Normally opex Fridays are boring why-turn-your-broker-screen-on kind of days. This one caught a lot of traders flat footed thinking they could rest into opex. The selloff had many scrambling to protect positions.

Market Stats for Friday

Market Stats for Past Four Weeks and Year-to-Date

I'll be filling in for Jim this weekend (and next). If I say something you don't like, blame it on him (wink). This weekend's report is a little long, which I apologize for since time is a precious commodity, but I wanted to cover a few more things than I get time for during the week.

As bearish as Friday was, the week ended positive for most sectors and broad indexes. The major exceptions were the tech indexes, with NDX down -1.5% for the week, thanks to Friday's -2.4% drubbing. YTD though you can see the tech indexes have been the leaders to the upside. The S&P 500 is up +14% and one factor helping the rally this fall is the fact that many fund managers are not up the same amount. Since their performance is generally measured against this index there's been a lot of scrambling to buy dips in hopes of at least matching the overall performance. Bonuses, if not jobs, rest on their ability to get at least on par with the market.

Keep in mind though that this performance anxiety can work both ways. If I as a fund manager am showing only an +8% gain for my portfolio, which is probably a good average of what most funds are currently showing, I can hope for some good buy entries and beat out the S&P's gains or I can be sure to get out of positions before the market declines and thereby protect the gains that I have. For the latter case I would be hoping the S&P will decline closer to the gains I've locked in. Friday's selling might have been this latter scenario where fund managers are quick on the sell button in hopes of keeping the gains they have. And when thousands of fund managers find themselves in the same boat and thinking the same way we could find that it will cause more volatility than normal in the remaining weeks of this month and into the end of the year.

In the table above I highlighted the numbers for the Transport and SOX (semiconductor) indexes, which are both a bit worrisome for the bulls. These two sectors are good reflections of the economy (shipments of inventory/raw materials/finished products is indicative of economic health and semiconductors are found in a wide variety of products today) and their relative weakness is another sign that the economy is not doing as well as the stock market's performance would have us believe. Oil's decline of -9% fits into the same category -- a slowing economy demands less oil and the price decline reflects that.

Highlighted in green is the Housing sector (HGX is the index) to note the huge outperformance of this sector this year. Even Friday's decline in the broader market barely touched this sector, which was down only -0.6% on Friday. Its price pattern argues for higher prices before the year ends. Of course it was one of the most beaten-down sectors in previous years and it's not unusual to see a strong bounce off a very oversold low. But is the rally real or is it an oversold bounce? We'll look a little more closely at the sector in this weekend's wrap.

The big news for the week, at least after Thursday, was GOOG's big earnings miss and the inadvertent early release of its report in the middle of the day on Thursday (GOOG blamed its publisher for the mistake). The Thursday smackdown led to further selling on Friday, especially in the tech indexes. Friday's decline was led by computers, telecom and biotech, which are three of the higher-beta (more speculative) sectors. Going back to my previous thoughts on fund managers, those managers trying to play catch-up might be using the higher-beta sectors but are especially cautious with them and ready to hit the sell button at a moment's notice to ensure they avoid the downdrafts in the more volatile sectors.

There was some volatility surrounding Spain's bailout. By the end of the week the EU leaders confirmed that Spain would get some help but there were no specifics on timing. Spain is dancing around the issue of needing a bailout but not wanting to commit to the ECB's requirements for it. They also want Italy to join them in the request. It's possible we're going to find out that Mario Draghi's bailout plan sounds great on paper but is going to be very hard to implement. Making money available is one thing but the countries will need to agree to the requirements for the money. It might not be much different than the many other programs that the Fed has tried -- you can lead the horse to water but you can't make him drink.

One of the pieces of good economic news in the past week was the data on housing starts, which exceeded all expectations, showing an increase to an annual rate of 872K. That was the fastest clip since July 2008 and certainly much better than the median forecast of 770K. Building permits, at 894K, were also up much better than the expected 815K and August's 803K. Existing sales were not as robust and had declined to 4.75M from August's 4.82M but roughly in line with estimates. There was also good news about the inventory, which was down 20% from a year ago. This helped median prices climb by 11%. An improving housing market is certainly good news for our economy. The big question of course is whether it can continue or if instead it's somewhat of a dead cat bounce. To help answer that question we of course go to the charts and I'll be looking at the housing index, HGX.

