of bonds. Needless to say, the Fed wants it all and I'm thinking they're going to lose it all instead.

Because of the potential problems in the debt department Credit Suisse analysts have pointed out the fact that European banks have seen deterioration in the 2nd half of 2010. This is putting even more pressure on them to sell more bonds in the 1st half of 2011, adding to the supply of bonds coming to the market (competing with governments). Credit Suisse feels it's going to become increasingly expensive for banks to seek additional funding and for this reason they believe large retail banks in particular are going to have a rough time.

And that brings me to a recommendation I posted on the Market Monitor last night. I was looking through the bank indexes and individual bank stocks and I noticed a particularly interesting setup on Bank of America (BAC) that I felt would be worth watching today. It has rallied up into resistance and could be ready for a reversal, which provides for a low-risk short play. I don't get much into individual stock plays but every once in a while I see one that's worth passing along as an idea to try.

BAC has resistance in the 14.33-14.55 area, based on a price projection at 14.33 where the 2nd leg of the rally from October is twice the 1st leg, a 38% retracement of the decline from September 2008, a downtrend line from September 2008 and the 50-week moving average at 14.55. I suggested a put play with April 14 puts (closed today at .86 x .87) for a downside target of 12.75 (the November high) and a stop at 14.60. For those who tried the play today you were unfortunately stopped out to the penny with a high today of 14.60. Care to try it again? Clearly the stock must decline tomorrow otherwise the setup is busted so keep an eye on how it's doing in the morning. With a profit objective of +1.75 on the underlying, a stop at 14.70 (above that the setup would clearly be busted) you'd be risking maybe 0.30 to make 1.75 which is much better than a 3:1 reward:risk ratio, a requirement in my trading rules. Anyway, just an idea to consider.

Bank of America, BAC, Daily chart

Another index showing the potential to be finishing its rally is the broker index. It has a 5-wave move up from the end of August, which fits as the conclusion of an A-B-C bounce off the July low. The c-wave for this move is 162% of the a-wave (common relationship) at 123.90. It's there. The top of the parallel up-channel for the c-wave is currently near 125. So the pieces fit for a top here or just slightly higher and a break below 121 would confirm the high is in--wait for it if you're tired of picking tops that aren't tops.

Broker index, XBD, Daily chart

On the TRAN's chart below I've labeled the wave count that I think fits price action the best and it looks good for a finish at Monday's high when it tagged the top of its rising wedge pattern from August (common pattern, eh?). After doing that it broke the bottom of the wedge yesterday but recovered back inside the wedge today. It was either a head-fake break on Tuesday or just a high bounce today. Another break of Tuesday's low near 5097 would confirm the rally is toast, with better confirmation by breaking below 5018. The TRAN and RUT look very similar.

Transportation Index, TRAN, Daily chart

I thought the pullback in the dollar would get down to about 78.45 for two equal legs down in its pullback but the 50-dma near 79 held it up and now the strong rally from last Friday indicates to me that the pullback has finished and the dollar has started its next rally leg. The coming rally should be strong--lots of dollar bears will be covering their short positions and lots of carry trades will get unwound. Look for more pressure on commodities (and the stock market).

U.S. Dollar contract, DX, Daily chart

As part of the "all-the-same" market, where most asset classes trade in tandem, we could see commodities lead us lower and when they move they tend to move fast. Yesterday saw the worst decline in 6 months so it should be an attention getter at the moment. At least keep the commodity index on your radar.

The commodities index, CRB, has so far failed just shy of the upside target area I've been watching--at 337-341--since Monday's high was 335.32. But it was a slight poke above the top of its parallel up-channel from February 2009 so that looks to be having more of an influence on price action. The current high has left a bearish divergence on RSI which has curled over. If the dollar continues to rally I expect this index to start down and it could be a fast decline.

Commodities index, CRB, Weekly chart

Gold also failed to make it up to a target that I thought it would reach--in the 1440-1450 area. But Monday's high of 1424.40 looks like the high since the break of the bottom of its wedge pattern has been broken with a 5-wave move down from Monday. The 5-wave move says we have a trend change so until proven otherwise (with a new high) it's time to short the bounces in gold, which it should get tomorrow.

Gold continuous contract, GC, Daily chart

Oil also has a clean 5-wave move down from Monday and that tells us a new downtrend has started. How far down is of course the big question and we'll just have to take it one leg at a time but for now look for a bounce to then roll over to new lows. The first real test will be the uptrend line from February 2009, currently near 85 (log price scale, whereas it's closer to its 200-dma when using the arithmetic price scale).

Oil continuous contract, CL, Daily chart

Tomorrow will be a quiet day for economic reports. If the unemployment claims number comes in good (or really bad), supporting (or not supporting) the expected jobs numbers on Friday it could move the market otherwise I expect to see no effect. Friday is the big day with all the jobs reports. The way the charts are set up at the moment I predict a disappointing reaction to the reports. Either that or we'll blow through resistance and scream to the upside in a blow-off move (I don't see it happening but hey, I'm been known to be wrong before, wink). Of course if it does neither then the market will go sideways. Now that I've covered my bases I can't be wrong.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, there's some solid agreement between the indexes and sectors that's showing us a top either has been made (RUT, TRAN) or is about to be made this week. Unless the RUT and TRAN blow out the top tomorrow or Friday, those two are the ones who have turned their blinkers on, signaling their intent to turn across traffic. The others look like they could be a day, or just hours, away from following.

That's the setup so we'll see how the market behaves tomorrow and especially Friday morning. It will certainly be interesting to see if the new moon on Tuesday will mark an important high. Not all new moons have been associated with market highs but all important highs have occurred on or near new moons.

SPX daily chart with MPTS

The ISEE call/put ratio closed over 200 today (205) which is simply a warning that too many are speculating about the long side (anything over 150 is excessive call buying and over 200 is frothy). The market pundits are doing a very good job getting the public believing the stock market will continue its rally and who knows they could be right. But that's not what I'm seeing in the charts, with the loss of momentum while seeing excessive bullish sentiment but as we all know, waning momentum and excessive bullish sentiment can both continue a lot longer than bears can survive turning in front of traffic. It's simply a caution flag on the race track.

Keep in mind though that an uptrend is still firmly intact. My attempt to call a top is just that--there are very few indicators (other than the RUT and TRAN) that are telling us the trend could be over. I'm looking at probable resistance levels coinciding with possible EW count conclusions to set up a reversal. The market will decide whether it wants to turn or not. The key levels to the downside are key (get it?) to the success of short plays. Without a break of those levels there is no confirmed reversal which means any short plays entered prior to confirmation must be strictly managed--short a rollover or against resistance and stop out if the rally continues to push through resistance. Then set up for the next level of resistance and we'll try it again. I don't like the risk:reward to the upside from here so it's either flat or trying the short side. Just be sure you understand the risk and manage it appropriately.

Good luck and I'll be back with you next Wednesday.

Key Levels for SPX:
- bullish above 1277 to 1292
- bearish below 1254

Key Levels for DOW:
- bullish above 11,860
- bearish below 11,530

Key Levels for NDX:
- bullish above 2282
- bearish below 2237

Key Levels for RUT:
- bullish above 800
- bearish below 778

Keene H. Little, CMT

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