The stock market has been chopping up and down since the August 21st highs, which looks bullish. All the market needs is even a small confirmation that more monetary easing is on the way and the hope is that Mario Draghi will provide it on Thursday.
Since the August 21st highs the stock market has been consolidating while waiting for more confirmation that the central banks are going to do more than just talk about further monetary easing. The good news for bulls is that the consolidation patterns look bullish. The worrisome news for bulls is that the consolidation patterns are reminiscent of past major tops in the stock market. Failed bullish patterns tend to fail hard so it's going to be important that the central bank heads tell the market what it wants to hear.
Mario Draghi will make an announcement for the ECB Thursday morning before the bell and the market anticipates some kind of confirmation that Draghi will back up his "we'll do whatever it takes" with actual steps in that direction. Any continuation of promises without definite plans could derail the rally. Today he was trying to assure the markets that the ECB has definite plans to purchase bonds to help the "peripheral countries" (Spain, Portugal, Italy, etc.) but will buy "sterilized" bonds. He is reportedly ready to buy an unlimited amount of bonds but will refrain from setting a public cap on yields (and the market might not be happy with that since the market could still become very worried about the ability for countries to repay the loans). Investors are also still waiting to hear whether or not public purchases of the same bonds will be subordinated to the ECB position. It sounds like Draghi is already hedging and we can expect a lot more promises to buy but restrictions on what the ECB will buy, especially if they don't put themselves ahead of the line in case of a country's default
The current risk for Draghi, in his attempt to assure the market while not overpromising, is that he has to be careful about any further promises for what the ECB will do before Germany's vote on September 12th on what the ECB will be allowed to do. While Germany is only one vote among all the EU countries, it clearly pulls some weight. Draghi must be careful in over-committing before Germany provides a green light (or not). In the meantime the market might not have the patience to wait for the green light or the new restrictions on what "buying" really means. Thursday could at least be more volatile than we've seen over the past two weeks.
One group that has become more nervous in the past two weeks is the insider group, which is the group of people who should know best what the true value of their companies are. Mark Hulbert wrote an article for MarketWatch today (Insider Selling) in which he cited some numbers from Vickers Weekly Insider Report, published by Argus Research. Corporate insiders have become more active sellers in the past two weeks and the latest ratio of selling to buying in NYSE-listed companies has been near 6:1, which is the highest it's been since the early May. This suggests the market may have gotten ahead of itself and insiders are taking advantage of the over-priced situation.
Insider selling is typically in excess of buying and the average for the period of mid-May through mid-August was 2.9:1, so about half the current rate. It's the timing of the increased selling, as prices approach the May highs, which should be disconcerting to bulls, especially since the current rally has been built on hope for more drug money from the central banks rather than on expectations of an improving economy. In fact the deteriorating global economy should have the DOW down probably at least 1000 points by now from where it's currently trading (if it's truly a leading indicator for the economy). Hope is a wonderful commodity but not in the stock market, at least not without stops.
Keep in mind that the NYSE weekly chart is bearish here as it has rolled over from another test of its downtrend line from 2007-2011 at its August 21st high. It hasn't pulled back impulsively from that line so it could be gathering strength to jump over it but when we hear about insiders increasing their selling, in addition to the waning momentum we're seeing in many indicators, it's certainly good enough for a warning to bulls to be careful in their expectations.
NYSE Composite index, NYA, Weekly chart
The market has essentially been on hold since the August 21st highs and prices have been consolidating since then (two weeks). The consolidation at the highs looks bullish and we have to lean that way until proven otherwise but I'll show why we have to at least be thinking otherwise. I'll start tonight's chart review with NDX, one of the more bullish indexes, and I'll start with a view from 30,000 feet and move in closer from there.
There are a couple of important price levels to review on NDX so make note of them in case we get some more rally from here. Starting with the monthly chart, it gives us some perspective from the run-up from 1994 into the 2000 high, low in 2002 and the bounce attempt since then. For the past 10 years (next month) the rally has been able to retrace almost 50% of the 2000-2002 decline. That's a lot of time and Federal Reserve help to get back 50% of the decline. The bounce is clearly a 3-wave correction to the impulsive decline into the 2002 low. An impulsive move followed by a corrective move will be followed by another impulsive move. It's basic EW analysis and it's a reason I think we'll see NDX break below its 2002 low at 795 before the bear is killed.
Nasdaq-100, NDX, Monthly chart
The a-b-c bounce off the 2002 low shows the a-wave retraced just shy of 38% of the 2000-2002 decline at the October 2007 high and the c-wave has made it up to just shy of the 50% retracement at 2805.80 (the April high was 2795.35). The current rally is also hitting the top of a parallel up-channel for the a-b-c bounce and its broken uptrend line from 1990-2002 and it's showing bearish divergence against the 2007 high. Good time to go long? Not me.
