Market Stats

Today started with a bit of a pullback as the details of the ECB lending program were shared with the public. The morning was spent in a mild pullback (the techs were a little more bearish as ORCL and other semiconductors had a tough time) before the buyers showed back up after lunch and slowly pushed the indexes back up to the flat line (except for the tech indexes which closed down). Following yesterday's very bullish day the bulls can certainly be happy nothing was given back.

Yesterday's rally was brought to us courtesy of the ECB (with the backing of the Federal Reserve's swap agreement) and their giveaways, I mean free loans, I mean low-rate (1%) loans. European banks hungrily gobbled up the money so that they could make money by lending it out at anything above 1%. I'd love to borrow at 1% and buy some Treasuries at 2% and make on my borrowed money. If the European banks use the money to buy bonds paying 4%-7% they'll do quite well (as long as the banks can get their principal back). I'd then pay myself a huge bonus at the end of the year for being a financial genius.

There were 523 banks who asked for a handout yesterday, borrowing 489 billion euros ($645B), which was considerably more than the 293 billion euros ($386B) that most had expected. I'm surprised more banks didn't borrow or maybe they all did.

Lending to the banks who then bought sovereign debt, dropping government yields, has many hoping that the sovereign debt issue has now been resolved. That may be a little wishful thinking, something the stock market is good at. While the ECB scheme could certainly help decrease the cost for governments to pay their debt, ultimately it's a question of whether or not the governments can pay their debt, regardless of how cheap that debt is. And today registered a little more concern in that regard, as I'll show in a bit.

The ECB is hoping the banks borrowing the money will use it to continue purchasing government debt, which is their back-door method of doing what the Fed is doing directly with its QE programs. Now all the central banks are essentially lending money to the banks and taking just about any kind of collateral, including Greek bonds (wink), in return. The global bank are becoming even more joined at the hip and will either survive through this together or they will fail collectively and miserably. Right now the stock market is betting on survival, but then the stock market could be accused of being forever hopeful.

One problem is that the ECB can't demand the banks purchase government debt with their newly found money. The banks could lend it out for other purposes or hold onto it and pay off their own maturing debt with the cheaper money, which would be a net zero as far as adding liquidity to the system (the current bank debt merely being replaced by the new and cheaper debt). This is one reason why the current ECB trick is creating some liquidity right now but could be removed over the next few months as about 230 billion euros of bank bonds mature in the first quarter of 2012.

Even the head of the ECB, Mario Draghi, said "Banks represent about 80% of lending to the euro area and the banking channel is crucial to the supply of credit." This point is important and a reason to keep an eye on interbank lending rates. Draghi predicted banks will experience "very significant funding constraints" for the "whole" of 2012.

Banks in the euro area need to refinance 35% more debt in 2012 than they did in 2011, totaling about 600 billion euros. Suddenly the 489 billion euros borrowed yesterday sounds like only a down payment. On top of all that bank debt there is still the massive government debt to buy. All of this sounds sobering, but it didn't spook stock market bulls who have an agenda for the rest of this month.

The ECB is trying to reduce fears in the banking community by making more and cheaper money available. Most economists agree that this latest action by the ECB, while helpful to the banks to reduce their costs and improve profitability (which is after all the central banks' main concern), it does not address the fundamental problem of too much government debt that continues to climb higher. And fear by the bankers is not helping relieve the liquidity between banks, which can be measured by the interbank lending rate.

After yesterday's initial gleeful reaction, today saw sovereign spreads widen again. There was a minor drop in the Italian 10-year yield on Tuesday but it was reversed today, closing near 6.8%. There seems to be just enough support coming in for Italian bonds to keep the yield below the dreaded 7%. But it's reflective of the worry about the debt, which is not something that can be solved by giving the banks more money. Spreads between European countries' bond yields and Germany's bond yields widened again today. And the TED spread (the difference between interest rates on interbank loan -- the 3-month LIBOR (London Interbank Offered Rate) -- and 3-month T-Bills) widened again today and is now at its highest level since May 2009 when the spread was dropping sharply from its October 2008 high.

