Market Stats

The bulls got some follow through today so they've got to be pleased about that. With the increased volatility and the roller-coaster ride it's been a challenge figuring out what the day might bring us. The market was clearly oversold after the strong selling into August and the selling momentum was clearly lessening (including lower volume) into the retest of the low on Monday and that's been followed by both short covering as well as real buying as the bargain hunters step back in. There are also some bullish expectations as we head into Friday's speech by Bernanke at Jackson Hole, WY.

The morning started with the durable-goods orders report at 8:30 AM. Orders rose +4% in July, helped especially by sales of autos and commercial aircraft. June was also revised higher to -1.3% from the previously reported -1.9%. Futures had bled off for most of the overnight session and it looked like we were going to have a negative open. But they popped higher on the 8:30 AM durable goods report, getting them almost back to the flat line for the start of the day.

The market ignored the bad side of the report which is that capital goods orders, which excludes defense and transportation sectors, declined by -1.5%. Core-capital orders provide a better read on how the private sector is doing so a negative number continues the slew of recent reports pointing to an economy that is slowing down. The big jump was in orders for transportation equipment (+14.5%) and motor vehicles and parts (+11.5%). Orders for most other goods fell.

Many are attributing this week's rally to hopes pinned on Bernanke giving us some more drug money and/or spiking the punch bowl when he gives his speech Friday morning at Jackson Hole, WY. Last year at this time is when he announced QE2 and the market was off to the races from there into May of this year. That announcement followed the large decline into the July 2010 low and then another one heading into the end of August. The August 27, 2010 speech marked the bottom and the DOW proceeded to rally from 9936 to May's high at 12876 (2940 points). An equivalent rally from last Friday's low near 10800 would take the DOW above 13740, close to a test of the 2007 high near 14200. That kind of potential has many traders itching to get long here and I think that's some of what we're seeing.

But as Jim mentioned last night, the market could be setting itself up for disappointment. Most know that Bernanke is not in a position to announce a QE3 program no matter how bad the stock market wants one. Deep down even those who want the extra liquidity from it realize it would be a sign of deeper economic troubles, ones that would be much more difficult to shove under the QE rug this time. So the risk is for another round of selling following Bernanke's speech on Friday and I think we'll see some profit taking Thursday afternoon/Friday morning if the rally continues into his speech.

Another consequence of Bernanke not announcing another QE program is what's happening to gold this week -- it's come crashing back down the past two days and many are attributing it to profit taking as gold traders fear no new QE program will mean a stronger dollar and lower inflation risk.

The flip side of this argument is that Bernanke will in fact pull another rabbit out of his hat. He has repeatedly told us that he has many tools to fight economic malaise and I am intrigued by an idea that some are now talking about. Specifically it's called the "Reverse Repo" and Justin Rohrlich covered it in an article written for Minyanville on Monday -- Turning Point for Homebuilders?

In the article Rohrlich quotes Neal Soss, chief economist at Credit Suisse Holdings USA, who was a former economist at the New York Fed, saying "The chairman knows the whole world is watching, so if he chooses not to say very much, the markets and the economy in some broader sense would be disappointed. It's absolutely critical that the Federal Reserve portray itself as having some relevance to the economic problems the society faces."

Many are in agreement that a QE3 program is not a viable option at this point but might become necessary later. So what's the Fed to do? Shawn Hackett, founder and CEO of Hackett Financial Advisors, believes the Fed has one trick up its collective sleeve. In his recent letter to clients he explains, "The definition of a reverse repo transaction is as follows: A purchase of securities with an agreement to resell them at a higher price at a specific future date. This is essentially just a loan of the security at a specific rate also called reverse repurchase agreement. Through QE-1 and QE-2 the Federal Reserve has helped re-liquify the banks and helped support runaway government borrowing at rates far below the true market rate by printing money. What quantitative easing did not do was get the fractional banking system going through the typical money multiplier effect. Banks are afraid to lend, borrowers are afraid to borrow and zombie loans remain in decay. This has kept the key housing asset market stuck in reverse.

The result is that the banks have deposited at the Federal Reserve $1.8 trillion of unlevered capital better known as NBR's (Non Borrowed Reserves). This is a massive amount of capital that is sitting there idle doing nothing and earning next to nothing. The Federal Reserve and the U.S government want this money to move into the system to help roll current government debt coming up for maturity and for future borrowings as well as for other bond asset purchases for states and municipalities and to help supply an expansion of cheap mortgage loans.

These NBR's can be levered 10:1 in the fractional banking system that we have today. This opens the possibility of extending bank credit by up to $18 trillion without printing any more money or reserves by the Federal Reserve. That is a lot of money and a huge expansion of money supply."

