August is shaping up to be one of the quietest months in a very long time as traders stop trading while waiting for word from central banks about more monetary stimulus.
August has been one of the lightest-volume months we've seen in a very long time. Current volume is running at less than half of what it was in May and June of this year. It seems when there's not much price movement there's not much for the HFT crowd to do. Considering HFT trading makes up about 80% of today's trading volume, when they go quiet there's not much happening in the market. Most traders don't know what to do from here since there's a high expectation for more monetary stimulus programs but what form, if any, it will take is the big unknown.
Most market participants expect some form of monetary stimulus and even a bad Empire Manufacturing number this morning could not knock the market down. The number came in a -5.9, which shows the economy in contraction, and was much worse than the +5.0 that had been expected and down from 7.4 in July. The only reaction was ho hum, especially since many think it will support the Fed's decision to implement the next QE program.
What's mind boggling to me is why anyone would think the Fed will pull the trigger on any kind of QE program now. Anyone who studies the Fed's modus operandi knows the Fed is reactive, not proactive. With an economy that is slowing but not considered in recession (yet) and a stock market that is much closer to its highs than lows, there's very little reason for the Fed to use up what could be its last bullet.
While the Fed might be worried that the economy is going to slow further, they are even more worried about their credibility. After several monetary stimulus programs they have virtually nothing to show for it except a higher stock market. If they pull the trigger on another program and it's ineffective they risk loss of faith in what the Fed can do. Since our entire financial system is based on faith and trust, another failed monetary stimulus program could be the start of a complete breakdown in that faith and trust. The financial collapse in 2008 was just a shot across the bow for what it would look like with loss of faith in the Federal Reserve and our banking system. And let's face it, the banks and their illegal actions and ineptitude have caused a further decline in faith in our banks. Loss of faith in the Fed would only exacerbate the loss of trust in our financial institutions.
The market has been so slow for the past two weeks and the indexes have barely moved. This puts us all on hold while waiting for something. It's hard to imagine the market will stay stuck until the end of the month to hear from Bernanke at the Jackson Hole meeting, but I guess we need to be prepared for that possibility. We've been hearing about the slow volume and the chart below shows just how slow the volume through the first nine trading days of August (which includes the last two days of July) was as compared to previous years since 2004. The volume is down -45% from last year and only picked up slightly on Tuesday with the stronger selling volume.
Total volume for first nine trading days of August, chart courtesy Business Insider
When we combine such slow volume with the excessive bullish sentiment and serious lack of fear (VIX dropped to 13.67 on Monday, which is lower than it's been since June 2007. It seems everyone is convinced more money is coming our way from the central banks and that the market can therefore only go up from here. The shorts are drying up faster than the Colorado River and that makes the market even more vulnerable to a downside disconnect if we get hit with a surprise event (black swan anyone?). For now we have to live with a market that is much more reactive to political events than economic and certainly fundamentals don't matter. It's our new market. But is it really new?
George Friedman and his stratfor.com articles are hugely informative in helping understand the geopolitical issues as well as the political-financial issues. In his August 7th weekly letter, Financial Markets and Politics, he discusses the EU situation, how and why it was created and how politically motivated all the financial manipulations have been.
What surprised me was his assertion that we're getting back into what is "normal" for political intervention in the markets. Friedman stated, "The investors' problem is that they mistake the period between 1991 and 2008 as the norm and keep waiting for it to return. I saw it as a freakish period that could survive only until the next major financial crisis -- and there always is one. While the unusual period was under way, political and trade issues subsided under the balm of prosperity. During that time, the internal cycles and shifts of the European financial system operated with minimal external turbulence, and for those schooled in profiting from these financial eddies, it was a good time to trade. ... [Since 2008, traders] now lived in a world where Merkel was more important than a sharp trader."
The last generation of traders has been used to mostly non-intervention (a freer market) but in fact it was a period out of the norm. I highly recommend the article since it discusses what we've been dealing with, especially since 2008 and what's happening in Europe. The important point is we are likely back into a period of political intervention as part of the normal market that we have to trade. We have to learn to deal with it since in reality it is part of the market. It's also important to understand the constraints that the politicians face (and the central bankers are included in this group) and as Friedman states, once those constraints are understood the market then becomes more predictable.
Friedman made a specific comment about HFT that I thought was an interesting observation, especially since I see the market as extremely vulnerable to a downside disconnect (Black Swan event). He states, "Even understanding and predicting what political leaders will do is of no value if you insist on a trading model built for a world that no longer exists. What is called high velocity trading [HFT], constantly trading on the infinitesimal movements of a calm but predictable environment, doesn't work during a political tidal wave. And investors of the last generation do not know how to trade in a tidal wave. When we recall the two world wars and the Cold War, we see that this was the norm for the century and that fortunes were made. But the latest generation of investors wants to control risk rather than take advantage of new realities."
