A common pattern that sets up a reversal is "3 drives to a high" and today's decline might have completed the pattern. It's a reversal pattern so we'll review what it might mean for the stock market.
Overnight equity futures had a quiet session and the day opened near the flat line. It looked like we might simply consolidate the recent advance before heading higher again. We got a little selling in the morning but then the buyers stepped right back in and drove the indexes back up. But the DOW was the only one that was able to make a new high above Tuesday's and when more selling kicked in and drove the indexes to new daily lows we had a small change in character that was a warning that perhaps the market has run out of buyers for now. The big question is whether today's selling has much meaning or was instead simply a much needed rest to shake out weak long players (itchy to grab their profit and/or limit their losses) before starting back up again.
As today's title and teaser indicate, I believe there's a good chance a bearish reversal pattern triggered today. The pattern is called "3 drives to a high (or low) and as I'll review in tonight's charts, this particular pattern is repeating on the weekly and daily charts. In fact last week I showed the weekly chart of XRT, the retail sector ETF, and pointed out this pattern and the warning from it (as goes the consumer so goes the economy and stock market). Certainly put buying in the S&P 500 picked up speed today -- you can the jump in VIX circled in the table above. Fear took a jump as the S&P 500 suffered its worst one-day loss for the year (it was the 2nd worst for the DOW, following the larger decline on February 4th).
One chart I've reviewed recently, and will update tonight, is the one for the home construction index. It too is showing signs of reversal and today's housing report didn't help. This morning's economic reports included some more data about the housing market and it continues to disappoint those holding high expectations for this market in the coming year. Housing starts fell 8.5% to a seasonally adjusted annual rate of 890K in January from December's revised-higher 973K. The number also came in less than expectations for a decline of only 40K to 914K from the first estimate of 954K for December. It was actually double that with a decline of 83K. Keep in mind that even the lower number of 890K is still more than double the number of new home sales. An inventory problem is dead ahead.
Better housing news came from the number of building permits issued -- they climbed to 925K from December's 909K (revised up from 903K) but still a little shy of expectations for 918K. Overall it wasn't a good report and the home builders got clobbered following the report, as did the home construction index (chart updated later). Toll Brothers was hit harder because of its earnings report, citing weaker than expected 4th quarter results (down -3.34 to 33.56, -9.1%). Tomorrow morning we'll get the number for existing home sales, which should help further develop the housing picture.
The other report this morning updated the PPI numbers, which came in higher than expected -- +0.2% for both PPI and core PPI, vs. expectations for +0.1% for both. This was somewhat mixed news since December's numbers were either side of 0.1% with +0.3% for PPI and +0.1% for core PPI. But the rise in the core rate is what will have the Fed feeling a little more nervous about letting their QE program get away from them (although I highly expect the Fed is secretly hoping for a high inflation number to start helping with the government's debt problem).
The Fed's hopes and plans were divulged a little more with this afternoon's release of the January 30th FOMC meeting. While no surprises were expected you would think this afternoon's selloff following the minutes would tell us the market doesn't like what the Fed is thinking. There wasn't much added about the state of the economy but there was further indication that the debate over how long to continue the QE program is heating up. The market of course doesn't want any debate on this issue, unless of course it's for more QE, not less. It's clear there are more FOMC members concerned about how and when to start easing off on the Fed's QE program, especially since all know they're in unchartered waters here:
"However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability [emphasis mine]. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy. A few also raised concerns about the potential effects of further asset purchases on the functioning of particular financial markets, although a couple of other participants noted that there had been little evidence to date of such effects. In light of this discussion, the staff was asked for additional analysis ahead of future meetings to support the Committee's ongoing assessment of the asset purchase program."
The dollar shot higher today, firmly breaking resistance and giving us all indications of a much higher rally to come. That tanked gold and silver and other commodities, having some scratching their head why higher inflation numbers didn't cause the opposite. It looks like more believe the Fed backing off on QE will support the dollar and hurt gold and other "alternative" currencies.
But the stock market was not happy with some of the Fed members' concerns and the price consolidation following the morning decline into the FOMC minutes was then followed by stronger selling right into the close. Overreaction and just some quick profit taking or something more serious? Let's see what the charts tell us.
Before jumping into the regular chart review I wanted to show an "economic" indicator, which is what I consider copper to be. Last week I showed a comparison of SPX to the declining advance-decline line, highlighting the fact that the new price highs for the indexes have been occurring on the backs of fewer and fewer stocks, something that's very common to see toward the end of rallies (it's part of the waning momentum typically seen as the market runs out of buyers).
