Market Stats

MarketWatch headline after the close -- "Dow Edges Higher for Third Straight Gain". OK, true but +1.8 points is not exactly something bulls will be writing home about. But the headline is good for public consumption and that's what keeps the public buying. As for the others, which were all in the red, who cares, it's only the DOW that counts. Right? We who watch and trade the market every day of course know better. But probably 90+% of the population, worldwide, watch the DOW and that's all that matters.

Other than the minor losses today (OK, minor gain for the DOW), today's trading was very lackluster. After the exciting days from Friday through Tuesday it was downright boring. The bulls will look at the strong recovery off Friday's big decline followed by consolidation today as the good kind of boring. The bears look at today's price action as topping (similar to previous highs). Just as the battle from Friday to Tuesday was played out with big price swings, so too was the battle played out today, but this time with little price swings. Where she goes next will be up to who feels greater conviction about why the market should go one way or the other. We in the meantime wait for the next signal.

The stronger sectors today were the techs while the weaker ones included the transports, home builders, gold and silver and the financials. Overall I'd say it was a slightly negative day, especially because of which sectors were weak, but definitely one of consolidation.

The day started out slightly negative as the futures had sold off some during the pre-market session and the economic reports didn't help much, even though the reports were decent. The ADP Employment report was positive in that it showed an increase of 187K jobs vs. the +150K expected. But it was lower than December's +247K which itself was revised down from the initially reported +297K. Understandably the futures market gave a great big yawning reaction to the number. It doesn't help much with the prediction for Friday's nonfarm payrolls number which is expected to be +125K (+140K private), up from December's dismal +103K.

The other good employment number was the Challenger Job Cuts report which showed a -46.1% decline from December's +29%. The numbers around the holiday period can be expected to be volatile so it's hard to discern any real meaning from this number. Certainly the lack of response from the market would agree.

In last week's charts I was showing a little more upside potential on the indexes (except the RUT) and this week's charts show the same thing. What I did not anticipate was a strong sell signal on Friday that would get completed negated with a strong rally back up on Monday/Tuesday. Call it manipulation (PPT) or new-month money or whatever you want; it doesn't matter. The market is what it is and we trade price action. One thing to note though is that it's common for price action to get a little more whippy with bigger swings at market tops as the bulls and bears get a little more emphatic with their trades (greed and fear levels rise for both).

So the setup this week is exactly what it was last week -- I see a little more upside potential but wary of a breakdown occurring at any time. Dip buyers will continue to look at declines as buying opportunities but what I see in front of us (soon) is a time when dip buyers are going to get hurt (if they don't properly manage their stops). While the top of this rally has been incredibly difficult to find, I think the market is becoming more and more vulnerable to a disconnect to the downside. The very significant bearish divergence at the current highs tells me there's very little support underneath this rally right now. But the trend is up and it's been good to stick with the trend. Just be careful about the bend at the end.

As usual, I've got some key levels on the charts to watch. A break of the key levels to the downside is the sell trigger. The market remains bullish until those key levels are broken. In the meantime I look for levels where a reversal might occur and patterns that clue me to the completion of the rally and start of a decline. The month of January may have been bullish but it did not add many points to the board and the waning momentum tells me to be very careful about any further upside expectations.

Starting with the SPX weekly chart, the top of the rising wedge pattern from the July low will be near 1320 by Friday. The August 2008 high is near 1313 so that provides an upside target zone for this rally. The uptrend line from August is near last Friday's low at 1275 so a break below that would be a bearish heads up. On a weekly basis the bulls must defend 1173 as a break of that level will mean at least a deeper retracement of the rally from July and potentially much more.

S&P 500, SPX, Weekly chart

Within the rising wedge from July-August I have an uptrend line from November, which SPX broke below on January 20th. It then hugged that trend line until its last test of it on Friday morning before selling off hard. Nice sell signal on that move but obviously the bulls thought otherwise. More like nice buying opportunity. Now price is once again back up to the broken uptrend line and once again not able to get back above it. This is bearish price action even if it is making new highs. And notice the strong bearish divergence as price makes new highs since mid January -- not bullish. I suspect the next break will not be so kind to bulls who try to buy the dip. In the meantime the upside potential to 1320 holds but that's not the way I'd want to trade it (other than quick day trades where you're watching it carefully). End-of-day trade setups on the long side (where you only check the status at the end of each day) are too risky in my book.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1300 to 1320
- bearish below 1275

