The week finished negative thanks to one day of selling, Tuesday, but some longer-term uptrends are holding and the week's consolidation leaves both sides guessing which side is going to take over in the coming week.
Market Stats for Friday
Market Stats for Past Four Weeks and Year-to-Date
I'll be filling in one more time for Jim. He'll be back with us next week.
Thanks to Tuesday's big selloff the week ended in the red but all of the week's selling was on Tuesday. Monday and the rest of the week after Tuesday were essentially doji days as the market absorbed the selling from October 19th and 23rd. Last weekend I had mentioned the SOX as being one of the weaker indexes this year but as you can see in the weekly numbers above, this week the SOX was the one of the few sectors that at least closed positive. Oversold bounce or the start of something bigger in the week to come?
If the SOX and banks, which was one of the weaker sectors this past week, get into gear to the upside then we'll get another rally but so far we only have a mixed message in that regard. The housing sector, which was highlighted last week as being particularly strong this year, was relatively weak this past week and it has been chopping sideways since its September high, up one week, down the next and then up again.
Other than Tuesday's overnight session there was an effort to rally equity futures during the overnight sessions and that created gaps to the upside when the cash market opened. But each gap up was immediately sold into and that's certainly not bullish. It's the sign of distribution -- get the best prices possible by creating some liquidity in the first half hour of the market that can then be used to distribute inventory without knocking the prices down too much. Rinse and repeat. That was the pattern last week and if it continues in the coming week we're going to see important support levels break. But short term the market looks oversold and ready for a bounce. The only caution in that regard is that severe declines typically come out of oversold conditions, not from overbought conditions.
Friday's economic reports included the Michigan Sentiment and the advanced GDP reading. The Michigan Sentiment was essentially in line with expectations and dropped only marginally to a final reading of 82.6 for October, from the previous estimate of 83.1. These numbers are near the low end of what was seen prior to the 2007-2009 market decline and at the high end of numbers seen since 2008, as can be seen on the chart below. I've drawn a line at 80, which seems to be a good demarcation line showing poor sentiment vs. OK to good sentiment (good would be above 90 and better would be above 100). Based on this sentiment gauge one could say people are feeling cautiously positive. These numbers tend to follow changes in the stock market, oil/gas prices, employment reports and other media reports. It's hard to know what effect all of the political campaigning (I was tempted to write "lies" instead of "campaigning") have had on sentiment but I have difficult believing it would be positive.
Michigan Consumer Sentiment
The GDP reading of +2.0%, which marginally beat expectations for +1.9%. It's an improvement from 1.3% for Q2 so it was good news. But admittedly it's hard to get excited about the low number. Combined with low employment growth it's not surprising to hear most people complain "what growth?" A chart put out by Doug Short, shown below, graphically depicts GDP and its components, which I think does a good job showing where GDP growth, or decline, has come from. For example, the big red bars during the last recession are the declines in private domestic investments. In addition to the lack of investments the blue bars show the declines in personal consumption expenditures (PCE). Those two combined can be real drivers of GDP.
GDP, 2007 to present, chart courtesy dshort.com
The growth in exports of goods and service, when higher than imports, shown in green, are often a good sign that we're coming out of a recession. Since 2001 that has been essentially neutral and other than the big shot in the arm back in Q4 2011 from domestic investments (red) it's been notably absent the past two quarters. PCE has been stable, running at close to 2% for the past 5 quarters. What helped Q3 this year is the bump in government spending (purple), which had been running negative for the previous 7 quarters (since Q4 2010). An unexpected jump in government spending jumped +3.7% in Q3, which of course makes one wonder if that might have been engineered to occur right in front of the elections. The majority of that spending was for the military. State and local government spending dropped a negligible -0.1%
The worrisome part of the GDP report is the fact that the improvement was largely due to government spending. The Keynesians will be happy to see that but debt-conscious people should be concerned. Unlike domestic investments, government spending might not be additive to a countries wealth. Government spending can crowd out private investment when credit becomes tight and right now the only one able to borrow more is the government (thanks to the Fed monetizing the debt). Many economists had expected GDP to drop in Q3 and if government spending does not continue to increase as it did in Q3 we could see a stronger drop in Q4. And if government spending continues to increase, propping up GDP, we'll have worsening government debt problem.
