Market Stats

Yesterday's decline left a 90% down day (90% of the volume to the downside), making it the 2nd one in the past 7 trading sessions. That's clearly a change in character for the stock market. Whether it will lead to anything more than just a relatively small correction to the rally is of course the current argument. Most will acknowledge the fact that the market is overbought and stretched to the upside, mostly on the belief the Fed won't let anything bad happen to us. I think the Fed gets way too much credit but what they have accomplished is setting very bullish expectations by most traders. And that has worked wonders for the rally, especially from last August.

The trouble with sentiment is that it can turn on a dime. Trading this market on fundamentals (improving economy, P/E ratios, S&P earnings, etc.) is a recipe for disappointment. Anyone trading for a while knows the market sells off on good news and "climbs a wall of worry" on bad news. While it's been a little frustrating using technical analysis in an attempt to determine the market's direction (finding support/resistance), it's still more reliable than using fundamentals. At least that's my opinion and of course I'm probably biased to believe that, having learned to use the technical tools at our disposal. Chart reading is where I think we'll make the most money, even if at times it seems to let us down.

Worldwide sentiment is obviously on edge right now. As the secular bear market has progressed since 2000 I've been saying we'll have cyclical bulls within it, such as the 2009-2011 rally, but the larger and overriding cycle is the secular one. The last secular bear lasted from 1966 to 1982 and then the secular bull to 2000 and now the secular bear should take us into 2016. These secular cycles are primarily swings in social mood and it's no coincidence that major wars come out of bear markets.

Why are the Mideast and N. African countries experiencing the social revolutions now? Did something fundamentally change to cause this? Not really. It's more a result of the social mood swing and we'll see it happening in more countries as the people become more and more frustrated and angry with their governments. It will happen here in the U.S. in the state capitols first as the states struggle to continue giving away money they don't have. People don't like to be told they can no longer have and I'm not making a political statement when I say unions are in business to ask for more, not give back. So the social acrimony will likely increase from here and that's merely a reflection of where we are in the bear market cycle.

I don't say this to make you depressed. I say it because it's just a fact of these cycles. Unless you traded the stock market back in the 1970s you've only known a bull market and the rally of the past two years was simply a reflection of the renewed hope that everything's better again. But in reality the excesses in the system, such as excess credit, have not been wrung out yet, which is the job of a bear market. A lack of interest in borrowing more and debt destruction (through defaults and paying down debt) is what the bear market cycle is all about. It will end when most are not interested in the stock market and the majority of the people feel we're stuck in a permanent malaise. That's when you'll want to be a buyer of stocks for the long haul.

The stock market is the best reflector of social mood and as the mood shift occurs again, which is what we're starting to see, the stock market will reflect it. Happy people invest in their future. Angry and frustrated people buy food and guns and when food is no longer available (or costs an arm and a leg) they take it out on their governments. They'll buy gold and bury it their back yard. They won't be buying stocks.

Believing in this cycle, as I do, has had me looking for a top to the stock market's rally rather than having an expectation that we'll rally to the moon as so many are calling for. I could be completely wrong, and certainly the rally went higher and lasted longer than I thought it would, but at least if you know the "fundamental" reason for my bearishness you'll at least be able to understand why I'm looking for a reversal to get short rather than a dip to buy. My opinion is only one of many that you read and hopefully it will help you make some informed decisions and at least make you aware of the downside risk, and why, so that you'll recognize it when it's happening.

I don't think the market is paying much attention to the daily economic reports right now, except for maybe the payrolls numbers in hopes of seeing an improvement in the employment picture (of course a good report could then spark worry the Fed will take away the spiked punch bowl). This morning's jobs numbers were a little mixed as the ADP report showed an increase of 217K jobs vs. January's 187K and expectations for 165K. The bulk of the growth (202K) came from the service sector. But this was countered with some not-so-great news about a surge in layoff announcements out of government/non-profit organizations, with a 20% increase to 50.7K, up from January's 38.5K, making for the largest number since March 2010.

The MBA Mortgage index dropped -6.5% for the previous week, following the +13.2% the week before that. It's a volatile number but the bottom line is we're not seeing many signs of growth in the housing sector. I'll have a chart later showing the non-seasonally adjusted new home sales and it's not a pretty picture.

With that let's jump into the charts, starting with the weekly view of SPX. It had rallied to within 8 points of a Fib price projection at 1352.67 where the c-wave of an A-B-C bounce off the March 2009 low would be equal to 62% of the a-wave, which is a common relationship when the 2nd leg of the bounce is weaker than the first (the first leg up being the March 2009-April 2010 rally and the 2nd leg up being the July 2010-February 2011 rally). As can be seen on the weekly chart, a break of the uptrend line from August would be the first sign of trouble for the uptrend. Based on the wave count for the move up from July I believe the break is coming but the bulls aren't in more serious trouble, on a weekly basis, until SPX breaks below the January 28th low near 1275.