TED Spread, March 2009 - December 2011, chart courtesy

The relentless climb in the TED spread since August is worrisome and it reflects fears among the banks who are demanding higher rates before they'll lend each other money. That's indicative of a credit problem that not even the central banks can relieve. It comes from distrust and as credit becomes harder and harder to get it will be reflected in a weakening economy and stock market. Enjoy the stock market's gains while they last because I don't think it will last much longer. A rally into year-end will be your best opportunity to get out of stocks and get defensive. And if Monday's lows are broken you'll want to get out sooner rather than later.

At Monday's low SPX hit its 20-week MA at 1202.44 (the low was 1202.37) and another good day or two it could test its 50-week at 1267.88, which is where last week's rally stopped. So it's a battle between the MAs at the moment. And if Santa's little helpers can bring good cheer to the bulls through Christmas we could see SPX back up to its broken H&S neckline near 1300 next week. As I'll get into, that would make an excellent finish to the bounce pattern off the October low and an outstanding shorting opportunity. The risk remains to the downside but hopefully we'll get the rally into next week to set up a longer-term shorting opportunity. I for one am tired of the jerking up and down and would like to get a nice trade that I can hang onto for more than a day.

S&P 500, SPX, Weekly chart

As shown on the daily chart below, two equal legs up from November 25th would have SPX up to 1310.77, which is only slightly above the broken H&S neckline. It would also have SPX tagging its 78.6% retracement of the May-October decline, something I thought it was going to do back at the end of October. This has been a common retracement level for 2nd wave corrections in this market (deeper than normal), which the bounce off the October low is labeled (the May-October decline was the 1st wave of the new bear market). Today SPX found support at its 50-dma at 1231.66 and the next resistance level is 1258-1260. That's where it will run into it downtrend line from July-October, its 200-dma and its 62% retracement of the May-October decline. That's why it would be even more bullish above 1260 -- the remaining shorts will scream like little girls (is that sexist?) as they run for cover. The bulls need to rally tomorrow otherwise today's hanging man doji could be considered a bearish reversal setting up. It's also a little worrisome that MACD hasn't been able to climb above the zero line yet.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1260
- bearish below 1200

Sticking with the daily chart above, if you look at the rally off the November 25th low you'll see the big white candle on the 28th followed by a day of consolidation on the 29th and then the even bigger white candle on the 30th. Bulls would love to see that kind of move again. I'm not sure what the central banks could do for an encore here but anything is possible. So on the chart below I'm showing how a very bullish run up to 1310 would look, getting to that level by next Wednesday the 28th. Why that date? It's a major turn date on the Bradley Model. Otherwise there's another important cycle (and Gann) turn date on January 2nd, just 3 trading days later. If the downtrend line from July (and 200-dma and 62% retracement) hold near 1260, it's possible it will complete a 3-wave correction to the December decline and start the next leg down from there. That bearish wave count would not become clearer until we saw an impulsive decline and especially with a break below 1200.

S&P 500, SPX, 120-min chart

The DOW has a very similar setup as shown for SPX. Two equal legs up from November 25th would have the DOW rallying up to 12761, which would be about 115 points from its May high. Color me doubtful about that happening but it's certainly a possibility. If it can get through 12400 I see upside targets at 12500 and 12620, the downtrend lines from May and 2007, respectively. The lower target is also where the broken H&S neckline is located at the end of the month. Any failure below its December 7th high near 12258 followed by a drop below Monday's low at 11735 would likely lead to a strong selloff.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,150
- bearish below 11,735

For both SPX and the DOW there might not be quite as much as bullish potential as I've shown on their charts. The wave count for the move up from October 4th is a double zigzag, which means two a-b-c legs to the upside that are separated by an a-b-c pullback (wave-x, which is the November pullback). The first a-b-c leg is the October rally and the second a-b-c move up is the rally from November 25, which needs the c-wave to complete (with a new high as depicted on their charts). The two a-b-c legs up are often related to each other in size and the 2nd leg up (from November 25th) would be 62% of the 1st leg up at SPX 1293 (keep that number noted on your charts in case it's hit and price reverses back down from there). For the DOW that projection is at 12393.90, which is shown on the 120-min chart below.