This week I compare SPX to what's happening in copper. Copper is one of the best reflections of economic strength since it's used in everything from industrial products (electric motors, wiring, semiconductors, pipes, etc.) to homes and automobiles. The price of copper is therefore a good measure of demand and therefore the economy.
As you can see in the chart below, the stock market has been rallying to new highs since the high in 2011 in spite of declining highs for copper. In other words the stock market has been rising not because of expectations for a stronger economy but more because it hopes the Fed's money will continue to force the market higher. That works for a while but usually payback's a bit** and when the selling starts it could get wild to the downside as the algo traders take advantage of the momentum (e.g., another possibility for a flash crash).
A few weeks ago I had mentioned I thought copper would soon finish its sideways triangle pattern that it's been since October 2011 (copper has run sideways while the stock market enjoyed some Fed money and bullish hopes for a new bull market). The sideways triangle fits as the b-wave in what I expect to be a large A-B-C pullback from its February 2011 high. The bump above the top of its triangle on February 1st, which looked like a breakout at the time, was the throw-over finish that these triangle patterns often experience (for the completion of wave-e of the a-b-c-d-e triangle). Now I'm expecting another leg down to at least match the 2011 decline, which points to 2.15 for a downside target, which is a price it hasn't seen since mid-2009. If the c-wave of the move achieves 162% of the a-wave then copper could drop down to 1.13 and test its late-2008 low.
In the meantime, to me, it's only a question of time before the stock market realizes the Fed's money will not be enough to hold things up.
SPX vs. Copper, weekly chart, 2009-present
Kicking off tonight's regular charts is a look at the DOW's weekly chart, it has been struggling beneath trendline resistance near 14020-14050 since February 1st. It formed a hanging man doji for the first week of February, a small doji for the 2nd week and now so far this week it has formed a small red candle. Nothing particular bearish about this chart yet other than the fact that it has stalled at resistance and the weekly oscillators appear to rolling over.
Dow Industrials, INDU, Weekly chart
The 3-drives-to-a-high pattern that I mentioned in the beginning can be seen since the October 2011 low. The March-May 2012 highs, followed by the September 2012 high and now the current high all pressed up against the long-term broken uptrend line from the 1971-1972-1987 highs and 2002 and 2003 lows. The longer-term view of this chart, from the 2009 low, shows 3 drives to a high in 2010, 2011 and now the 3rd drive in 2012-2013 is itself 3 drives to a high (the same as reviewed for the XRT weekly chart last week). It's not bearish yet on the weekly chart but a decline from the current high would complete this reversal pattern, which makes this one potentially very important to consider if you're thinking of holding long through the next pullback.
The daily chart below doesn't show the longer-term uptrend line from 1971 but does show multiple trend lines (and the top of its up-channel from 2010), including its broken uptrend line from October 2011 that is now acting as resistance. Today's close is slightly below its 20-dma near 13940 but hasn't yet broken Friday's low. I could argue for another rally leg (green dashed line), one that will take the DOW above its 2007 high but not until it can get back above today's high at 14058. A drop below 13850 would be stronger evidence that an important high may be in place. There will remain the potential for just a multi-week pullback before heading higher but that would not become more apparent until I can see what kind of pullback/decline develops from here.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 14,100
- bearish below 13,850
The DOW's 60-min chart below shows a shallow rising wedge pattern for price action since its February 1st high, the bottom of which held as support today. We could see a choppy rise back up for a final move up inside the wedge pattern, which would be negated with a drop below Friday's low near 13900. Respect the upside until then. I see the potential for a little lower Thursday morning and then a bounce in the afternoon, potentially up to a little more than 14K to back test the bottom of its up-channel from December 31st.
Dow Industrials, INDU, 60-min chart
The three DOW charts are not convincing enough for me to say THE high has been made. So perhaps a minor new high for the DOW while the other indexes make high bounces to lower highs? That's basically what it did this morning and I don't discount the possibility from happening again.
While a new high looks possible for the DOW, I can't say the same for SPX and the other indexes. Yesterday SPX popped above resistance near 1524 where it had been struggling for days, leaving small doji candlesticks. It also closed above its trend line along the highs from April-September 2012 and had many feeling very bullish about the breakout. It turned out to be a head-fake break and bull trap. This morning's very minor new high followed by the lower close created a key reversal day and today's candlestick is a bearish engulfing pattern at resistance. It found support just above its 20-dma and it could be good for a bounce tomorrow but this one looks done to the upside, which its shorter-term pattern supports.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1524
- bearish below 1514
SPX is the one that has me thinking the overweight woman is belting out her song. Assuming we'll see a multi-week pullback/decline from here, the question that still needs to be answered is whether it will be a choppy pullback correction before heading higher (green dashed line) or instead start the next major decline. The answer to that question will only come with further price action. A drop below the December 18th high at 1448 would solidly confirm there will be no more new highs for the year.