The Fed has of course become the enabler to the government's profligate spending ways. The Sugar Daddy to the spoiled child. What the Fed sees is the government spending may be the only game in town right now. Personal consumption has at least been steady but not increasing. Domestic investments, other than the spike in Q4 2011, have been declining since Q4 2009. So helping government spending is basically all the Keynesians saying "be fruitful and multiply!" What they want to multiply is the money supply. Adding liquidity to the financial market is their intent (and they figure they'll worry about how to extract later).
In a fractional reserve system it's very important for money to multiply (through the use of credit) and as the chart below more vividly shows, the velocity of money growth has been in decline since 1997. This is the real battle the Fed has been fighting and they've been at it now for 15 years. $16T later and the Fed has nothing to show for its efforts. How's that hopey changey thing workin' for ya Mr. Fed? As you can see on the chart, the 1990s were boom times for our economy and certainly the stock market. The velocity of money had its 2nd leg up for the climb off the 1946 low, which marked an important low following the Great Depression. Now it has dropped below the consolidation through the 1960s and 1970s. All the Fed's horses and all the Fed's men have tried to put Humpty Dumpty together again and the only thing they've managed to accomplish is further debasement of our currency and enable our government to spend wildly. Sooner or later this madness needs to stop.
Velocity of Money, 1900 through Q2 2012
All of this is of course just background stuff to what's going on in the market. As traders we really don't care what happens in the next 10 years; we only care about what happens next week. I am a technical trader and if you tell me why I should buy a stock because the P/E ratio is (pick a number) I will politely push you away if you can't show me a chart. But I try to understand the fundamental issues facing our market since it gives me a longer-term perspective and then I try to tie in technical patterns to either refute the fundamental picture or support it. The statement that makes a lot of sense to me is "fundamentals tell me what I should buy (or sell) and technical charts tell me when."
So before moving to what could happen next week let me start with a very long-term picture of the DOW. This is a technical chart but it shows (to me) why the fundamental weakness of the economy and market (even if that weakness is not currently showing in the numbers) will soon be seen in the charts. The DOW's quarterly chart below is from 1900 but I'm focusing on the move up from 1937-1942.
I've drawn a parallel up-channel for the rally and then an internal trend line across the highs from 1971-1987. The DOW punched out the top of the channel in 1996 in its parabolic move up to the high in 2000. It then pulled back to the top of the channel at the 2002 low (resistance-turned-support) and made a new high in 2007. The 2008 crash dropped it back into the channel, an important technical signal that an important high was made, and came close to the mid-line of the up-channel at the 2009 low. The rally from 2009 has the DOW back up to the top of the channel but it has repeatedly failed, since first testing it in April 2010, to get back above the channel (except for brief piercings). When you see price action like this, with price pushing up against resistance but not able to get through it, while momentum is waning (shown later), it's a sign of exhaustion in the trend.
Dow Industrials, INDU, Quarterly chart, 1900-present
In addition to the top of the up-channel acting as resistance there is the internal uptrend line from the 1971-1987 highs, where the DOW found support in 2002, broken in 2008 and is essentially co-located with the top of the up-channel and holding price down. While it could certainly press higher, especially in the short term (after all, this is a quarterly chart), I think the risk for bulls is clear. If you're wondering why I've been, and remain, longer-term bearish the stock market, this chart is a big reason (and for a host of fundamental reasons).