Looking over the HGX charts, I'll start up high (monthly) and work lower (daily) to show what I'm watching. If you're interested in trading this sector a good ETF to use is XHB since it has good daily option volume and OI and therefore tight spreads. It's also relatively cheap, around $26, to trade it instead of its options.

If you talk to market analysts I think you'll get almost unanimous agreement that the health of the housing sector will drive our economy. So much is wrapped around the housing sector that even the Fed has made it their priority and one of the primary reasons for keeping interest rates so low. Whether it's the construction industry, and the hundreds of thousands of jobs related to the housing market or the associated sectors such as furniture, appliances and the multitude of purchases made for homes (and all the jobs associated with those sectors) housing drives our economy. And therefore measuring the health of this sector is important to measuring the potential health of our overall economy.

The housing sector has had a very good year and in fact 4 years since the bottom in March 2009 (although not so great in the middle years in 2010-2011). If you had bought this sector at the March 2009 low you would have tripled your investment at the current high. Unfortunately for those who were in this sector at its 2005 high you have not yet seen even a 50% recovery of your loss, which is shown on the monthly chart below. But it's getting close to the 50% retracement near 174 with last Thursday's high at 169.56, which was a minor new high above September's, one of the first sectors to accomplish that.

PHLX Housing sector, HGX, Monthly chart

The bulls are very happy to see HGX break its downtrend line from the 2005, 2006 and 2007 highs, currently near 155.50. As is more readily visible on the weekly and daily charts below, not only was the downtrend line broken in September but it was back tested twice and held. Thursday's new high is a bullish sign from this perspective, plus the fact that the sector held up well while the broader market sold off. But as I'm depicting, I'm thinking the break of the downtrend line could turn into a head fake break (not that this market has ever done anything like that before).

The impulsive decline from 2005 has been followed by a 3-wave correction from the 2009 low. While it's always difficult trying to figure out how high a correction might go in this case, the larger pattern calls for another leg down, which fits in the bigger secular bear market picture. The 50% retracement near 174 makes for a possible upside target, which has some shorter-term price objectives correlating with it.

Looking at the bounce off the 2009 low, the weekly chart below shows the corrective pattern for the bounce, which is what keeps me thinking bearish longer term. I'm bearish the market not because I'm a perma-bear (my nature is exactly the opposite) but because price patterns like these tell me it's too early to be thinking longer-term bullish. When I turn bullish for the next bull market (I had turned bullish in late February 2009) I suspect I will again be a lone voice. At any rate, the leg up from October 2011 would have two equal legs up at 173, only a point away from the 50% retracement. Slightly higher, near 180, is the top of a parallel up-channel for the bounce off the 2009 low.

PHLX Housing sector, HGX, Weekly chart

Once the current rally leg from October 12th finishes it should be the completion of the leg up from October 2011 which should finish the bounce correction off the March 2009 low. The key level for the downside is therefore the October 12th low near 155 -- a break below that should lead to a much stronger decline over the coming year. In the meantime, the shorter-term pattern, shown on the daily chart below, shows a parallel up-channel for the rally from June, the top of which is currently near 180, the same as the larger up-channel on the weekly chart. For the 5-wave move up from June (for wave-c) the 5th wave would equal 62% of the 1st wave near 173, the same projection for two equal legs up from October 2011. The 5th wave would equal the 1st wave near 184. Based on the monthly, weekly and daily charts, retracements, projections and trend lines/channels, I think a good upside target zone is 173-184 before the end of the month. But a drop below 155 would tell us the top is already in place.