As noted on the chart above, if we get a another leg down into 2014-2016 that equals the 2000-2002 decline in percentage terms, not points since the same number of points would drive it underground, we're looking for a downside target of about 475. If that seems too outrageous, keep in mind that a typical parabolic rally, which is what the 1994-2000 rally was, will return to the start of the rally in the following correction. This has been true throughout the history of parabolic rallies and the 1994 level is near 350. That's not a prediction but it's certainly the risk for those who decide to hold through the next "correction."
Moving to the weekly chart below, I'm showing a rising wedge pattern for the rally off the March 2009 low, with the top of the wedge being the broken uptrend line from 1990-2002. You can see how NDX made it up to the line in February 2011 for a back test and again in March/April 2012. The question now is whether or not it will reach that upper trend line one more time (to complete a "three drives to a high" pattern). If so then we'll see NDX rally up to about 3000 by October/November, which is supported by the Presidential election year cycle (calling for a rally into November).
Nasdaq-100, NDX, Weekly chart
But before the NDX can make a run up to the 3000 area it must get through some potentially tough resistance levels. The 50% retracement of the 2000-2002 decline hasn't been tagged yet so 2805.80 could be an electric fence if computers are programmed to sell there. Only slightly higher is 2821.52, which is where the 5th wave of the move up from August 2011 would equal the 1st wave. The daily chart below shows a couple of other levels to watch if we get a least a little more rally. The 5th wave of the move up from June 4th would equal 62% of the 1st wave at 2823, very close to the larger 5th wave projection. It would be equal to the 1st wave at 2871.87. The 127% extension of the April-June decline is at 2890.94 and this extension is a common reversal level if the rally leg is not a bull run but is instead part of a larger corrective pullback or the completion of the rally. So we've got the 2806, 2822-2823 and then the 2870-2890 levels to watch over the next week. Above 2900 should be a strong indication that the rally will continue into the end of October and target 3000.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2785
- bearish below 2735
Moving in closer to the look at the choppy mess since August 21st, the pullback pattern looks more like a bullish descending wedge and especially if the market hears good things from the ECB on Thursday we could see the market head higher from here. A break above Friday morning's high near 2785 would be a bullish signal. But even if the market is to rally into next week there is a good possibility that we'll first see another leg down to finish the descending wedge pattern, in which case we might see NDX close its August 16th gap near 2735. Much below 2735 and I'd start thinking about a failed bullish pattern and that would likely mean strong selling to follow.
Nasdaq-100, NDX, 60-min chart
The daily chart of SPX looks the same as NDX, including the bullish looking consolidation following the August 21st high. The small descending wedge fits as the 4th wave of the move up from July 24th and it would achieve 62% of the 1st wave near 1435, which is near the projection at 1437 for two equal legs up from June 4th (using the June 19th high as the completion of wave-A). The 5th wave would equal the 1st wave at 1459. A back test of its broken uptrend line from July 24th through the August 24th low will be near 1430 on September 12th, the day we'll hear from the FOMC and whether or not the ECB will have Germany's blessing. Keep in mind that 1430 level since it's the important one on the Gann Square of Nine chart (discussed last week).
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1413
- bearish below 1395
The bearish interpretation of the pattern since the August 21st high is very bearish since it considers the choppy pullback as a series of 1st and 2nd waves to the downside. I'm always reluctant to seriously consider this option because more often than not it turns out to be what it looks like -- a bullish continuation pattern. But with previous major market highs looking like bullish continuation patterns we have to remain aware of the very bearish potential here.
Failed patterns tend to fail hard because the majority of traders have positioned themselves for the expected continuation of the trend (up in this case) and when it instead fails by breaking down we will have a lot of owners of stock quickly puking them back to the market (sorry to be so graphic but it does convey the kind of panic that happens as traders literally become sick to their stomachs from fear of loss). This is why you don't want to hang onto long positions if price breaks down from these bullish patterns. As shown on the 60-min chart below, a drop below 1395 would likely see SPX dropping down to the next support level near 1380-1385 where it will find its uptrend line form June 4th though the July 24th low as well as its 50-dma. Below 1380 and it will be bombs away.
S&P 500, SPX, 60-min chart
The DOW has been relatively weaker since the August 21st highs as money has been rotating into the higher-beta names (although not today as some money rotated into the safety of the bluest of the blue chips). Its pullback also looks like a bullish descending wedge and as long as another drop down to the bottom of the wedge doesn't drop below 12900 it remains potentially bullish from here. The upside projection near 13386 still stands but below 12900 and it would very likely be a fast 300-point drop to its 200-dma near 12720.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,152
- bearish below 12,900
The RUT was strong on Tuesday but other than a couple of buy programs that might have triggered some short covering it's not clear whether it will get follow through from here. It's bullish that it broke its downtrend line from August 21st, which keeps alive a move up to at least 830 (potentially on up to 848 if the buying continues into next week), but a drop back below 807 from here would sound the alarm bell for bulls to abandon ship.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 820
- bearish below 807
Since the March and May highs the S&P Banks index (BIX) has had a devil of a time trying to break the downtrend line from 2010 through the March 2012 high. The downtrend line has been hit no less than 14 times since July 19th. The market is clearly respecting this downtrend line. Bulls will see the price action underneath this line as a bullish consolidation, gathering strength (getting rid of the weak holders) in preparation for a break above. A rally above 161 would definitely be bullish. The bears see resistance holding and a rolling topping pattern. A break below the August 24th low at 156.82 would signal the start of a likely breakdown. Let price lead the way.