Now we move in closer and look at the weekly chart that I've shown before. The leg up from 2009 on the chart above is shown on the weekly chart below. Not drawn on the quarterly chart is a parallel down-channel based off a trend line across the lows from 2002 and 2009 and the parallel is attached to the 2007 high. As you can see, the DOW came up to the top of this channel and has rolled over. It got pinched into the end of a rising wedge for price action since May 2011. The 3 highs in 2010, 2011 and 2012 are the tests of the top of the up-channel and trend line on the quarterly chart. Three drives to a high is a common reversal setup, especially when accompanied by bearish divergence as is evident since the May 2011 high. Therefore a break of the uptrend line from October 2011 would be an important break.
Dow Industrials, INDU, Weekly chart
The final (?) leg up on the weekly chart above, from June, is shown on the daily chart below. The parallel up-channel for the rally from June was broken with the big red candle on October 19th and a break of a channel like this is usually a very good indication that the rally finished. It consolidated for a day on Monday at price-level support near the May and August highs and its 50-dma, near 13350, but then broke with authority on Tuesday. Tuesday's decline then broke the uptrend line from October 2011, the important uptrend line on the weekly chart above. It's been consolidating for the past 3 days just below this broken uptrend line, each day back testing it (with the morning gaps) and then failing. Seeing anything bullish here yet?
Dow Industrials, INDU, Daily chart, log price scale
Key Levels for DOW:
- bullish above 13,590
- bearish below 12,970
But wait! There's hope for the bulls here, at least for a bounce in the next few days (red dashed line on the chart). The above charts are using the log price scale, which I prefer to use on longer-term charts, especially when there's been a large price change and I'm using trend lines/channels. But the chart below is viewed with the arithmetic price scale, which many traders use. Notice how the DOW is now finding support at the uptrend line from October instead of it being resistance. Traders who see this might become emboldened to buy support (and bears cover their shorts).
Dow Industrials, INDU, Daily chart, arithmetic price scale
If we do get a bounce this coming week we could see resistance at the bottom of its down-channel (failed bull flag pattern), near 13200, or back up to support-turned-resistance near 13350. I have the key level to the downside at 12970 because a break below that level would be a solid break of the uptrend line from October 2011 (no matter which scale was used) and its 200-dma. The break of the 200-dma is what would get the attention of many fund managers (we could probably also expect the announcement of another Fed program to save the market, I mean the economy).
Unlike the DOW, SPX has not broken its uptrend line from October 2011 yet, even with the use of log scale price, as shown below. Friday's low came close to the line and if it breaks below the psychologically important 1400 level, which was support at the end of August, it will also be a break of its uptrend line. For reference, that uptrend line is close to 1386 using the arithmetic price scale, about 8 points above its 200-dma near 1378 on Monday. The market is short-term oversold so a bounce would not be unexpected from here. Whether that bounce turns into something bigger or just a correction to the decline from October 18th is something that will have to be evaluated when we get the bounce. Continue to keep in mind that the market is vulnerable here and oversold does not mean a bounce has to happen. Be careful trying to catch falling knives.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1464
- bearish below 1400
On Friday I had recommended shorts tighten up their stops because of the bullish divergences showing up as SPX chopped lower toward its uptrend line from October 2011. It might have one more minor new low, perhaps to test 1400, before it will be ready for a bigger bounce in the coming days (into month end is what I foresee). A 50% retracement of the decline from October 18th is near 1433 and provides a good upside target if the bounce gets started. A drop below 1400, unless quickly reversed, would be much more bearish.
S&P 500, SPX, 60-min chart
NDX also chopped its way lower since first testing price-level support near 2660 on Tuesday. And then for the past 3 days it has been hammering on its 200-dma, which will be near 2656 on Monday, but closing above it each day. Each time it hammers on it the weaker it becomes so the bulls really do need to get a bounce started now. The new down-channel from September, for both price and RSI, puts the bears in control here but I see the potential for at least a bounce up to the top of the channel (green dashed line) before heading lower again. The bullish path calls for an up-down sequence to be followed by a rally into year-end. I consider that less probable but something I'll be looking for if the price pattern over the next week or two supports it. The risk is for support near 2660 to give way and price to collapse from here as the bearish wave count unwinds a 3rd of a 3rd move down, in which case we could see the June low in just a couple of weeks (or sooner).