What caught my eye of course in the above paragraph was "fortunes were made." I don't know about you but I want to figure this new market out so that we are the ones in that fortune-making group. Together we'll learn and figure it out and get ahead of the pack. And in closing, Friedman states, "We have re-entered an era in which political factors will dominate economic decisions. This has been the norm for a very long time, and traders who wait for the old era to return will be disappointed. Politics can be predicted if you understand the constraints under which a politician such as Merkel acts and don't believe that it is simply random decisions. But to do that, you have to return to Adam Smith and recall the title of his greatest work, The Wealth of Nations. Note that Smith was writing about nations, about politics and economics -- about political economy."
So that's our new reality and it's not going to go away. We've got a different market environment from what most of us have known and we need to accommodate the political decisions and how they'll affect the market. I will always believe the chart patterns are our best way to understand what prices are doing. It's by no means easy but the patterns measure the emotional swings and there are tools, such as EW, Fibonacci, trend lines, momentum indicators and more, that will enable us to get an early indication of what the market is doing, where it is likely headed and where it could reverse.
Starting off with SPX tonight, I'm using a weekly chart showing price action since the 2009 low. Price is once again near the top of a parallel down-channel based on the trend line across the lows from October 2002 and March 2009 and a parallel attached to the 2007 high. The April 2012 high came within 6 points of the line, which is currently near 1416. Tuesday's high near 1410 was also 6 points shy of the line. Also near 1416 is a Fib projection for the leg up from October 2011 where it would equal 62% of the first leg up from March 2009 to the May 2010 high. Those two legs even look like each other (fractal) and therefore the 1416 target looks like a good one here. If that doesn't hold the bulls back (and keep in mind that it might not get there) there is higher potential to about 1450 where it would hit the top of a parallel up-channel for price action since the June 2010 low.
S&P 500, SPX, Weekly chart
While I'm trying a couple of wave count ideas, which won't be clearer until the rally off the March 2009 low has completed, I think it's important to note the trend line resistance levels and the fact that the bounce has formed a rounding top appearance. The chart below shows the rounding top and how the wave count could play out into 2014. Notice that the trip back down to the 2009 low should happen faster than the climb up and the bulk of the loss probably won't occur until 2013.
S&P 500, SPX, Weekly chart
Zooming in on the leg up from June, it too looks to be in a topping pattern. We've seen this many times before -- I call it the choppy top where it looks like a bullish consolidation and then it suddenly lets go to the downside. But I can't rule out the possibility that the bulls will break resistance at the downtrend line from October 2007, which was tested on Tuesday near 1410, and push higher to 1426 for two equal legs up from June. A drop below 1389 would be the first bearish sign and below the August 2nd low near 1354 would confirmation that a top is in place.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1426
- bearish below 1389
The choppy sideways/up price action over the past two weeks is either a bullish consolidation or it's a bearish ending pattern. On the 60-min chart below I show the possibility for some additional chop into early next week to finish the move up. Upside resistance levels, beyond the downtrend line from 2007 (near 1410), is the top of the parallel down-channel mentioned earlier with the weekly chart, near 1416, and then the April high near 1422 and the projection to 1426 for two equal legs up from June. Below 1395 would be a short-term sell signal and then we'd have to see if the sell triggers on the daily and weekly charts get hit.
S&P 500, SPX, 60-min chart
The DOW has been pushing up along the top of its rising wedge pattern, with the last test of the line with Tuesday's high. It remains possible for another leg up following the sideways consolidation over the past nine trading days, in which case I see upside potential to the 13385.70 projection (two equal legs up from June 4th and two equal legs up from July 24th). But we've seen many tops get put in with this kind of sideways consolidation so we have to remain aware of that potential. A break of its uptrend line from July 24th, near 13140 on Thursday, would be the first sign of trouble for the bulls but it still takes a break of its August 2nd low near 12779 to indicate a top is in place.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,280
- bearish below 12,778
NDX is providing a good example for us to follow right now. From another trading group I received a copy of a pattern that someone uses for his trading. It's basically an A-B-C pattern and he uses it to project both time and price. For those who use EW (Elliott Wave) analysis you'll recognize it as a correction to the previous trend.
As Keith Newcombe explains in his book, "The X-A-B pattern is often used to forecast future price action. The Fibonacci Extension technique constructs the next trend line B-C parallel to the X-A trend line. The length of B-C will be a Fibonacci percentage of the length of the X-A line. The three most common lengths considered are 0.618, 1.000 and 1.618. The example shows these three target price levels.
"Variation: Point C (the 1.000 Fibonacci Extension) can be obtained by moving the X-B line to point A. The line A-C is equal in length to X-B and parallel to X-B. The A-C line is a measured move to the Price Time Target. The expression Price Time Target (PTT) comes from the book 'Precision Trading with Stevenson Price and Time Targets'."