For some reason QCharts doesn't show the trend lines on the 60-min chart in the same location as on the daily chart so I have to kind of fudge the difference in my analysis. The 60-min chart below shows an expectation for one more leg up to complete a 5-wave move up from last Friday. I was expecting to see that today but there was no oomph to the bulls' efforts today. So maybe Thursday. The 5th wave would equal the 1st wave at 1314.82 and it would be 62% of the 1st wave at 1310.21 (those will change if it pulls back a little further before running up to the new high). But it's possible a very tiny 5th wave finished yesterday and today's pullback was the start of a more serious decline. Therefore any hard selling (below 1300) would have my attention as it would suggest we've already seen the high.

S&P 500, SPX, 60-min chart

As with SPX I've been expecting the DOW to make it a little higher and the trend line along the highs from August, currently near 12130 and then 12150 by Friday, makes for a good upside target. I have a Fib projection on the chart showing 12076.60 for an upside target (based on the wave structure of the rally from November),which is only about 19 points above today's high, so that's the first level to watch for potential problems. Any decline from here back below 11800 will signify a more important high is in place. Don't be in a hurry to buy the dips if that happens. We'll get at least a larger pullback to correct the rally from November if not the one from July.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,000 to 12,150
- bearish below 11,800

One of the stocks that's been helping the DOW make new highs is Caterpillar (CAT), which was again at the top of the list of DOW stocks today. I've been watching CAT in the last couple of weeks because it has a very interesting setup that I thought I'd pass along. Normally I don't spend much time on individual stocks unless I see something interesting and worth consideration for a trade. And yes, even a boring DOW stock is worthy of consideration, especially one that has increased almost 5 fold since March 2009 (putting many sexy tech stocks to shame).

Especially with a weekly chart and even more so with a stock/index that has moved a lot of points, it's very valuable to look at the chart using the log price scale. It essentially gives you a visual perspective of price changes on a percentage basis rather just points. If you use trend lines this is a must -- compare log scale and arithmetic scale and you'll see a very different picture between the two. So doing that with CAT shows a rather interesting setup.

Using the log price scale for CAT and drawing a line across the highs from October 2009 and December 2010 and an uptrend line from July 2009 and the lows in June-August 2010 gives us a rising wedge pattern, which is bearish. Today's rally has taken it up to the top of the wedge. As noted on the top chart below, a throw-over above the wedge to tag the century mark at $100 could be a nice finish to its rally. The bottom chart below is the exact same chart but I switched to the arithmetic price scale.

Caterpillar Inc., CAT, Weekly chart

You can see the rising wedge on the log scale becomes a perfect parallel up-channel on the arithmetic scale. Is this coincidental or does it have even more meaning with both price scales giving us the same message? I think it's important. Also note on the bottom chart the broken uptrend line from 2002-2006 that it has poked above this week. Watch for where it closes and if it closes back below 97 I think it would be a good sell signal.

So who cares about CAT, right? Boooring. One trade idea for it, assuming we get the sell signal from it, is a LEAP put. If you buy a January 2012 put, two strikes out as an example, the current price for the $80 put is 4.35 x 4.45. If the bearish rising wedge is the correct interpretation it will eventually be completely retraced. If you hold the LEAP put for the longer term, you can sell front-month puts against it as an effective way to work the cost basis of the LEAP put down (think of it as a covered call in reverse). Just a trading idea (but wait for the confirmed break down)

BTW, Exxon Mobil (XOM) is in a similar position if it closes back below $83. Its longer-term pattern points to a move back below its July low at 55.94. Currently trading at 83.41 (this week's high was 83.98), you could buy the January 2012 $75 put for about 3.60. It has a very low implied volatility (about 21%), which has been ticking higher in the past week and would head higher in a decline, which helps increase the value of puts. Again, just a longer-term trading idea on a boring DOW stock (but wait for the break below 83).

Back to the sexy techs, on January 20th NDX broke its uptrend line from August and then spent the next week trying to get back up to it, finally reaching it on Thursday, January 27th. That led to a kiss of the trend line, a slap and a selloff on Friday. Nice sell signal. But the decline held its broken trend line along the highs from last April-November (resistance turned support), near 2258 and the bounce from there emboldened the I-wanna-buy bulls who drove it right back up. If the bulls can keep it going, another test of the broken uptrend line will be near 2265 on Friday.