PHLX Housing sector, HGX, Daily chart

If I'm correct on the longer-term picture for the housing sector it's confirming the idea that we're not finished with the secular bear market yet. Considering the secular trends tend to run 16-18 years, and if we consider the end of the last secular bull as 1999 (about a year before the broader averages topped), we should be looking for 2015-2017 for the end of the bear. Many time studies point to mid-2016, which means another four years of potentially volatile price action before we can start looking for generational opportunities on the long side.

As Todd Harrison often reminds his readers on Minyanville, it won't be a pleasant journey but we've got to get through it to get to the other side and for traders who can see and trade both sides, there's some good money to be made in trading vs. buy-and-hold. If you're comfortable long only then at least getting into cash instead of riding a bear market down will put you ahead of millions of investors.

For long-only traders it's not time to exit the market yet. We have no confirmation yet that the uptrends are at risk. We've got longer-term and shorter-term up-channels still intact and moving averages supporting the bulls. What I try to do with my charts is show where I think the market could reverse and what the key levels are. Breaking a key downside level, depending on your trading time frame and what chart you're looking at, will tell you when to exit long positions and possibly look to trade the short side. Traders who want to trade both directions are always looking for reversals -- it's a way to constantly challenge ourselves as to where the trade could go wrong and just as importantly, where to switch the direction of our trading (trying to stay with the direction of least resistance). Knowing what kind of trader you are will help you decipher my charts to help you in your trading. With that let's move to the broader averages and some other sectors.

After an a-b-c pullback pattern from the September 14th high it was looking like a good setup for a breakout once we got this past week's rally. That was until Friday's selloff. So far price remains inside a bull flag pattern (or a slightly expanding triangle), shown on the daily chart below. But Friday's sharp decline was not "normal." I know, define normal in this whacky market. What the bulls must do here is immediately rally the market on Monday. As depicted with the green lines, there is still the potential for a higher 5-wave move up from the October 12th low but that potential would be negated with a drop below 1425. I show the key level at 1421, the bottom of the consolidation pattern because there's the possibility it will complete a larger corrective pullback pattern with one more touch of the bottom. But below 1421 I would have a very difficult time justifying why I would want to be long the market and every reason to be out or short.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1471
- bearish below 1421

Thursday's high may have been a truncated finish (no new high above September's), which is common in a weak market that has been held up too long without strong support underneath. Sound familiar? A minor new low on Monday around 1426 would complete an impulsive wave count to the downside and that would suggest we'll be looking for a bounce in the early part of the week and then get ready to get short. A high bounce on Monday would have me thinking long. Needless to say, it's a bit tricky in the middle with these reversals of reversals (also a common topping pattern in this market -- each major top has finished similarly, leaving what looks like a bullish continuation pattern and then breaking down instead, catching too many traders leaning the wrong way).

S&P 500, SPX, 60-min chart

Do you remember the Gann Square of Nine chart that I showed two weeks ago? Here's the link to the larger version of the chart below: Square of Nine chart. I had made reference to the blue vector at the top of the chart, crossing through the March 2009 low at 666/667, and pointing out that 1429/1430 was an important "vibration" off the March 2009 low (6 squares up from that low). Friday's low stopped at 1429.85, which might have been purely coincidental (wink). The bulls want to see that act as strong support to launch the next rally leg. Price has already achieved the level 90 degrees to that vector, at 1467, and the next level of importance is 180 degrees, which can't be seen at the bottom of the chart but it's at 1505/1506. That happens to be only slightly above the top of a parallel down-channel for price action since the 2002 low and 2007 high that I've shown previously on the weekly charts. If the bulls can do their thing next week and carry it into the end of the month that's the upside target we'll be looking for.