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2785
- bearish below 2655
The RUT broke its uptrend line from October 2011 when it gapped down on Tuesday, which also had it breaking price-level support near 820. For the rest of the week it found the 820 area to be support-turned-resistance. I will note that the uptrend line from October 2011 was tagged to the penny when viewing the chart with the arithmetic price scale, which will be near 808 Monday. Only 2 points lower is its 200-dma. Add the bottom of its down-channel from September into this mix and there are lots of reasons for the bulls to jump in here. In fact the short-term wave pattern of this week's price action supports the idea we'll get a quick rally on Monday, maybe into Tuesday, and the upside price projections for the bounce are 820 and then 829 if 820 breaks. Those projections also line up with the 38% and 62% retracements of the leg down from October 17th. The 20-dma will be near 829 on Monday and the 50-dma only marginally higher near 831. If the RUT drops below 806, either on Monday or after a bounce, it will turn the price pattern very bearish, especially with the break of what should be solid support.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 843
- bearish below 806
Friday saw a jump in bond prices, which caused a quick drop in bond yields. On the daily chart TNX (10-year yield) had gapped above its 200-dma on Thursday and slammed into its downtrend line from April 2011, at 1.836%. Friday's gap down, back below its 200-dma, leaves an island reversal on the intraday chart and an evening star on the daily chart. I think this is a significant reversal signal but we'll need the next day or two to confirm it (with a continued decline in yields). Keep in mind that a decline in yields means buying in bonds which could mean a rotation out of stocks and into bonds.
The weekly chart of TNX shows where I think we are in the pattern. The choppy rise off the July low looks to be part of the descending wedge pattern for the leg down from February 2011. The descending wedge calls for one more leg down, which I depict down to about 1.2% by early 2013. That should put in a long-term bottom and start the next phase of its 60-year cycle, meaning it should set off for a high for the cycle in about 30 years. Bonds will NOT be the place to be invested once that bottom is put in. The only bonds you'll want to be in will be short-term that you hold until maturity and then roll into the next one at the higher rate. If TNX breaks out from here, with a move above its September 14th high at 1.892% it would mean a longer-term low is probably already in place.
10-year Yield, TNX, Weekly chart
Whether TNX has already made its low now or will do so by early 2013, the message is clear -- bond yields are about to start heading higher soon. It will mean the bond market will start demanding higher yields to compensate for the higher risk of owning government debt and that will in turn make it more expensive for the government to keep borrowing trillions that it doesn't have and is not likely to get. The end game is getting closer and will be forced by the bond market.
An interesting indicator of stock market interest is a comparison between SPX and TNX, which shows relative strength of one vs. the other. When comparing one stock vs. another or a stock vs. its sector/index you can identify which ones are stronger. In a bull market you want to be in the stronger stock/sector and in a bear market you want to be short the weaker stock/sector. Comparing SPX to TNX can provide a good guide for when stocks are outperforming or underperforming bond yields.
When evaluating the SPX/TNX weekly chart below you can see how much SPX had been outperforming yield since the 2008 low. In fact, as the curve shows, the climb in stocks relative to yield went parabolic into the July high. But since that high it has now broken below the parabolic curve and retested it, which is indicating less interest in the stock market and more interest in bond yields (the thinking here is that bond yields will start to outperform stock yields). It's another caution flag thrown on the field and telling stock investors to get defensive.
SPX relative strength vs. TNX, Weekly chart
Since my last update on the banking index, the BIX, I opened the price-support zone to 157-159 (from 158-159) to accommodate the previous touches near 157. This week it's been using that level for support so obviously traders think it's important. But so far the price consolidation inside this zone looks bearish (sideways price following a move down is typically a continuation pattern, not a reversal pattern). From the chart below it's clear that a break below 157 will be a confirmed break of multiple support. We should see a quick trip down to the 200-dma, near 154 in that event. But for now support is still holding and a bounce up to at least 160 for a back test of its broken uptrend line from October 2011 remains a possibility in the coming week.