S&P Bank index, BIX, Daily chart
The transportation index is in trouble and by extension so is the broader market. The TRAN is a very good indicator for the economy and yesterday's FedEx warning is very likely not the only one coming. When shipments decline it's because production is in decline (needing fewer materials to manufacture items and fewer finished goods to ship). On Wednesday the TRAN broke its uptrend line from June but then recovered in the afternoon and closed on the line. Whew! But today it broke it again and did not recover, and it closed below yesterday's low. Bummer. The TRAN is clearly underperforming the broader averages at this time and I think it's our canary in the coal mine, which just fell off its perch. As a miner, I'd be exiting the mine right now, regardless whether or not the major averages could make a new high from here (which would be an outstanding shorting opportunity).
Transportation Index, TRAN, Daily chart
The dollar appears to be basing near its downside projection at 80.78 for two equal legs down from its July 24th high (exactly opposite the stock market) while trying to hold onto its uptrend line from August 2011. At the same time the euro is banging its head on its downtrend line from May 2011 and both appear ready to resume their primary trends (up for the dollar and down for the euro). If true then both currencies should react the Fed and ECB announcements, suggesting more weakening of the euro (from their monetary easing program) and strengthening in the dollar (not as much, if any, monetary easing from the Fed).
U.S. Dollar contract, DX, Daily chart
Gold has been rallying in anticipation of more monetary easing, which is inflationary and gold bugs like inflation. But even with the ECB giving more information about what their program will be gold did not continue its rally today. It instead gave back a little. Is it all priced in already? But gold could turn bullish here if the rally continues much above 1700, which is already a little higher than I expected to see. Its downtrend line from September 2011 is near 1685 so if that's used as support on a back test and it then heads back above 1700, especially if the dollar is drop below its 200-dma at 80.78, I'll turn bullish the shiny metal. But for the moment I'm expecting the little flash higher to be a false breakout and for gold to start its next decline. Back below 1647 would confirm gold has topped.
Gold continuous contract, GC, Daily chart
Oil continues to look like the stock indexes and at the moment it looks like it's in a bullish consolidation pattern since its August 23rd high. It's holding above its 20-dma, now near 95.35, but it has broken and back tested its uptrend line from June 28th and could simply drop away from here. A higher bounce for another back test next week could see oil challenging 100, above which it would be more bullish. But at the moment its bounce pattern off the June low suggests a complete retracement of the bounce, so back below 77 and potentially much lower.
Oil continuous contract, CL, Daily chart
Thursday's economic reports include the ADP employment numbers, which are used to gauge what Friday's nonfarm payroll numbers will be like. ISM Services is expected to drop a little but still stay above 50. The big announcement that traders are waiting for will be from Mario Draghi and the hope is that he will announce the next big bond-buying program. But they could be disappointed with just promises of the same while he waits until Germany's vote next Wednesday.
Economic reports and Summary
We can expect some fireworks in the futures during the pre-market session as the ECB announces their rate decision (analysts are split in their opinions about whether or not the ECB will cut the rate from 0.75% to 0.50%) and what kind of bond-buying program they plan to implement. Investors want to know whether or not the ECB's purchases will be senior to other market participants, in which case the market will balk at the program. Draghi will follow the 7:45 AM EDT announcement with a press conference at 8:30 AM EDT. In between those two events we'll have the ADP employment report at 8:15 AM. It's anyone's guess how the market will open after all that.
The patterns over the past two weeks look like bullish continuation patterns and hope springs eternal for the bulls who expect the central banks to dump wheel barrows of cash into the market. If we do get another leg up into next week I'll be watching for signs of slowing/diverging momentum since it should be an outstanding shorting opportunity (for at least a pullback if not the start of the next major decline). The market is primed in expectation for a continuation of the rally and most traders are positioned for it. That makes it potentially dangerous if the central bank heads continue jawboning without much in the way of specifics. If the bullish consolidation patterns instead turn into failed patterns, look out below. It's the same way major tops have been created in the past. By this time next week we should have a very good idea whether or not we've seen the top or will be nearing one.
Let price lead the way and good luck with your trading. Play it safe for now and keep your powder dry -- we'll have plenty of opportunities to take advantage of the next big move (up or down) but only if you have money in your trading account. 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