S&P 500, SPX, Weekly chart

SPX broke its uptrend line from November last Wednesday and then bounced back up to it (breaking slightly back above it) on Monday and Tuesday but then sold off sharply on Tuesday, leaving a bearish kiss goodbye at the retest. It's now finding support at its uptrend line from August-November, currently near 1308. Today's candle is a little spinning top doji and could be considered a bottoming pattern or simply a continuation (down) pattern. We have to let Thursday's price action tell us which. As depicted, I think the market will head lower in a pattern similar that shown on the chart below but clearly that's just a guess at this time. The price/time relationships between the wave fit nicely for a move down to 1225 by expiration week.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1344
- bearish below 1294

The star doji shown on the daily chart above is shown in more detail on the 60-min chart below. Notice the choppy price action at the broken uptrend line from August, which looks more like a continuation pattern rather than an impulsive start to a bounce. That's what has me leaning to the downside, either immediately in the morning or after another leg up for the bounce, potentially up to the 1317 area before heading lower again. If SPX gets above 1326 I'd say there's a good chance the dashed line depiction will play out (or possibly something more bullish).

S&P 500, SPX, 60-min chart

The DOW is bouncing around a few different trend lines as traders battle it out near the high. After breaking its uptrend line from November last week it bounced back up to it at Monday's and Tuesday's highs and then sold off sharply on Tuesday. It's the same as SPX -- a bearish kiss goodbye. Today, like last Thursday, if found support at its uptrend line from August (log scale) and formed a star doji today. A rally back above 12280 would be potentially bullish while any continuation lower from here will be bearish.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,400 to 12,600
- bearish below 11,980

Different index, same story. NDX broke its uptrend line from August last week, bounced back up to it this week and then sold off sharply. You can see why I like this setup so much -- it's one of my favorite patterns to play. We could see NDX walk back up underneath its broken uptrend line (we've seen that a time or two in the past year or two) but that would be just a guess here. In the meantime it looks like the path of least resistance is to the downside, especially if NDX breaks below its 50-dma at 2305 and then last week's low near 2285.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2400
- bearish below 2285

Last week the RUT found support at its 50-dma and then on Thursday it found resistance at its broken uptrend line from August (the small white candle on Thursday). It then gapped up on Friday and back above the trend line. Monday's spinning top doji was followed by Tuesday's selloff, creating the evening star reversal pattern. Yesterday it again broke the uptrend line and today it again found it to be resistance. Looks like a similar setup as last Thursday doesn't it? If tomorrow gaps up and the RUT gets back above its trend line, currently near 816, which is near the 50% retracement of the decline from Tuesday's high, it could be bullish for another run higher (dashed line). But the bulls need to prove themselves on that score and in the meantime it's a bearish setup for a kiss goodbye at resistance. I'm projecting a 5-wave move down into opex week, with a downside target near the November high at 739. That's obviously speculation on my part but it would be a typical pattern.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 838 to 850
- bearish below 794

The RUT's short-term pattern may be pointing to a little whipsaw price action dead ahead so be cautious about that possibility. The move down from Monday might need a minor new low (798-ish) that will then be followed by another bounce up that could test the broken uptrend line again (bold red price path). Or like the others we could see a morning bounce that finds resistance near 816 that is then followed by a stronger decline (dashed-line projection). That's the setup I'd prefer to see (dashed line) since it would offer a lower-risk setup for a short entry. There is the possibility that the market will simply sell off from here and a break below 795 would say get short and hang on for the ride down. A rally back above 828 would negate the bearish wave counts on the chart and suggest caution by both sides until the pattern clears up.

Russell-2000, RUT, 60-min chart

Looking at the Total Market index (Wilshire 5000) for some confirming clues from the big index, it supports the bears (sorry bulls). Last week's decline broke its uptrend line from August (log scale) and Monday's and Tuesday's highs were retests of the broken trend line. Tuesday's strong selloff left a bearish kiss goodbye. These bearish setups don't always work but the odds are in favor of it working and the risk can be kept tight. When they do work they work like yesterday. If you like playing the short side that was a sweet setup. But now the bears have a little work to do and need to break below the 50-dma at 13655 and last week's low near 13640, and stay below, in order to get a bigger bang out of their short position.

Total Market index, DWC, Daily chart

The VIX gave us a confirming bearish signal for the stock market by breaking out of its bullish descending wedge last week and then successfully testing the top of the wedge. That's bullish for the VIX and consequently bearish for the stock market.