You've seen me use this technique many times on my charts. The A-B-C bounce is a classic EW correction with two equal legs up for the bounce, finding resistance at the top of the parallel up-channel. Real price action is of course never so precise and in fact often quite hard to discern where one wave starts and the other ends. This is particularly true for b-waves which tend to be choppy messes (like 4th waves).
But looking at the A-B-C pattern, the chart below looks like a very similar setup for NDX to reverse back down after it completes an A-B-C bounce correction off its June 4th low. It exceeded two equal legs up, at 2724, with a high of 2742 on Tuesday but it stopped at the top of its parallel up-channel. Why did it stop there? I've also noted the time equality between wave A and C (where they were equal in time on Monday). It's a good setup for a reversal and now we wait to see if it happens from here.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2745
- bearish below 2664
NDX tested the top of its parallel up-channel from June 4th and again has pulled back from it. Unfortunately it doesn't have a clear wave pattern to suggest it's going to head down from here but if I ignore that and go with just the A-B-C pattern and the channel, it remains a good place to be short. An appropriate stop level would be just above Tuesday's high near 2743 although it could make just a minor new high and then reverse back down again. The indexes are just motoring sideways and the safest thing to do is simply wait until we get a better wave count finish to the upside or an impulsive move to the downside. A break below Tuesday morning's low near 2721 would also break its uptrend line from July 25th, shown on the chart below, so that's another signal I'm waiting for.
Nasdaq-100, NDX, 120-min chart
It's always a good idea to keep an eye on the semiconductor index because you want to see it supporting a move in the tech indexes. Semiconductors are found in just about anything we buy today and therefore the health of the SOX will give us clues about the health of the economy. Right now I show a setup for a reversal back down in the SOX and if it does start down from here I doubt it will do so by itself. There's an a-b-c bounce off the June 4th low and it made it back up to its broken uptrend line from October-December 2011, which was almost tested on the first bounce off the June low. There's a little more upside potential to 412 where the c-wave would equal 162% of the a-wave but the break of its uptrend line from July 23rd is the first warning sign that its bounce might have finished.
Semiconductor index, SOX, Daily chart
The RUT was out in front today with a +0.9% gain while the DOW finished slightly negative. That could be bullish but I'd want to see the RUT break its downtrend line from March, near 808, before turning even short-term bullish on this one.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 808
- bearish below 765
Bonds continued to sell off today and now the 10-year yield, TNX, is at/near an important level that could set up a reversal. The bearish wave count for TNX (bullish for bond prices) calls for another leg down into October/November and the a-b-c bounce off the June 4th low has the c-wave equal to 162% of the a-wave at 1.787%, which was achieved today. The next lines of resistance are the downtrend line from April 2011, near 1.858% and then its 200-dma at 1.873%. If TNX starts back down from here (or from slightly higher) I think stocks will stay in synch with it.
10-year Yield, TNX, Daily chart
There's not much of a change in expectations for the dollar, gold and oil from last week's update. The dollar's pullback looks like it needs more downside work and a drop down to the June low at 81.39 looks like a good possibility before heading higher again.
U.S. Dollar contract, DX, Daily chart
Gold's sideways triangle pattern continues and unless it breaks down sooner or rallies out of it and gets above 1643 I think we'll see gold consolidate in early September before it sets up a good shorting opportunity.
Gold continuous contract, GC, Daily chart
Oil looks on track to reach the 62% retracement of its March-June decline, at 97.84, before it should be ready to head lower.
Oil continuous contract, CL, Daily chart
Tomorrow's economic reports include housing starts, permits and the Philly Fed number. There's an expectation for the number to improve from July's -12.9 to -5.0 (so less bad) but another negative surprise like the Empire Manufacturing number could create more worries about a slowing economy. Of course that would be a good thing (with many believing it will help the Fed make the decision to implement another QE program). Let's face it -- nothing matters to this market right now except what it thinks the Fed will do. And if the Fed doesn't do anything then at least we have the ECB that will something. Right? I mean Mario Draghi promised us he'd do everything he can to save us. We won't know what the ECB will do until at least mid-September.
Economic reports, summary and Key Trading Levels
The market is clearly on hold, as it has been for the past two weeks, while it waits for word from the central banks. It's ignoring all else. The way the price pattern is setting up I think there is going to be a big disappointment (the market is not going to get the monetary easing it thinks it deserves). We might see a larger pullback into the end of the month and then a bounce to a lower high in front of the Jackson Hole meeting but that's just speculation.
If the market continues to chop its way slowly higher over the next two weeks I think it will be the ending pattern that will finally break when it realizes the Fed is all talk and no action (for now). In the meantime there's not much to trade unless you're a day trader and can find some good stocks that are moving. Don't force trades just to trade -- keep your powder dry for better trading times ahead. I think we're going to have some good opportunities soon.
Good luck and I'll be back with you next Wednesday.
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