Gann Square of Nine chart

The DOW's bull flag pattern is shown on its daily chart below and similar to SPX it could tolerate another test of the bottom of the flag, near 13250 but any lower than that and I'll believe much more strongly in the bearish wave count calling for a 3rd wave down that started from Thursday's high. That would have the DOW dropping quickly to the 13K area to test its 200-dma and uptrend line from October 2011. Following the test of its May 1st high, at 13338, as well as its 50-dma and uptrend line from June, Friday's test is worrisome for bulls -- repeated tests typically lead to failure, especially when support like this is retested so soon after the first test. Whereas SPX was closed on its 50-dma (almost to the penny), the DOW closed a few points below its 50-dma and uptrend line.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 13,670
- bearish below 13,250

With the new low for NDX it has a 5-wave move down from September's high and it's possible we'll be looking for a bounce correction to start soon. But with the small overlap between the 4th and 1st waves there is the potential for it to be a 1-2, 1-2 count to the downside (as labeled on the chart below) and Friday's decline is the start of the 3rd of the 3rd wave down. Since this move typically has a big gap in the middle of it we need to remain aware of the potential for a very strong decline in the coming week. That's not a prediction but is a warning since it won't be a good time to be long. If price slices through the H&S price projection and its 200-dma at 2647 it would be a strong signal that we could get a little mini crash before it finds a bottom (such as the June low before the end of the month). Again, not a prediction, just a warning. The break of its uptrend lines, from June and more importantly from March 2009, needs to be reversed quickly by the bulls.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2785
- bearish below 2647

AAPL has been one of the leaders to the downside, following its leadership role to the upside into September's high, and has certainly had an outsized influence on NDX. Its H&S topping pattern, the break of the neckline and then last week's failed back test of the neckline were the signs that bulls needed to heed. AAPL was shouting from the mountain top (the one with bearish divergence against the August high) that it was ready to take a rest and descend. It's now approaching potential support near 600 and considering its earnings announcement is scheduled for this coming Thursday (after the market closes), it could find that level to be either support, or perhaps resistance if it's first broken early in the coming week.

The price objective out of AAPL's H&S topping pattern is to about 600. Slightly lower on Monday, near 596, is its 62% retracement of the May-September rally as well as its uptrend line from March 2009 through the November 2011 low. This is a very important trend line for the bulls to defend and I'd be very surprised if it broke on the first test. Even the wave count supports a bounce soon -- it has a 5-wave move down from September and should therefore be ready for a larger bounce to correct the move down. But, if the move down from September is a 1-2, 1-2 wave count, as discussed with NDX, then its uptrend line will be sliced like a hot knife through warm butter, as well as its 200-dma near 584 on Monday. I would not want to bet on that kind of downside move but remain aware of the potential if you try to catch a falling knife and buy support at 596-600.

Apple Inc., AAPL, Daily chart

With the bottom of the RUT's bull flag pattern and its uptrend line from June coinciding near 815 on Monday, that's the level for bulls to defend. Otherwise a break below 815 would elevate the bearish wave count that's similar to that discussed for NDX -- a 1-2, 1-2 count to the downside that calls for a screamer of a selloff in the coming week. But the bulls are not dead here and in fact it's a good buying opportunity (assuming it doesn't gap below support on Monday morning) for at least a bounce off support. At least your risk is small -- just be sure to honor your stop if it's hit.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 854
- bearish below 815

Bonds and stocks continue to have an inverse relationship and with money running out of stocks Friday it ran into the perceived safety of Treasuries. The Fed would of course like to see Treasury bonds held up so that rates stay low. There's a lot of government debt yet to be funded and as long as rates stay as low as they are it will seem like almost free money. When yields start climbing higher, and they will likely do so next year at the latest, it's going to get a lot more expensive for the government to fund its debt. It's exactly the same problem Greece, Spain and others are finding. It doesn't matter how the debt problem occurred (Spain for example didn't spend wildly but their housing crash has caused a much larger problem than it did in the U.S.), it only matters how it's going to be paid and how expensive it will be.

The day of reckoning will come for the U.S. when the market will insist on higher yields to compensate for the added risk but as long as Treasuries are perceived as a safe place to park money we'll see money flow into them and the price pattern, as I interpret it currently, has the bond rally continuing through the rest of this year.