Dow Industrials, INDU, Daily chart

Still referring to the chart above, the a-b-c move up from November 25th would have the c-wave equal to 62% of the a-wave at 12369. The 78.6% retracement of the May-October decline is at 12347 (hard to see with the latter two Fibs practically on top of each other). This makes the 12347-12394 area a potentially strong area of Fib resistance. And then 100 points higher is the downtrend line from May. I'm thinking the DOW will not make it through this area and that the bounce off the October low will end there (assuming it makes it there). It's the area I'll be watching for failure and then get into a significant short position.

BTW, the ending diagonal (rising wedge) idea is just something I'm considering and watching for over the next few trading days. It would be a typical ending pattern and would add to my confidence about an end to the rally. Notice that it would finish with a quick throw-over above the downtrend line from October 27th, stopping out shorts and sucking in more longs, followed by a reversal right back down, leaving a bull trap and frustrated bears. We'll see how it sets up in the next week and hopefully by next Wednesday we'll be closer to a setup that I can help you take advantage of.

The techs have more of a mixed message today after their negative day. Yesterday's rally failed short of its 200-dma near 2288 and today it closed back below its 20-dma near 2262. If the market is going to break down instead of rally, it will be the techs leading the way and a break below 2209 would be our canary. Otherwise if it gets into gear to the upside there's Fib and trend line resistance near 2400.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2317
- bearish below 2209

The RUT could be the first above its December 5th high at 752.71 as fund managers jump into the small caps, hoping for some outsize performance to the upside. That makes it vulnerable to hard selling if the market reverses back down and a break below 700 would likely be followed with a quick decline. In the meantime, if the bulls continue to drive the market higher into next week and the RUT can get above trendline resistance near 740-745, it should have no trouble getting up to its 200-dma near 764 and above that it should head for 792 for two equal legs up from November 25th.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 742
- bearish below 706

There's been very little fear in this market since December 8th, the last high for SPX. Even as the market pulled back the VIX continued to drop, which was odd behavior. There was a lot of call buying and/or put selling as traders were convinced in the year-end rally scenario. That's a little worrisome -- no fear and no wall of worry to climb. But as long as the call buying continues it keeps up the bullish pressure on the market so it's bullish until it's not. The risk is that it could violently snap back, exacerbating any selloff in the market. The VIX looks to be close to finishing a bullish descending wedge pattern and a drop to the 18 area next week, presumably with new highs for the stock market would add credence to the idea that we should be looking for a major reversal after that.

Volatility index, VIX, Daily chart

Another sign of heavy call buying/put selling is the put/call ratio. The ratio is approaching 0.8 which as you can see with the chart below has been a level associated with previous market highs. It closed at 0.81 today and it's been lower back in April, May and July (also market tops) but the last few times it's approached 0.8 we've seen market highs. For now it's simply a warning.

SPX vs. Put/Call Ratio, Daily chart

Supporting the stock market's rally the past two days is the bond market which has seen some selling (risk-on trade is back). If TNX can rally higher tomorrow it will break its short-term downtrend line from December 2nd and its 20-dma, both at 1.979%, which is where it stopped today. A little higher is its downtrend line from October 27th, near 2.02% and then its 50-dma at 2.056%. A rally above 2.06% would be bullish (bearish for bond prices) for a run potentially up to a price projection near 2.5%, which would also be bullish for the stock market. For now I don't think TNX will make it above 2.06%.

10-year Yield, TNX, Daily chart

U.S. Treasuries could see more buying, thereby driving yields back down, if fear comes back to the European bond market. A rise in European bond yields and the TED spread would be another sign that the Fed/ECB effort to simply flood the banking system with cheaper money is not going to fix the problem. That's why it's important to keep an eye on these spreads and European bond yields, especially if money runs back into U.S Treasuries, driving TNX lower. The stock market follows TNX.

Of the two bank indexes that I follow, BIX and BKX, BIX is stronger. While BIX is close to testing its December 7th high, and broke its shallow downtrend line from October 27th, BKX remains relatively lower and has not yet broken its steeper downtrend line. So I'm watching BIX for upside targets, which first is its 200-dma at 129.50. Only slightly higher is the top of a parallel up-channel, near 130.20 tomorrow. And then just above that is the 62% projection for the 2nd leg of the bounce off its November 23rd low. If the banks get a lot of lovin' in the next week, two equal legs up from November 23rd is at 136.99. Follow the banks (money).