In order to get the money "out there" the Fed needs a way to get the banks to lend the money that they're sitting on (some $1.8T) so that the fractional reserve system will do its work. To enable this to happen the Federal Reserve created a list of entities that can take these loans and spend the money (on Treasuries, stocks and other "investments"). This approved list is called the Reverse Repo Counterparties List

Hackett continues in his newsletter, "The NBRs would be loaned by the banks to the entities on the approved counterpart list. The entities on the approved counter party list would then take the money and buy short duration government bonds which have the highest quality and lowest risk. The government would guarantee to buy these securities back from these entities at an agreed to premium thereby generating a guaranteed return for the counterparty and the bank that loaned these counterparties the money. Even though rates on short duration government bonds out to 5 years are very low when you gear up 10:1 then the return on capital becomes very exciting indeed.

This then would allow for maturing government debt and new government debt to finance at ultra low interest rates thereby kicking the can down the road by minimizing the accelerating interest expense as a percentage of tax revenue. It would also allow for the Federal Reserve to say publicly that they are no longer printing money like they did with QE1 and QE2 which everyone would be against and to say that this is simply a normal expansion of bank credit that should have already happened but did not due to unusual extraneous conditions. It would also remove the worry about near term government funding and allow politicians to avoid taking any major austerity measures during a time of economic weakness.

It is an ingenious plan for sure. The public is very aware at the inflationary implications of printing money like quantitative easing. They may not be as aware that expanding bank credit is even more inflationary. This could allow for the current Ponzi scheme to go on longer before the public becomes fully aware of the dilutive effects of such a massive expansion of monetary policy."

Inflation is not Bernanke's worry right now, nor the White House's. They want to see some immediate benefits (within 6 months) and this program could do it. It could also ignite a stock market rally with the thought that inflation is good for stocks. Fundamentals would clearly take a back seat but there would be hopes for an economic turnaround from such a program (more homes built and all the jobs associated with them, even if they underestimate the lack of demand from buyers of homes due to an inability/lack of desire to borrow).

I will admit it's a brilliant plan even if it accomplishes nothing (which I suspect will be the case) except for higher inflation. I view it as the Fed's Hail Mary pass. Needless to say, it will be interesting to hear what Bernanke announces on Friday. One other note on the timing of the Bernanke speech -- there will be a new moon on Monday and this year new moons have been associated more with market tops than bottoms. That's not a prediction but just something to think about.

Before we get to tonight's charts and the short-term view of the market, I was asked for my longer-term view and how the price action since 2000 could be viewed, especially considering we may be starting the next bear market cycle. There are several different ideas for what the next bear market leg down might look like, with the more bearish folks thinking we're starting a sharp 5-wave move down from this year's high that will take us well below the March 2009 low into 2013, potentially in 2012.

I'm viewing the price action since 2000 as more corrective and part of a larger choppy pullback pattern (albeit with large price swings) within the longer-term bull market over the past century. I also think we'll see the market drop below the 2009 lows but it could be a relatively choppy/whippy ride down rather than a sharp decline. The correction to the previous long-term bull market has a few more years to play out (to complete the secular bear market) and I'm thinking we'll see some big swings up and down into 2016 at a minimum.

The SPX monthly chart below shows how the consolidation pattern since 2000 fits as a correction to the rally over the past century. I've drawn parallel channels to show how price action has responded within the channels. The strong rally in the 1990's pushed above the top of the bold parallel up-channel from the 1930's and then dropped back inside the channel in the 2001-2002 decline. It then found support at a parallel line (blue dotted), which acted as support/resistance since the 1940's, and bounced back up to the top of the bold channel in 2007. From there it dropped back down, leaving a bearish kiss goodbye. The 2011 high was a test of that blue dotted parallel line and the recent selloff left another bearish kiss goodbye.

SPX monthly chart, 1928-2017

The note "As above, so below?" on the above chart has to do with the throw-over above the bold channel into the 2000 high. If SPX drops an equal amount below the channel, a common occurrence, that lower line crosses through 2016 near 550, which is also where the trend line along the 2002-2009 lows crosses.

For a view of prices in both nominal dollars (non-inflation-adjusted) and constant dollar (inflation-adjusted) I dumped price and inflation data into a spreadsheet and plotted prices since 1870. The top chart below is price in nominal dollars while the lower chart has prices in constant dollars (which shows how much prices really pulled back vs. in nominal dollars). This time I drew the parallel up-channel using the 1929 high and 2000 high (waves 1 and 3) and attached the parallel line to the 1932 low (wave 2). The bottom of the channel crosses 2016 near 475, which is close to the 1994 low and a common retracement level in the wave count for the parabolic move up in the 1990's. It's common for the 4th wave to work its way down/over to the bottom of a parallel channel drawn this way. The lower chart has the same channel and interestingly the bottom of the channel crosses the same level in 2016.