The wave count that I've been tracking on the SPX 60-min chart, shown below, has us completing a 5-wave move up from February 4th, which in turn completes a larger 5-wave move up from December 31st. For my preferred EW count this completes an a-b-c move up from November, which completes the 5th wave of the rising wedge pattern for the rally from October 2011. That in turn completes the whole bounce pattern off the 2009 low. This is why I consider the top here (if it got put in today) to be very important. The alternate wave count calls for a 5-wave move up from November and that means we'll be looking for a sideways/down choppy correction over the next several weeks before heading higher again. Which wave count will stand up and be counted will become clearer only after we see what kind of pullback/decline we get. In the meantime, because of the downside risk I consider holding long positions through a correction to be too risky vs. the potential gain later this year.
S&P 500, SPX, 60-min chart
NDX remains a choppy mess although today's bearish engulfing candlestick is a reason for bulls to worry. But so far today's close is only a very minor break below the bottom of its up-channel that price has been chopping up and down inside since January 2nd. A more solid break for the bears would be its uptrend line from November, along with its 50-dma, both near 2718, and then confirmed with a drop below its February lows just above 2715.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2790
- bearish below 2715
The RUT's wave count for its rally from November is a clear count and it strongly suggest the rally is now complete, finit, stick a fork in and call it done. Steak tartar. That in turn calls the a-b-c move up from June 2012 complete and in turn all the way back to its 2009 low. The RUT led the way up and I suspect it will lead the way back down. This index seems to be a favored one by the algo traders -- they like volatility and lots of movement. Today's -2% was only best by the home construction index (-6.7%). But the bulls still have a chance here, if only because its uptrend line from November-December was only broken by a minor amount. At 917 it could be quickly recovered on Thursday. It also held its uptrend line from January 8th and supports the idea that we could see one more, and final, leg up to complete the rally. It would certainly throw the bears one of the bigger curve balls -- knock them all out, convince them the market is never going to go down and then roll over for good without them. It takes a decline below 900 to convincingly tell us the top is in place.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 931
- bearish below 900
AAPL's weakness hasn't affected the market lately but I'm hearing more complaints recently about AAPL's inability to rally and how great a stock it still is (even if you consider just its enormous cash position). But sentiment is a funny thing and fundamentals go out the window when traders start to give up on a stock. The daily chart below shows my expectation for another leg down to the 393 area to meet two price projections overlapping near there. The projection crosses the bottom of its down-channel at the end of February. From there I expect to see a choppy sideways/up correction before heading lower again. But after a new low there is the possibility of a stronger bounce (following an a-b-c pullback from September. Assuming we'll get the new low by the end of the month it will be a good buying opportunity even if only for a tradable bounce.
Apple Inc., AAPL, Daily chart
Tom McClellan posted a couple of interesting charts comparing AAPL to previous high flyers, showing sentiment for a stock follows a familiar pattern. The first comparison is against RCA back in 1925-1932. It was considered a darling stock back then that could do no wrong and was destined for much higher prices. One could argue the same about AAPL and this chart was only through November 2012. AAPL has dropped below its May 2012 since then, which is not reflected on the chart below.
AAPL (through November 2012)) vs. RCA (1925-1932), Monthly chart courtesy mcoscillator.com
A more recent comparison by McClellan was done with MSFT's pattern from 1999 through 2000. AAPL's run from 2010 has followed a very similar pattern and as noted on the chart, February 19th (yesterday) would be an expected low that leads to a sizeable bounce. I think AAPL has lower to go but then a bounce off the 393 area could mimic the one shown for MSFT (the one off the note pointing to February 19 on his chart).
AAPL (through January 24, 2013) vs. MSFT (1997-2000), Daily chart courtesy mcoscillator.com
They're interesting price comparisons and I think it does a very good job at showing why fundamentals are not the way to go when evaluating a stock's value. AAPL has seen its day in the sun and even though it will continue to be a very good company with very good products (look at how much longer RCA produced strong products, as well as MSFT to this day). But it doesn't mean their stock prices will hold up.