S&P Banks index, BIX, Daily chart
The U.S. dollar has stalled at its previous October highs near 80.25, and at its 50-dma, poking above it on Friday, at 80.24, but closing below it. Without bearish divergences against its earlier October highs it's looking like the dollar has enough momentum to make a break and head higher. It takes a drop back below its October 17th low at 78.97 to turn the pattern bearish and a break above its 200-dma at 80.73 to turn more bullish. The longer-term projection for the dollar, as shown on its weekly chart below, is for a move up to at least the top of a sideways triangle pattern, the top of which is a downtrend line from March 2009. That downtrend line intersects the top of a parallel up-channel for its bounce off the 2011 low near 87.60 at the end of April 2013.
U.S. Dollar contract, DX, Weekly chart
Neither gold nor silver have changed much since my Wednesday wrap when I last showed the gold chart so I thought I'd take a look at silver this weekend. Its pattern is not that much different from gold's but tends to react a little more when a bigger move is coming, which I think is the case. Following the pullback from the October 1st high, at 35.44, a rally above that level would be potentially very bullish and I'd expect to see over the next several months at least a challenge of the all-time high at 49.82 in April 2011. But I think the higher-probability move is a decline. What's not clear yet is whether the metals will consolidate into 2013 inside a descending triangle (flat bottom, lower highs), the bottom of which is near 26 (1530 for gold), before breaking lower or if it will simply head lower from here. The pattern has been choppy since the 2011 high and I show the potential for that to continue although I would not be surprised to see it head more sharply lower if 26 breaks.
Silver continuous contract, SI, Weekly chart
The weekly chart of oil below shows that in May 2012 it broke its uptrend line from January 2009 to October 2011, made a low in June and then bounced back up for a back test of its broken uptrend line in August and September. On the daily chart the September 14th high was also a back test of its broken uptrend line from June so it was a double slap after a kiss goodbye at the $100 level. The next potential support level should be near 79, which is an uptrend line from October 2011. If we're going to get a big sideways triangle consolidation then that level will hold and we'll see oil consolidate well into 2013 before it gets it gets another rally leg started. A break below 79, which is what I'm expecting to see but price is the final arbiter, should put it on a path that will take it below 60 in early 2013 (and then eventually for a retest of the 2009 low.
Oil continuous contract, CL, Daily chart
Next week will be busier than last when it comes to economic reports, especially next Thursday and Friday. There aren't any big changes expected and until Friday's payrolls numbers there shouldn't be much that will be market moving. Wednesday's ADP report, as a precursor to Friday's report, could move the market if there's a surprise one way or the other. There is an expectation for a slight drop in ADP employment and a slight increase in nonfarm payrolls. The unemployment rate is expected to tick back up a little to 7.9%.
Economic reports and Summary
The major stock indexes consolidated for most of last week and some look like they're ready to break down while others look like they're ready for a bounce at least into the month-end (and fiscal year-end for some) before heading lower again. I think there's enough evidence to say we've seen the high for the year and therefore a bounce would be a shorting opportunity until the bulls prove that's not a good idea.
There is the potential for a stronger decline in the coming week and a breakdown on Monday would have me backing away from any expectations for a bounce. In fact the risk for the market, currently, is that we could see a violent decline -- the wave pattern supports the possibility and crashes come out of oversold conditions, which is where we are (it might look at least something like the decline in August 2011, potentially worse). I never like to play a crash because they're so rare. But at the moment I have to mention the potential is here again. Hopefully the danger will pass because they're very difficult to trade (unless you're already short it's next to impossible to catch the move). Obviously they're painful for those who are long the market.
There could be more than a few expecting a bounce into month-end and with the broader averages holding support (depending on how you look at some of the charts) a breakdown instead could get many fund managers scrambling to protect what profits they have. So again, while I'm not forecasting a breakdown in the coming week I am saying there's a setup for one. At the very least it could be a whippy few days so trade carefully.
Good luck, stay cautious and I'll be back with you on 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