Volatility index, VIX, Weekly chart

Another index that has broken its downtrend line is the bonds. TLT, the 20+ year Treasury ETF, is shown below and the break of its downtrend line from August (which is yet another trend line from August that's been broken) is bullish. We could be at the start of a rotation out of stocks and into bonds. What's not clear at the moment is whether bonds will rally a little further before pulling back and then rallying stronger into April (bold green) or pull back from here and test its low and broken trend line before heading higher. But the bottom line is that bonds should get a rally to at least retrace a portion of the decline from August. That would of course decrease the yields, keeping the direct correlation between yields and the stock market intact.

20+ Year Treasury ETF, TLT, Daily chart

The Fed Beige book was released in the afternoon and in it the Fed referred to the increasing number of businesses that are passing through higher input costs or were planning to do so in the near future. This is a measurement the Fed watches closely because it tells them whether or not inflation is going to become a more worrisome problem. If customers are willing to pay higher prices that's a good thing for businesses but inflation worries will have the Fed easing off the gas pedal and not drive so much new money into the monetary system. That could spook the stock market. It's that good news-bad news thing.

The Fed says the good thing is that wages are not rising. Good for who? Oh that's right, the Fed's mandate is not to worry about the welfare of the people, only the bankers. They're watching for improving market conditions, one that will improve hiring, while hoping to see inflation not rear its ugly head. No one seems to be worried about deflation anymore. The next round of debt destruction (perhaps led by the municipal bond defaults, along with additional mortgage defaults) should bring deflation back to the forefront.

Of the 12 Federal districts, only Chicago reported the pace of business being a little slower than this time last year. The other 11 districts reported conditions improving at a "modest to moderate" pace.

One important development that was cited were the improvements in the commercial real estate sector, an area that many were worried about in the recent past but now seem to think the worries were overblown. The DJ REIT index (DJR) has held up well since the March 2009 low but it may be in trouble soon if this week's decline continues. On a news-related spike on Monday it punched above the top of its rising wedge pattern but then spiked back down yesterday and sold off a little more today. At this point that price action left a throw-over finish to its rally and a sell signal was created by dropping back inside the wedge pattern. It needs to break below the bottom of the wedge near 226 to confirm the rally from 2009 has probably completed and then we'll start hearing about more commercial real estate troubles. The short side of this sector can be played with SRS, the inverse ETF.

DJ REIT index, DJR, Daily chart

In the private real estate sector the news has not been very good. New home sales, reported last Thursday, were down 13% to 284K annualized, which is the lowest rate ever. Of the non-seasonal adjusted 19K "homes" sold in January a little over half of them were vacant lots or under construction. And if you've got an expensive home (over $750K) it's getting harder to sell -- only 500 of them sold in January. The chart below is not a pretty picture if you're trying to sell a home or plan to this spring:

New Home Sales, non-seasonally adjusted numbers

The fact that the number of homes sold has dropped below the 2008 and 2009 lows is not a good sign for our economy. The stock market rally from 2009 has been a total disconnect from reality and another reason to question it. Housing reflects our economy and has a huge impact on consumer sentiment and psyche. Without an improvement in the housing market it's very difficult to justify the uber-bullish projections we've been hearing for the stock market for the coming year.

The banks have been one of the weaker indexes recently, which has pointed to lower lows for the broader averages. BKX closed below last week's low today while the BIX and XLF (financial sector ETF) are struggling to hold at their respective lows. But today XLF closed below its 50-dma after getting a bounce off it last week. That's clearly bearish and a break below last week's low at 16.34 would likely usher in stronger selling. Whichever way the market heads the rest of this week, keep an eye on the banks and you'll want them supporting the move to add confidence to your trade.

Financial sector ETF, XLF, Daily chart

After matching the DOW with a new high above its January high, thereby negating the bearish non-confirmation between the DOW and TRAN, the TRAN sold off hard last week. Makes one wonder if the rally in the transports was manipulated in order to negate the non-confirmation. But that would be just conspiracy talk (wink). In any case, the TRAN finished February with a higher high and lower low and last week's decline broke its uptrend line from August, which is also a breakdown from its parallel up-channel, signifying a change in its trend to the downside for now. The trend is your friend until the bend at the end and we've had the bend. A break below last week's low near 4917 would signify the next leg down is in progress, one that should make it down to its 200-dma near 4650.

Transportation Index, TRAN, Daily chart

The dollar continues to struggle and has broken its uptrend line from 2008, which could clearly be bearish and pointing to much lower lows for the dollar. But the selling is weak and choppy and continues to suggest it's getting ready for another leg up, as depicted on the chart below. Perhaps it will test the November low and the bottom of a bullish descending wedge pattern, both at 75.63. It could even make a minor new low and not necessarily be bearish. But it will need to rally above the February 14th high at 78.87 to turn the pattern bullish.