The weekly chart of the 30-year bond yield (TYX), which is of course inverse to price, shows a descending wedge pattern for the decline from early 2011. The rally into last Thursday's high stopped at the downtrend line from April 2011 and Friday's sharp decline (although that can't be seen on the weekly chart) may be the start of the next leg down. A drop below 2.66% would confirm the downside pattern whereas a break above the September 14th high at 3.108% would be a bullish breakout (which would be a sign that the Fed is losing control of the bond market because inflation is moving higher than they want).

30-year Yield, TYX, Weekly chart

If bond yields head higher (bond prices lower) it could be helpful to the stock market initially. Money rotating out of bonds and into stocks would help a rally and the perception that we're going to have higher inflation would have many investors wanting to be in stocks (and gold) rather than bonds. But investors would have to be careful about what they wish for. Other than the pain of high inflation, data shows that stocks do best when inflation is running at about 2-3%. Below that, and just as significantly, above that range it has been shown that stocks underperform. If bonds start selling off and inflation gets out of control to the upside we could see bonds and stocks get back into synch to the downside.

One other reason why I don't believe bonds have much higher to go, except perhaps into the end of the year, is that we're at the end of an important long-term cycle for bonds. The cycle runs approximately 60 years peak to peak and the last high in yields was 1982. The trough is of course mid-cycle so 30 years takes us to where we are now. We should be ready to start a 30-year cycle where bond yields will head higher again. In other words, investments in bonds have run their course.

This is important for long-term investors who may have moved a lot of their money out of stocks and into bonds over the past several years, which a large majority of retail traders have done, especially in their retirement accounts. Based on the chart above we'll know when it's time to get out of bonds and I'll be sure to update this as the pattern develops. But be thinking about this and have a plan for getting out of bonds once they've confirmed a bottom is in. And if you're in anything other than U.S. Treasury bonds, especially if you're in high-yield (junk) bonds or municipal bonds that you don't know (such as in a municipal bond fund), it's not too early to start exiting them. They will be most at risk for a fast price decline.

If stocks are also declining it's going to be a very difficult investment environment where cash will be the safer bet (except that high inflation will obviously not be good for savings accounts). And no, I don't think gold will hold up in this kind of environment -- it will likely be a time when all asset classes decline. We'll have time to figure this out as it happens.

Considering the selloff in the broader market and some telltale sectors, the financials held up relatively well. I can look at the sideways consolidation for BKX since its September 14th high as a bullish consolidation inside a sideways triangle. That pattern suggests another leg up (and the final one since triangles point to the final move) and a price projection to 55.74 by mid-November looks very possible. But as with the other indexes, the bulls need to step back in now. Any further drop in the banks is going to mess up the bullish pattern and quickly turn it bearish. There are multiple support levels just below the current price but if they all fail and BXK drops below 48.80 it will be lights out for the bulls. The rally from June would then be complete and that would complete a longer-term bounce correction.

KBW Bank index, BKX, Daily chart

While bank stock prices are doing well we need to keep in mind that it's because of false propping by the Fed. With the aid of smoke and mirrors investors are led to believe banks are healthier than they've ever been and besides, the Fed is not going to let them fail. I suspect the next banking crisis (and we will have one in the next year or two) will be met with much less willingness to bail them out. Too big to fail for the four largest banks (JPMorgan Chase, Citigroup, Bank of America and Goldman Sachs) will become too big to bail when you consider the level of derivatives these banks are employing. In an era of abnormally low rates of returns the banks have been employing derivatives to boost their earnings. And the problem now is far worse than it was back in 2008.

The Office of the Comptroller of the Currency sends out quarterly reports that include derivative exposure by banks (and the difficulty in reporting this is one of transparency -- the problem is probably even worse than is being reported). The latest report, for the 2nd quarter, showed $222.5 trillion (that's a 'T' not a 'B') of notional derivatives held by insured U.S. banks and savings associations. This is up from "only" $203.5 trillion from the 2nd quarter of 2009. And this makes banks safer?

