Market Stats

The market is proving to us that if doesn't start with a gap up, and even after gaps to the upside, there's simply no buying pressure. The bears haven't been able to do squat but the bulls can hardly call themselves winners either. Stuck here in the middle with you as we wait for some direction in the trading.

The price pattern is set up such that I wouldn't be surprised to see another gap up on Thursday morning, which would actually do a nice job finishing off the wave pattern and as the 3rd gap of the year it could potentially be an exhaustion gap. I'm getting ahead of myself but if you don't have time to read anymore, that's my market wrap in a paragraph.

The January 3rd gap up was followed by stagnation the rest of the week and had you gone long following the morning gap you would have been underwater for the rest of the week. Then Tuesday's gap up cleared resistance but once again had you gone long following yesterday's gap up you'd be underwater. If we get another gap up tomorrow I suspect anyone who goes long will be underwater with no follow-up rescue. The bears aren't getting any traction yet but I'm seeing evidence of a market held up on vapors and the coming decline could be very swift (especially if there's a catalyst that gets the selling started with a bang to the downside). The flip side is that the slow melt-up could simply continue and as we head into opex week next week there may be more of a bullish effort to hold things up (or look out below if it breaks down).

It's been a very quiet week and other than Tuesday morning's gap up there's been no excitement in the market, either way. This afternoon we got to see the Fed's economic outlook with the release of their Beige Book. They reported the economy improved across all regions in the final six weeks of 2011 and attributed it to sales during the holiday period (the period captures both Thanksgiving and Christmas).

The report shows housing continues to show weakness but the home builders have been on a nice upswing since October. Lennar's (LEN) good earnings report launched the stock above its April 2010 and February 2011 highs; the home builders index is still working on getting above its January 2011 high. But while the home builders are getting their houses in order, the pace of home sales can best be characterized as "modest."

As an overall assessment, the beige book said "The reports on balance suggest ongoing improvement in economic conditions in recent months, with most districts highlighting more favorable conditions than identified in reports from the late spring through early fall." While favorable holiday sales, especially as compared to 2010, paint a positive picture, there is acknowledgment that the consumer spending might not continue post-holiday. In fact there are guesses that it will not.

With the lack of jobs for so many and an effort by most to pay down their debts, spending will not likely continue as it did during the holidays. A separate Fed report showed that borrowing increased significantly in November (at the fastest pace in the last 10 years). That kind of borrowing can't continue and it simply puts more pressure on consumers to rein in their spending and pay down the debt.

The generally positive report will box the Fed in as to what they'll do at their next FOMC meeting on January 25th. The economy does not warrant much in the way of stimulus from the Fed. They would have a difficult time justifying another huge round of stimulus. And yet the financial system is weak and getting weaker. We can expect rates to stay the same of course, through 2013 according to the Fed, and more jawboning about how many tools they still have to help themselves, I mean the banks recover their losses. If we continue to experience tame inflation numbers it will help the Fed continue with their monetary stimulus programs.

The market's rally during the holidays and in the first trading week of the new year has caused a big shift in trader sentiment. The table below shows the AAII sentiment shift towards bulls and more significantly, away from bears in last week's report. Bears are throwing in the towel and according to last week's survey the amount of bearishness dropped from 30.9% to 17.2%, cut nearly in half. I know we have more than a couple of readers who are starting to feel this market is never going to drop. The latest AAII survey shows we now have the widest spread between bullish and bearish sentiment since May 2011. I probably don't need to remind you that May 2011 was the high for the stock market.

AAII Sentiment Survey

The new stock market highs are now being accompanied by some strong bearish divergences in most market breadth indicators, momentum, and volume. It's a dangerous time to be bullish the stock market and in fact the sentiment picture fits perfectly for what should be the top of the 2nd wave correction (the big correction to the May-October decline). The contributing factor for strong 3rd waves (declines especially) is the large number of bulls and scarcity of bears at the top of 2nd wave corrections -- all those who are long the market, especially the late buyers, make the market vulnerable to a selloff. Keep in mind that a market full of stock owners is a market full of sellers-in-waiting.