U.S. Dollar contract, DX, Weekly chart

As the world worries what kind of powder keg is ready to explode in the Mideast, we've seen money run into oil (for obvious reasons) and gold and silver (to combat inflation worries and worries in general). Gold has run up to a new high which opens the door to the $1500 level that I've pointed out in the last couple of updates. That's where the top of its parallel up-channel from 2005 is currently located and is shown on the weekly chart below. The pattern remains bullish as long as price remains above its uptrend line from April 2010, currently near 1345, and would turn bearish with a drop below the January low near 1309.

Gold continuous contract, GC, Weekly chart

If gold is to rally higher it might need a pullback first. As shown on the daily chart below, it has run up to the top of a parallel up-channel from January. I can satisfactorily count the rally from January as completing a 5-wave move which calls for at least a pullback to correct that leg up before proceeding higher. More bearishly it could mean it's putting in the final 5th wave of its rally and will start a longer-term decline, which would reflect a greater concern about deflationary factors instead of inflationary. For the short term, a drop below 1392 would be bearish and then I'll be watching the price pattern to help determine whether or not we should look for another rally leg. For the time being be aware of the vulnerability for at least a pullback.

Gold continuous contract, GC, Daily chart

I read a popular silver newsletter today (I won't mention any names) and in it the author described the strong rally that we've seen in silver and went on to explain why it's not a bubble. All I could hear as read it was that "it's different this time." Whatever. If it looks like a bubble, walks like a bubble and smells like a bubble it's a bubble. Looking at the weekly chart below, if this were anything other than silver (or gold or oil for all the "fundamental" reasons they should be rallying as well) would you be worried about buying into a bubble? It's great while it lasts but you don't want to be the last buyer holding the bag here.

Silver continuous contract, SI, Weekly chart, arithmetic scale

So after looking at the above chart I thought to myself, "Self, you're not being fair. You should look at it with the log price scale." Not only did I look at it with the log price scale but I placed a parabolic curve on it and even with the log price scale one could easily argue that silver has truly gone parabolic as it scoots higher above the parabolic curve. But not to worry, it's different this time.

Silver continuous contract, SI, Weekly chart, log scale

Poor oil is getting most of the blame for last week's stock market decline. This reminds me of the talk back in the early part of 2008 when oil was skyrocketing higher and the stock market kept rallying into May. We were told that higher oil prices were due to extra strong demand (primarily from China) and that this meant strong economic performance so the stock market was reflecting that. Then the stock market started back down and we were told it was because of the higher oil prices and how it was going to squash the economic recovery. These explanations would occur on back-to-back days!

So here we are again with the pundits telling us the stock market was rallying with higher oil prices because, yes, you guessed it, increased demand for commodities indicating economic growth. Now the stock market is heading lower and the reason we're told, yes, you guessed it, is because the higher prices are going to squash our economic recovery. Is it any wonder why we even listen to these people? There's a reason I leave my TV off during the day and instead listen to soothing music.

Last week I pointed out 103.69 as a potentially important level for oil since that's the 62% retracement of the 2008 decline. There's higher potential to just shy of $120 to the top of a parallel up-channel from 2008 but first it needs to get through 104. Based on a wave count and a price projection for the move up from April 2010 it could be finishing right here so the risk is for the news-related spike up to suddenly deflate.

Oil continuous contract, CL, Weekly chart

Thursday's economic reports will probably be ignored unless there are some surprises. Anything that could cause the Fed to change their position is always a factor but there are no expected big changes from the previous reporting period.

Economic reports, summary and Key Trading Levels

Today can be viewed as either bullish or bearish, depending on the color of the glasses you wear. The support at uptrend lines and/or 50-dma's can be interpreted as bullish and as I pointed out on the RUT's chart, the pattern is similar to last week's before the explosion higher on Friday (thanks in part to another run higher in the overnight futures). I see the potential for a little higher for the bounce off today's low but if it starts with a gap up and strong rally then we'd be looking at improved odds for the bulls to wrestle the market away from the bears.

The flip side of the coin is that the price consolidation and little doji stars at support is just a consolidation/continuation pattern before proceeding lower again. Based on the spike down from resistance on many of the indexes (bearish kiss goodbye) on Tuesday, today's consolidation looks to me like a bearish continuation pattern and that's what I'm projecting on most of the charts. I've been disappointed on many failed setups in the recent past and I don't discount the possibility for it again. Respect price action no matter which way it goes and no matter how wrong you think it is.

The bottom line is look for a continuation lower but don't be surprised by a rally instead. I see the possibility for a bounce in the morning before heading lower again but a bounce that holds up past noon could be more bullish. Good luck and I'll be back with you next Wednesday.

Key Levels for SPX:
- bullish above 1344
- bearish below 1294

Key Levels for DOW:
- bullish above 12,400 to 12,600
- bearish below 11,980

Key Levels for NDX:
- bullish above 2400
- bearish below 2285

Key Levels for RUT:
- bullish above 838 to 850
- bearish below 794

Keene H. Little, CMT