But it's currently battling, again, strong Fib resistance at 2330-2331 and notice the huge bearish divergence on the oscillators at this possible triple top. At 2331 is the 38% retracement of the 2000-2002 decline (which certainly keeps the 2009-2011 rally in perspective). Looking at the 2009-2011 rally as an A-B-C bounce, the first leg up (wave A) was the March 2009 - April 2010 rally and the 2nd leg up (wave B) is the rally from July 2010. The daily chart below is zoomed in on the c-wave. Near 2330 the c-wave is 62% of wave (A), which is a common relationship (as is equality). I don't think NDX stalling near this 2330-2331 is coincidental. So any failure to press higher and a drop back below 2258 would tell us the high is already in place and be looking to short the rallies from there.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2330 to 2365
- bearish below 2258

Last week's chart of the RUT was the one that I thought was pointing to a selloff sooner rather than later. It had bounced up to its broken uptrend line from August and I thought it was a very nice setup to try the short side for the next leg down. If you took the short it was an excellent trade but I hope you honored your stop when it rallied back up this week for what was yet another foiled attempt to short the market. Now we've got the same setup again. Is the 2nd mouse going to get the cheese?

Friday's decline stopped short of breaking the 50-dma, which was bullish. Once it held again on Tuesday the bulls came roaring back and now the bounce off the January 25th low looks like a slightly larger a-b-c bounce back up to the broken uptrend line. Last Thursday the RUT left a doji at resistance and sold off. Great sell signal but the bulls thought otherwise. Now it has left another doji at resistance. Hmm, repeat performance? The bears are going to be tentative but it's often when the 2nd mouse gets the cheese so any selloff from here will be another sell signal. And if it does sell off from here I don't think you'll want to be looking to buy the dip, at least not for the next couple of weeks. If the market pushes a little higher from here, keep an eye on that broken uptrend line, currently near 806.30 and then 808 on Friday, which would be a test of the January high.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 808 to 830
- bearish below 775

Last week I showed the weekly chart of TYX, the 30-year yield. It is very close to its long-term downtrend line from 1994 near 4.69% - 4.70%. Thinking it should push a little higher is one of the things that has kept me thinking the stock market should push a little higher with it. Once yields peak, which I think they're close to doing, we should see a rally in the bond market and potentially rotation out of stocks. The daily chart of TYX shows the small rising wedge pattern since the late-December low. This is an ending pattern and should be complete with one more new high, which coincides with resistance at its longer-term downtrend line. Even if yields have a much more bullish future, they will need to pull back and at least correct the 5-wave rally from August. More bearishly (for yields, bullish for bonds), we could see TYX head for 2% before it's finished.

30-year Yield, TYX, Daily chart

Inflation worries will show up in the bond market because higher rates of return are demanded by bond holders to compensate for the loss in the face value of the bond from inflation. So watching bond yields can help give us a sense for how the bond market is feeling about inflation (which is smarter than the stock market in this regard). By the chart above we can see that the bond market has been worried about it but not quite sure yet (no breakout to the upside in yields).

Many bond traders who are fearful of inflation will use Treasury Inflation-Protected Securities (TIPS) to hedge against inflation. The principal value of TIPS increases in value at the same rate as the CPI (Consumer Price Index). The principal amount, or the face value of the bond, will also change depending on the demand for the bonds. If a higher yield is demanded then the price of the bond drops, and vice versa. Watching the prices of the TIPS can help us determine the level of concern about inflation.

I think the TIP chart below is telling us inflation is not a worry and soon will be telling us that deflation is the worry. Since dropping down to the bottom of an up-channel from March 2009 TIP has been sliding up along the bottom of the channel in a bear flag pattern. It's looking like the flag, and up-channel, are about to break soon and when it does, confirmed with a break below 105.48, it will speak volumes about the inflation/deflation debate. Our stock market rally has been based upon the premise that the Fed will accomplish its goal of re-inflating the economy so if they lose that battle, as evidenced by this chart, we could see the stock market start back down as well. At least that's the theory and risk to those who believe the stock market only has "up" in its future.

Treasury Inflation-Protected bond fund, TIP, Weekly chart

The banks were one of the weaker sectors today and that's always worrisome to the bulls. XLF has stalled at its January 14th high which is also the price projection for two equal legs up from August (at 16.75). So far the retest is accompanied by bearish divergence so any drop back below its uptrend line from November, near 16.40. would be a bearish heads up that a break of its key level at 16.20 is probably next. Until then there is still bullish potential at least up to the top of its rising wedge pattern near 17.00.