At the same time that market sentiment is hitting an extreme not seen since May 2011 we're seeing some strong bearish non-confirmations of the rally in the U.S. stock market. Last week I showed the Shanghai index (SSEC), which last week closed at a new weekly low for the first week of the new year. The Baltic Dry Index (BDI), which tracks very closely with the Shanghai index, also closed sharply lower for the week and has continued lower this week. Copper (JJC) is holding up but remains inside a bearish sideways triangle pattern from October.

The chart below is busy as I've added the SSEC, BDI and JJC behind the SPX to show their relationships. SSEC has been steadily dropping since last May (it peaked in late 2009) and BDI has dropped sharply from its 3-wave bounce in 2011 after topping in October. On the right side I show JJC down since October while SPX has pushed back up to test its October high (while the DOW has pushed above its October high). At the bottom right I show the trend in the volume since the August and October lows. So basically, there's nothing supporting our rally, especially considering the financial problems in Europe (e.g., Italy is now required to pay more than 7% on its 10-year bonds, which is considered unsustainable and that's WITH direct ECB support and all the swap agreements and loans to banks). The stock market has turned a blind eye to the rest of the world and markets but don't get blindsided by the coming stock market decline.

SPX-SSEC-BDI-JJC, Weekly chart

SPX has finally made it up to the 1293.32 price projection, which is where the 2nd leg of the bounce off the October low is 62% of the 1st leg. Two equal legs up is at 1376, which would be a retest of the May high at 1370. I don't think it's going there but price is the final arbiter on that subject. Only slightly above the 1293 target is the broken H&S neckline that runs from the November 2010 high through the March and June 2011 lows (matching a similar pattern for the 2007 high). That neckline was tested (marginally broken intraday) on October 27th and it's back up for another test. First mouse (the one who shorted that high in October) gets the short squeeze and the 2nd mouse (the one who shorts the current test of the neckline) gets the cheese. At least that's the setup.

S&P 500, SPX, Weekly chart

On the daily chart I'm showing we'll get a small push higher to 1300-1302 to test the broken H&S neckline. Slightly higher at 1307 is the 78.6% retracement of the May-October and then just above that, near 1310, the bounce off the November 25th low would have two equal legs up. That's why it would be bullish if it breaks above 1310. There is the possibility we saw the high on Tuesday and a drop below Monday's low near 1274 would say the high is in place and to start looking for bounces to get short.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish potential to 1293-1310
- bearish below 1274

The pattern for the rally from December 19th has been full of 3-wave moves which is one thing that gives it the appearance of being an ending pattern. One short-term wave count has Tuesday's high counting well for the completion while another wave count calls for one more new high, which could come tomorrow (the BOE and ECB will announce new bailout, I mean monetary stimulus, programs on Thursday and that could have our market gapping up or down. A gap up that finishes around 1300 that then fails to hold and closes the gap would be the indication the rally is over. Short a bounce after that, using the day's high for your stop.

S&P 500, SPX, 60-min chart

In October the DOW tagged its broken H&S neckline practically to the penny. It stopped about 15 points shy of the line on January 3rd but nailed it again yesterday. Those big gaps to the upside still couldn't break through that trend line. Tomorrow it will be near 12528 so watch that level if we get another gap up since it could be the last one (the exhaustion gap). But if the bulls can hold on into the end of the week, the 2007-2011 downtrend line crosses the top of a rising wedge pattern at 12606. The bulls need to defend Monday's low near 12334 since a break below that level would tell us the high is in place.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish potential to 12,500-12,600
- bearish below 12,333

I don't have a chart for the semiconductor index (SOX) tonight but it has now rallied up to its 200-dma at 388.61, testing it yesterday and today and now showing some short-term bearish divergence. If the SOX can break over its 200-dma, which it hasn't tested since July 2011, and hold it on a weekly closing basis, it will be bullish for techs and in turn the broader market. But if the 200-dma holds as resistance, it will be a bearish kiss goodbye here and that will be a sell signal.