S&P Banks index, BIX, Daily chart

The pullback in the transports in December had the TRAN testing and holding its uptrend line from October 4th, which is bullish as it tested and held on the 14th and again on Monday. It also means a break of its uptrend line, near 4830 and its 20 and 50-dma's, would be a sell signal. Today's rally closed marginally above its 200-dma at 4976 and has upside potential to a Fib projection at 5222 by the end of the month.

Transportation Index, TRAN, Daily chart

The stock market and U.S. dollar continue to act inversely and sometimes it's hard to figure out which one is the dog and which is the tail. The currency is the much bigger market and I think the stock and commodity markets are reacting the euro/dollar rather than the other way around. So watching the dollar continues to provide important clues. This afternoon the dollar started back up after pulling back from a midday high. The stock market also pushed back up to its highs and that was a divergence from normal behavior. It's simply a warning that stocks might reverse back down tomorrow. During the overnight session the dollar had dropped to support near 79.50 (broken downtrend line from October 4th) and the bullish wave count calls for a continuation higher. If the stock market rallies higher with it, I will become even more suspect about the gains made in the stock market the closer we get to the end of the month/year. If the dollar drops below 79.50, which should lead to at least a larger pullback for the dollar, it would be bullish for the stock and commodity markets.

U.S. Dollar contract, DX, Daily chart

Gold is finding resistance at its broken uptrend line from January-September and I expect to drop to a minor new low before consolidating once again and then lower. It takes a rally above 1668 to at least negate the bearish wave count.

Gold continuous contract, GC, Daily chart

Oil got a big bounce with the stock market and both could continue higher into next week. That could have oil back up for a retest of its November 17th high at 103.37 and another test of its broken uptrend line from February 2009. Otherwise the high bounce could lead an even stronger decline in a 3rd of a 3rd wave down. A break below its 50-dma near 95 would be a bearish heads up.

Oil continuous contract, CL, Daily chart

Tomorrow we'll get the final Michigan Consumer Sentiment number but there should be no surprises. It's doubtful we'll see any market moving reports.

Economic reports, summary and Key Trading Levels

I've outlined upside targets for the indexes and we've got a good setup for a rally into next week to finish the bounce pattern off the October 4th low. The bounce pattern is a correction to the May-October decline, which is the important part to remember. Once the correction finishes, we'll be due a stronger decline than what we saw this year (3rd wave). That would mean a fun time for bears in the 1st quarter of 2012 but a bad time for the bulls. Considering the downside risk I'm strongly recommending getting out of long positions by the end of the year. If Monday's lows are broken you should get out sooner.

In addition to the upside targets, such as DOW 12400-12500, there are some potential turn dates to mark on your charts. First up is the MPTS chart showing the next new moon on December 24th. Say what you will about how silly it is to use the moon for turn dates but you can't argue with the black circles (new moons) at all those highs this year.

S&P 500, SPX, MPTS Daily chart

The next date is December 28th. This is an important turn date on the Bradley Model, which is the date I've used on my charts for a market high. The next turn date is based on the Solunar Model that Chris Carolan has been referencing in his newsletter. The chart that I have from him was last updated on December 9th, which called for a pullback into mid month and then a rally to a new high on January 2nd. So far the DOW is following the model. Adding to the strength of a January 2nd turn date is the Gann Square of Nine chart that shows January 2nd is 90 degrees from the October 4th low. On the Gann Sof9 chart 90 degrees is most often associated with completion of corrections.

DOW Solunar Model, chart courtesy Chris Carolan

So we've got some upside price targets and potential turn dates to keep an eye on, especially if time and price marry up. But keep in mind that until the December highs are exceeded, we could be getting just a high bounce correction to the December decline. If the market turns back down it could accelerate lower quickly. Take a break below Monday's lows seriously -- it would be time to bail out of your long positions and get short.

Good luck and I'll be back with you next Wednesday. Happy Hanukkah and Merry Christmas to all. May Santa bring you something better than a lump of coal. Have a joyous time with your family and blessings to each and every one of you as we finish up this difficult year.

Key Levels for SPX:
- bullish above 1260
- bearish below 1200

Key Levels for DOW:
- bullish above 12,150
- bearish below 11,735

Key Levels for NDX:
- bullish above 2317
- bearish below 2209

Key Levels for RUT:
- bullish above 742
- bearish below 706

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying


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