Financial sector SPDR, XLF, Daily chart

We know the banks have been bailed out in the past with a slew of government programs and we know they continue to get bailed out with the help of the Fed keeping interests effectively at zero (actually negative when you consider inflation) to allow them to get free money and then lend it out (well, supposedly lend it out) at market rates. Or even buying Treasuries with the money gets them an instant return on their borrowed money. Of course we also know the bigger banks are using some of that borrowed money to "invest" in the stock market as well, using very high leverage at the same time.

Most people are very angry about the banks getting bailed out with the TARP money and all the other alphabet-soup programs the Fed and Treasury came up with. So instead of more bailout programs, which the people would find highly offensive (especially after hearing, again, of the big bonuses the bankers are paying themselves), the banks are simply being bailed out through a little-known program with Fannie Mae and Freddie Mac, which are of course government owned now.

In late December 2009 Timothy Geithner had removed the cap on how much the two could receive to support their purchases of mortgages from the banks (the limit had been $200B each). He effectively gave each a blank check to take however much money they needed to buy the mortgages. And buy they've done and they're not at all selective in what they're buying. They've enable the banks to unload all their pieces of cow dung onto the American public (since the taxpayers own FNM and FRE). This is a bailout of extraordinary magnitude and yet most people are completely unaware of what's happening. They say the people get the government they deserve so I guess we deserve what's happening to us. You can read a little more about this from Henry Blodget who quoted Barry Ritholtz in his article The Perfect Bailout.

I realize it's important to enable FNM and FRE is buy the mortgages so that it frees up the banks to do more lending, which is designed to get the housing market restarted. But it's the government support of the housing market in the first place that has it so screwed up. What I don't like is the bailout of the banks and allowing them to offload their underperforming loans without taking a loss when it's their fault they even have a loss. Then they pay themselves huge bonuses because they think they've done such a good job. Instead, the losses are being pawned off on the American people and most don't realize the additional debt burden we're taking on just so that the banks don't have to take the losses. Do you see why Jefferson warned the American people to never allow a central bank, a consortium of private banks (e.g., Goldman Sachs), to exist? They exist to take care of themselves at the expense of the people.

But I digress, and speaking of houses, it's been a while since I've shown the chart for the home builders and it's not exactly clear yet whether its bounce has completed or not but the daily chart suggests it might have. One of the leading sectors to the downside today was the home-builders index so it's currently looking weak. The weekly chart shows a little more upside potential before it would hit its 200-week MA near 303 and then its downtrend line from 2005 near 315. The January 14th high was 290.30 and the wave count on the weekly chart calls for another steeper selloff to follow and any continuation lower from here will increase the likelihood that we've already seen the high for his index.

DJ Home Construction index, DJUSHB, Weekly chart

While the DOW has been pushing to new highs in January and then another yesterday and today, the Transports have been notably absent. Along with the home builders the TRAN was the leading sector to the downside today, down -1.9%. The TRAN made its last high on January 18th and even yesterday's rally failed to top last Friday's. Bullishly it's holding (barely) onto its 50-dma but the longer it consolidates near this important moving average the more likely it will break. It did close below it today so any continuation lower tomorrow will be bearish. A drop below last week's low near 5015 would be a sell signal since it would be a confirmed break of its 50-dma as well.

Transportation Index, TRAN, Daily chart

DOW Theorists are looking at the TRAN's inability to confirm the DOW's new highs as bearish non-confirmation. Looking at the DOW and TRAN on top of each other shows the glaring divergence and as long as this continues the more likely the DOW will follow the TRAN and not the other way around. On the chart below I've noted the last non-confirmation which was bullish -- in November the DOW made new lows on November 16th and 29th below its November 1st low while the TRAN tested its November 1st low on November 16th but made a higher low on the 29th. This was bullish non-confirmation and the DOW followed through to the upside. Now we've got the opposite situation and I'm expecting to see the DOW follow through to the downside.