The techs have been showing relative strength and this year's rally has brought NDX up close to its downtrend line from July-October, currently near 2392. That line could stop NDX from exceeding its October high, which the DOW and SPX have now done. As with the others, a drop below Monday's low near 2342 would be a sell signal.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2400
- bearish below 2342

The RUT is now approaching the top end of the target zone of 760-770, which are Fib projections based on the wave count from October and the 62% retracement of its May-October decline. It's also near the top of a rising wedge pattern for the leg up from December 19th. The pieces are now in place for a long-lasting high and all we need is for price to confirm it. A rally much above 773 would be a bullish move, especially if it can hold 770 on any pullback.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 770
- bearish below 740

Today's stock market rally/holding flat was not supported by the bond market which also rallied. The dollar also rallied so the stock market was in effect thumbing its nose at the world and holding onto its gains (and tacking on some more in the NDX and RUT). TNX, the 10-year yield, dropped lower today and stopped at its broken downtrend line from July-October. It's possible we're going to see a bullish back test and kiss goodbye, which would be supportive of a further rally in the stock market. A push back above last Friday's high at 2.044% would be a bullish move. Otherwise its shorter-term down-channel from November/December calls for another leg down, especially if it drops back down into its longer-term down-channel (with a break back below its downtrend line from July).

10-year Yield, TNX, Daily chart

The banks have been strong since November, thanks to all the central bank bailouts and free loans. The rally has now brought the BIX back up to its broken uptrend line from July 2009. At the same location is its 200-week MA, which was last seen in October 2007 (when the stock market peaked). It will be interesting if the stock market peak again coincides with the BIX testing its 200-wma. The BIX is also testing its 62% retracement of the leg down from February 2011 and its July 2011 high, which was the last high before breaking down strongly into August. Needless to say, there's a fair amount of resistance here so a failure would be expected. The flip side of that coin says a rally much above its July high at 141.17 would be bullish, especially since it would be rallying out of a rising wedge pattern for its leg up from November.

S%P Banks index, BIX, Weekly chart

The TRAN is fighting to get above a trend line across highs since November, which fits as the top of a bearish rising wedge pattern. There's a Fib/projection zone at 5222-5285 and one more positive day would have in the zone. Above 5300 would be bullish and below 5000 would be bearish.

Transportation Index, TRAN, Daily chart

The dollar could be trouble if it can't break above Monday's high at 81.85. It has met a price objective at 81.72 where it has two equal legs up from August, potentially completing an A-B-C bounce. The recent highs are showing some bearish divergence. So a break of its uptrend line from October, near 80.80, would be a bearish heads up for at least a larger pullback. The larger price pattern is looking for a strong dollar rally and a break above the parallel up-channel from August, near 82.60, would confirm we'll likely see a strong rally to follow.

U.S. Dollar contract, DX, Daily chart

While I've been looking at the dollar bullishly, with an expectation for it to continue to much higher levels, whether from here or after a pullback correction, there are two factors that have me questioning my bullishness. The first factor is seasonality. A lot of currencies experience reversals around the turn of the year. The dollar rallied into the new year and that sets it up for a reversal to the downside.

The second factor is the commercial traders' position, which is net short the dollar, long the euro. This euro net long position for commercial traders can be seen in the chart below:

Euro vs. Commercial Trader Position, chart courtesy Tom McClellan

As you can see, as the euro has declined from its last peak in May 2011 the commercial traders have continued to increase their net long position, to the point that it is now at its greatest level as a percentage of total open interest (largest net long position in the 12-year history for the euro). They've added to their long position since the October high for the euro. This is clearly not a timing tool for trading but it shows you the commitment of commercial traders and they're betting big on a rally in the euro and a decline for the dollar. It's usually not a good idea to bet against commercial traders.

But what if the commercial traders are wrong? It has happened before -- look at the net short position that was growing strongly in 2005-2006 (it's hard to read the dates at the bottom of the chart but each vertical line is one year) while the euro kept rallying into a 2008 high, forcing the commercial traders out of their short positions, which had peaked in the middle of 2006. It helped fuel the rally in the euro into its peak in 2008. They've done a better timing job since the low in late 2008 but there's no guarantee they're correct. It's just risky betting against them.