SPX weekly chart, 1870-2011

Getting in a little closer to this big correction, the SPX monthly chart below shows price action since the 2000 high. I'm showing an idea for a large descending wedge to complete a double zigzag wave count (a-b-c-x-a-b-c) for the 4th wave correction. I think the bear market will end in 2016, maybe as late as 2018 and the idea shows a low near 550, matching the projections on the charts above. S&P 500, SPX, Monthly chart

Based on my analysis of the chart patterns above I think we should expect a final low for the bear market in the 475-550 area in 2016. But as you can see in the chart above, it could be a wild ride to get there.

For tonight's charts I'll start with a weekly view of the DOW and step in closer to see how the week is setting up. The move down from May is a 3-wave move so far and as such could be just a corrective pullback that will now lead to a rally to a new high into the end of the year. I don't show that possibility because there's simply a lack of evidence, especially considering the ending pattern for the rally into May, for a strong rally from here. The rally leg from Monday could be one that completes a 4th wave correction that then leads to another selloff, one that takes the DOW down to the 38% retracement of the 2009-2011 rally. From there we'd be due a larger bounce correction into the end of the year, setting up an even larger decline early next year.

Dow Industrials, INDU, Weekly chart

The 4th wave idea is shown more clearly on the daily chart below. An a-b-c bounce off the August 9th low, with the c-wave now in progress, would lead to another decline. But on the daily chart I'm considering a different wave count, which calls the July 21st high as the completion of the rally from 2009. That means the decline to August 9th is the completion of the 1st wave down of the new bear market leg. The result may not make much of a difference short term but the next selloff, if it's to be a 3rd wave down (as labeled on the daily chart) it's going to be a strong selloff into September/October. It takes a rally above 12K to turn the short-term pattern bullish although it might be good only for a trip back up to its broken uptrend line from March 2009 - August 2010.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 11,500 and more bullish above 12,000
- bearish below 10,800

As a guide for the current bounce I've drawn a parallel up-channel (bear flag?) and have a projection to 11727 where the a-b-c bounce would have two equal legs up. That projection crosses the top of the channel on Friday (coincidence?). A rally above 11750 would point to the possibility for a push up to 12300, which is about where the broken uptrend line from March 2009 is located.

Dow Industrials, INDU, 120-min chart

Another idea for the current bounce is shown on the SPX daily chart below -- a sideways triangle 4th wave (light red and dashed line). This pattern says the market will trade in a narrowing range over the next few weeks (working off the oversold conditions in time instead of price). A little more short-term bullish would be two equal legs up for the bounce, which points to 1228, near the price-level resistance at 1225, the April and November 2010 highs. Rallying above 1228 and holding above would then target 1250-1270.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1195 and more bullish above 1270
- bearish below 1120

Unless NDX is also going to get stuck in a sideways triangle consolidation pattern, upside targets for it are at 2236 (50% retracement) and 2284 (62%).

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2185 and more bullish above 2320
- bearish below 2030

The RUT is showing the same potential for a little higher. There could be a slightly different corrective wave pattern playing out and I mention this if only to again caution everyone to not get complacent about any move, including the current rally. We could find reversals on a dime and big reversals. Taking profits every day on winning plays, and setting breakeven stops quickly is a recommendation until the larger pattern clears up, which could take a few weeks.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 725 and more bullish above 775
- bearish below 650

We've seen a reversal in bonds (selling) as the stock market rallies, which could be a strong indication of reallocation programs as bonds become the riskier asset to own. The 10-year yield, TNX, which moves opposite to the price of the Treasury Note, continues to be in synch with the stock market. A bounce up to at least 2.5%, if not 2.86%, is the potential. You can see the RSI looks ready to bounce back up as well.

10-year Yield, TNX, Weekly chart

But TNX could be at the start of a stronger rally. Tom McClellan, who writes the "The McClellan Market Report", whose parents developed the McClellan Oscillator, published an interesting chart a few days ago. As he said, "Well, here is a comparison of T-Bond prices last year versus this year, aligned on a calendar day basis. In 2010, bond prices topped 3 days before Bernanke's Aug. 27, 2010 Jackson Hole speech. Looks like we are setting up for deja vu." Last Thursday's low was a little earlier so far, 6 trading days earlier. It is an interesting comparison though:

T-Bond Prices leading up to Jackson Hole speech, 2010 vs. 2011

After a minor throw-under below the price projection to 35.11 BKX has started a bounce which should have further to go. It's just a guess at this point but I'm showing a 3-wave bounce up to its broken trend line along the lows since March, near 41. It needs to first get above 39.40. A drop below 35 would be a bearish sign.