DOW vs. Transportation Index, Daily chart

Just maybe the U.S. dollar might have found a bottom. So far the low that was put in last night at 76.88 was about 13 cents above the uptrend line from March-July 2008. Whether the dollar is longer-term bullish or bearish, the short-term pattern (the first half of 2011) calls for a rally. That pattern would change if the dollar broke below the November low at 75.63 but I'm not anticipating that. The more likely scenario calls for a rally at least to the 88 area over the next several months and then it will be decision time as to whether we're going to see a much stronger rally or a dollar crash instead. We've got time to worry about that later (which will obviously have an impact on other asset classes).

U.S. Dollar contract, DX, Weekly chart

Gold has remained inside its down-channel from January 3rd and will remain bearish for another leg down as long as the downtrend line holds. I'm anticipating a decline to its 200-dma near 1285 to complete a 5-wave down. That 5-wave move would then be followed by a correction of it and as depicted, a bounce into March, perhaps back up to the 1350 area, would then set up another leg down. There is the possibility that the move down from January will complete a larger pullback corrective pattern from November/December so staying short gold once the down-channel is broken would not be the smartest place to be. It's possible (not shown) for another final rally leg to the 1500 area before its long-term rally from 1999 completes and then start the larger correction to the downside.

Gold continuous contract, GC, Daily chart

Oil has had such a choppy pattern since May that it makes it difficult to figure out what's next. My best guess is shown on the chart below and it calls for one more down-up sequence to finish the rally, perhaps up to the 95-98 area. But any break below 85 now would signal the top is already in place.

Oil continuous contract, CL, Daily chart

With the market stuck at the flat line today, and futures still at the flat line this evening, maybe one of the economic reports tomorrow morning will kick start a direction for us. The reports typically are not market moving so it's not likely they'll do much. Friday's payrolls numbers will be the big deal, especially if there are any positive or negative surprises.

Economic reports, summary and Key Trading Levels

My highly sophisticated black-box trading system, which I'll make available to you at the low low price of $4995 because you're so special to me, is the MPTS (Moon Phase Trading System). While normally very reliable it's been on the fritz lately (hence the discounted price from $6995) and I'm having my programmer perform some tweaks. Frankly it's been a miserable failure since the end of November when each new and full moon has simply meant "buy more". It's supposed to mark important turning points and all it's done is mark minor dips which have been good buying opportunities. So the question now is whether or not tomorrow's new moon will coincide with a more important top, which it's done fairly well in the past, or just another minor dip that's coming which should be bought. We'll know soon enough. Considering the other signals I'm getting from the charts I would not be in a hurry to buy the next dip, or at least if you do you'll want to keep a tight leash on it. Don't get lulled into the same sense of bullish complacency that seems to be affecting (infecting?) so many bulls right now.

SPX with MPTS, Daily chart

Just as last week, the charts point to the potential for a little more upside and until the bulls do something wrong (they did last Friday but quickly recovered) you should stick with the trend. But I don't see a lot of upside potential and I see a whole lot of downside risk and therefore to chase the market higher at this point is, I think, asking for trouble, especially if you can't watch the market during the day and make some trading decisions. I still think that when the market breaks it could go very fast and Friday's decline may have been a shot across the bow of the USS Bullship. While the ship is obvious ignoring the warning, the next shot may take out the steerage and then a hole placed amidships.

The bottom line is that while bears can be accused of being in denial about the current rally I think it's very important for bulls to not get lulled into a sense of complacency. Just about everyone I talk to says a rally this year is a done deal. The Fed is behind it, it's the 3rd year of the presidential cycle, etc. When I hear these people say the rally can't fail it makes me very nervous. A can't-fail rally is doomed to failure; it's just the way the market works (too many get on board for the rally and then there's nothing left to push it higher -- think of it as one big Ponzi scheme).

And to those who argue the 3rd year of the presidential cycle has a very envious winning record I say yes, but. The first two years of the presidential cycle are normally not so good for the stock market. We've had two outstanding years. Might the cycle be flipped upside down this time around? Will the 3rd year be down in this case instead of up? I think it's a distinct possibility. But that's all speculation. I'll stick with the chart patterns and right now they're warning me about a finish to the rally, if not here then only slightly higher. Caveat Emptor.

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

Key Levels for SPX:
- bullish above 1300 to 1320
- bearish below 1275

Key Levels for DOW:
- bullish above 12,000 to 12,150
- bearish below 11,800

Key Levels for NDX:
- bullish above 2330 to 2365
- bearish below 2258

Key Levels for RUT:
- bullish above 808 to 830
- bearish below 775

Keene H. Little, CMT