But if the euro continues to decline it could cause a stronger selloff as the commercials whittle down their long position, the opposite of what occurred in 2007-2008. That in turn would be reflected in a strong rally in the dollar, which is what the bullish wave count calls for. So call me a nervous dollar bull with one foot holding the exit door open.

Gold has broken out of its down-channel from November, and has popped above its broken uptrend line from January-September 2011, opening the door for a move up to the 1700 area to complete a 2nd wave correction to the 1st wave down from November. It's also possible we'll see gold consolidate in more of a sideways move so the upside is by no means guaranteed. Once the correction finishes we should see gold head lower again.

Gold continuous contract, GC, Daily chart

While gold needs to rally up to its downtrend line from September, silver is already there and struggling. A similar 3-wave bounce correction off the December low could see silver challenging the 32 area before turning back down. If it drops back down from here we might see more of a sideways triangle consolidation pattern develop before heading lower again.

Silver continuous contract, SI, Daily chart

Yesterday oil tagged its November high again but it's losing momentum and any new highs from here should be marginal and shortable. However, there is upside potential to 110 so a rally that holds above 105 should be able to tack on another $5. A break below 98 should usher in stronger selling.

Oil continuous contract, CL, Daily chart

Natural gas is at an interesting spot and will either break down harder from here or get a bounce before heading lower. The weekly chart below shows a parallel down-channel from June 2011 that's inside a larger down-channel from January 2010. It looks ready for a bounce off the bottom of the channel and could get a larger upward correction before heading lower again. If it stays inside the steeper down-channel we could see NG down to the 2.13 projection before the summer (for two equal legs down from January 2010). You could play a bounce with the futures contract or with UNG or keep it on your radar screen and play it short following a bounce to the top of the channel, short from there and then long at the bottom of the larger down-channel. Lots of pundits on the Cheerleading Network of Buffoons and Clown keep calling for a rally in NG so when they stop we should finally see it rally. Not before.

Natural Gas continuous contract, NG, Weekly chart

Tomorrow will be a little busier than today for economic reports and the retail sales reports could move the market if there's a large enough surprise. Otherwise most of the numbers are already baked into the cake.

Economic reports, summary and Key Trading Levels

With the BOE and ECB announcing new bailout plans on Thursday, we could see the market opening with another large gap. Otherwise I don't know of any other news that could move the market. Right now the stock market is ignoring bad news from Europe. While the news continues to be bad (certainly not improving), just coming off the front pages has the stock market thinking everything is honky dory and a good time to get long. Nothing could be further from the truth and as I tell people, it will matter when it matters. And when it matters it will probably matter a lot. The market will suddenly sell off hard and most will stand around scratching their heads in wonderment as to why now?

Sentiment is a funny thing and it can, and does, turn on a dime. Greed can turn to fear in a heartbeat. And when you have lopsided sentiment with the kind of spread we now have been bulls and bears, with a real dearth of bears, we have a market with lots of sellers-in-waiting. One spark of fear and all those long players suddenly turn into sellers.

We're heading for opex next week, which is typically bullish (but statistically not much more than regular weeks) but can be very bearish if the selling starts. There are usually lots of bull put spreads that need protecting, if not long call positions, and any hedging to protect those long positions (if not covering of the long positions) just adds to the selling pressure. Throw in the low-volume market we have and it's a recipe for potential disaster for bulls who are not prepared to exit quickly. That's the state of the market I see right now. There's certainly upside potential, which needs to be respected if you're trying to short this stubborn market, but the downside risk is much greater (imo) than upside potential. Trade accordingly.

Good luck as we head for opex and keep in mind that we could see a head-fake move tomorrow in front of opex. I'll be back with you next Wednesday and we'll see how the potential top this week worked out (or not).

Key Levels for SPX:
- bullish potential to 1293-1310
- bearish below 1274

Key Levels for DOW:
- bullish potential to 12,500-12,600
- bearish below 12,333

Key Levels for NDX:
- bullish above 2400
- bearish below 2342

Key Levels for RUT:
- bullish above 770
- bearish below 740

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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