Sheila Blair, the former head of the FDIC and the only one who seemed to have a grasp on how to handle the problem with the banks (but was ignored by Bernanke, Paulson and Geithner at the time), is now the Chairperson of the System Risk Council and she recently sent an email stating she understands some derivatives are ordinary hedges but says the "sheer magnitude, complexity and opacity creates an almost impenetrable web of interconnections that makes our global financial system vulnerable to systemic shocks." She is strongly advising federally insured banks get rid of all risky derivatives. Anyone care to take bets how quickly that will happen or that it will even happen at all before the next crisis? My hope is that the four major banks are completely dismantled during the next crisis, including the firing of all top bank executives (without a golden parachute for them -- they've raped and pillaged the public enough). It's the only way the problem will truly get fixed but it's going to be a very painful and scary time for the markets when the next crisis develops.

Moving over to the Trannies, it's almost getting comical watching its pattern. Looking at the daily chart you could be forgiven for thinking you're looking at a tick chart in the middle of a choppy day. As I had mentioned Wednesday night, I thought the TRAN would make a stab up towards the 5200 area to tag its downtrend line from July 2011 and a price projection at 5198 where it would have two equal legs for an a-b-c bounce off the September 28th low. Thursday's high was just shy of 5193 and Friday it got slammed with the rest of the market. Now the overlap of the October 5th high means it's not an impulsive move higher from September 28th and the a-b-c bounce has a high likelihood of being retraced. For obvious reasons it's hard to get a bead on direction until price breaks out of this congestion zone but the overall pattern is not bullish. Of course the primary message from the transportation average is that it's not supporting the DOW and we remain on a Dow Theory sell signal. It's just a question of when the broader averages will let go of their perch.

Transportation Index, TRAN, Daily chart

On Wednesday I said the dollar bulls needed to see an immediate bounce on Thursday and it did. It then continued higher on Friday and is again attempting to break its downtrend line from July and got back above its short-term uptrend line from September. But it got stopped at its 20-dma and could go either way from here. We need to see a break above 80 or below 79 to have price showing the way. I believe the rally will continue but price is the final arbiter.

U.S. Dollar contract, DX, Daily chart

Gold has now dropped down to its 50-dma at 1720 and the price pattern looks good for a bounce in the coming week, perhaps back up to its 20-dma, currently near 1764, before heading lower. If 1720 doesn't hold then we'll probably see a drop down to the 1700 area. Keep in mind that the longer-term pattern calls for gold to drop below 1530.

Gold continuous contract, GC, Daily chart

Oil's choppy pattern in October leaves me wondering if we'll get another leg up for the bounce off the October 3rd low or if instead it will simply continue lower right from here. I think if the stock market heads lower from here oil will likely follow. If the stock market continues to rally into the end of the month I think oil will continue to hold up/push a little higher for its bounce.

Oil continuous contract, CL, Daily chart

It will be quiet on Monday and Tuesday as far as economic reports go. It will be Wednesday before we get some meaningful reports, including new home sales data and the next FOMC rate decision and words of wisdom from our fearless Buzz Bernanke. If the market declines further on Monday and Tuesday I suspect he'll arrive at the meeting in his fully loaded helicopter, ready to spread goodies to all his good little children in the banking industry.

Economic reports and Summary

Friday's decline looked more bearish than I would have expected if we're to get more highs into the end of the month. Following the impulsive rally from October 12th up to Thursday's high we should have gotten a smaller pullback to correct that rally before heading higher again. That's what the bullish pattern called for. The bearish pattern suggests a much more difficult time ahead for the bulls. If the market doesn't start a rally immediately on Monday but instead breaks down we could see a hard decline over the next few days before it finds some kind of support to consolidate before dropping lower again (stair-step pattern lower).

Buying the "dip" could work Monday but only if the bulls step back in quickly. Because of the downside risk I would keep stops tight on any long entry. If the market does break down you'll want to get short (scary entry) and hang on. I know I don't need to tell you how difficult it is to short a gap down but the bearish pattern suggests that will be the way to go. Or just sit tight and let the move happen and then look to set up for a short play later in the week. We're at an inflection point here and how Monday goes will likely point the way for the rest of the week.

Good luck and I'll be back with you on Wednesday, by which time we should be able to get a good sense for how the rest of month will play out.

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