Banking index, BIX, Daily chart

The TRAN found support at the mid line of its down-channel from July, typical for the 5th wave of the move. It needs to do better than today's high to break out of the channel and assuming it will be able to do so there is upside potential for a bounce into September and up to 4800-5000 before selling off stronger into October. The TRAN is sporting one of the cleanest wave patterns and this one might be our best guide for what to expect over the next several weeks.

Transportation Index, TRAN, Daily chart

The dollar is still stuck in neutral and unable to get out of the 73.50-74.50 area where's it's been since the 1st of the month. In reality it's been stuck in neutral since May's low. There's no change to the weekly chart I posted on Monday.

But the lack of movement in the dollar hasn't stopped the metals from making a big move this week. Gold's strong run higher might have finished at its high of $1917.90 on Monday. I can see the possibility for a quick move down to shake out some longs and suck in some shorts and then make a final new high to do the opposite. But the strong reversal off Monday's high, with the key reversal day on Tuesday and follow through to the downside today (down more than $100), is a warning to gold bulls that we could be at the start of a large correction to its bull market rally. Today's decline of $104 (-5.6%) was the biggest drop since March 19, 2008 (-5.8%). You'll probably recall that 2008 was not a good year to own commodities, including the metals.

In addition to the price pattern calling for a decline, there are a couple of other reasons to think gold could see at least a significant pullback. I had mentioned earlier that gold traders may be fearful that the Fed is not going to do another QE program, which has helped commodity prices in general and gold in particular. Gold also reached the price of platinum and each time it has done that it has also marked a high for gold. And this month marks a Fibonacci 144 months from the start of its strong rally in 1999. It's possible the 12-year rally has finished.

Gold's run has been reflecting fear -- fear of global conflicts, fear of bank failures, fear of the dark. That fear is what generally causes the parabolic move into a spike high (the same kind of fear, but in reverse, that causes a spike low in stocks). The stock market has been selling off on the same fears. This week's reversal in both might be an important clue that the corrections for each could continue for at least a couple more weeks.

As pointed out on Monday's weekly chart for gold, it came very close to tagging the trend line along the highs from 2006 and 2008, near 1975. If the current pullback is just a shakeout we could see another stab higher to $2000 and the trend line in early September. But if gold drops below $1725, which it came close to today, it would indicate the rally is very likely over. We'd then be looking at a higher probability move down to at least the $1600 area and potentially much lower.

Gold continuous contract, GC, Daily chart

Silver had a great setup on Monday/Tuesday for a short play as I liked the topping signal with the throw-over above its rising wedge followed by a drop back inside the wedge yesterday, creating a sell signal. As mentioned on the Market Monitor yesterday, short silver with a stop at the Monday night high at 44.27 is the recommended position for silver. Look for a bounce back up from support near 39 as a shorting opportunity since the risk:reward profile is good (downside potential to 26 if not lower). Proof will of course be a break below the wedge (uptrend line from June) and its 50-dma, currently at 38.30. If gold gets another leg up for its rally I have to consider that possibility for silver as well (red dashed line) and a rally back above 43 would likely be pointing to that. It would just be another shorting opportunity.

Silver continuous contract, SI, Daily chart

Similar to the stock market, oil could get an a-b-c bounce off its August 9th low and two equal legs up points to 92.46. Its downtrend line from May is currently near 95.

Oil continuous contract, CL, Daily chart

Tomorrow's economic reports will only be the unemployment claims. Friday's GDP numbers, before the market opens, could be a market mover, especially if it influences how traders will guess what it will mean for Bernanke's willingness to do more for the economy. So a bad number could see a positive response.

Economic reports, summary and Key Trading Levels

The last two days are an excellent start to what could become a bigger rally, especially if Bernanke doesn't say anything to disappoint. I'd be a little (OK, a lot) concerned if we continue to rally into Friday's speech. It would look too much like a buy-the-rumor, sell-the-news setup. A pullback tomorrow that finds support at a Fib retracement of the rally off Monday's low would be a decent setup for another rally leg following Bernanke's speech.

We of course have no idea what could happen after Friday. Bernanke will surely present something in support of the stock market, um, I mean economy. Whether it will be enough to satisfy the drug needs of the market is anyone's guess. Hopefully by the end of the day tomorrow I'll be able to offer a higher-probability setup for those on the Market Monitor but in reality it's going to be risky no matter what position you're in. Flat or hedged should be a consideration.

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

Key Levels for SPX:
- bullish above 1195 and more bullish above 1270
- bearish below 1120

Key Levels for DOW:
- bullish above 11,500 and more bullish above 12,000
- bearish below 10,800

Key Levels for NDX:
- bullish above 2185 and more bullish above 2320
- bearish below 2030

Key Levels for RUT:
- bullish above 725 and more bullish above 775
- bearish below 650

Keene H. Little, CMT