In the beginning of tonight's report I mentioned the housing industry and some signs of weakness. Yesterday's NAHB Housing Market index fell to 46 from January's 47 and vs. expectations for an improvement to 48. This knocked the home construction index down and it briefly broke its uptrend line from November but held it at the close. This morning's disappointing housing starts number kicked the index in the teeth and knocked it much lower. It has now broken down from its up-channel from November. It's possible it will be a huge head-fake break followed by another rally to at least test its January high and back test its broken uptrend line, especially since it's only a 3-wave pullback so far so anything's possible. But that's sure not the way I'd want to bet my money here. The break of the up-channel should indicate the rally has finished
DJ U.S. Home Construction index, DJUSHB, Daily chart
Keep in mind the longer-term pattern for this index that I've shown recently, when calling for a top near 504, has a confluence of Fib projections in this area. The A-B-C bounce off the late-2008 low retraced 38% of the 2005-2008 decline. The bearish divergence against the September-October 2012 highs is very apparent on the weekly chart below, which fits for the 5th wave of wave-C (the leg up from October 2011. This index is the one that tells me the housing market is going to be a major disappointment this spring, which will only depress expectations for the broader economy that much further.
DJ U.S. Home Construction index, DJUSHB, Weekly chart
One ominous sign that the causes leading up to the previous housing bubble -- risky mortgages insured by Fannie Mae and Freddie Mac (backstopped by AIG and other insurers and mortgage derivatives) -- is that it is being repeated by the government's FHA (Federal Housing Authority). FHA-insured mortgages are up 10-fold since the early 2000s and have more than quadrupled since 2008, from 7% of the mortgages to more than 33% today. This of course follows the collapse of the mortgage market in 2008 and the federal government has stepped in to fill the void, putting tax payers on the hook directly rather than through the bailing out of banks and insurance companies. Unbelievable.
What's scary, and a reason you can see no one in the government has learned anything, is that the only requirement for FHA insurance is a 3-1/2% down payment. In an effort to get people their mortgages we're setting up another wave of future defaults (certainly very little risk for someone to walk away from their mortgage). But to do one better, the FHA will fold in that 3-1/2% down payment into the mortgage to enable the mortgagee to essentially get a 100% mortgage, the same craziness that led to the subprime slime problem.
For an FHA-insured mortgage you also only need a FICO score of 600 or better, which is a very low credit score (you can still get a FHA-insured mortgage if your credit score is below 600 but you have to come up with a 10% down payment). This is of course all being done in an effort to pump up the housing market but they're using the exact same tactics that led to the false housing boom last time. Will it be any less false this time? Fool me once, shame on you. Fool me twice, shame on me. Now add the huge problem with runaway government-backed educational loans, at more than a trillion dollars, that are starting to default at a rising rate and the government is in far worse shape than just its own deficit problem. Scary times indeed.
The bank will continue to be at risk if we're entering another recession so it will important to watch the financials. BKX dropped hard today and it has now convincingly broken its uptrend line from December 4th, which is the bottom of its up-channel for the rally from November. The wave count for the rally from November can be counted as complete and as the 5th wave of the move up from October 2011 it's the completion of an a-b-c bounce off the 2009 low. So another trip back down looks ready to start.
KBW Bank index, BKX, Daily chart
Just when I started to give up on the dollar's rally it turned around and started up strongly from its low on February 1st. Today's sharp spike up has now convincingly broken its downtrend line from November, which I was thinking was the top of a sideways triangle pattern that would lead to another leg down for the dollar. Instead, the breakout to the upside and the rally above 81 puts it on a course for at least 81.70 where it would have two equal legs up from September 2012. It will turn more bullish above 81.70.
U.S. Dollar contract, DX, Daily chart
Gold has broken down and today it dropped below the bottom of its down-channel that I've been showing on its chart. I've been mentioning its bearish wave count that called for this break so today's decline is confirming the wave count. It calls for gold to stair-step lower into April. If it makes it down to price-level support near 1525 it could set up at least a bigger bounce so gold bears will need to see that level break convincingly. The Daily Sentiment Index (DSI), from trade-futures.com, shows very bearish sentiment on gold and silver right now and it's at the same low levels where we've seen tradable bottoms in the metals before. It's therefore a time for caution if you playing the short side in the metals.
Gold continuous contract, GC, Daily chart
Oil's break below 95 puts it on a bearish price path that will only be negated now with a rally above recent highs. Look for support at its 50-dma at 93.43, which is also near the top of the first parallel up-channel from November, which oil broke above in January. It's often support when tested from above.
Oil continuous contract, CL, Daily chart
Tomorrow's economic reports include the unemployment claims data, CPI (more inflation data), existing home sales (no expected changes), the Philly Fed numbers and Leading Indicators. There are some potentially market-moving reports there, both before the bell and at 10:00 AM.
Economic reports and Summary
The price pattern was set up for a top at any time and therefore today's decline needs to be taken seriously. If THE top is in place then all we'll get are bounces to lower highs that will offer good shorting opportunities. In other words, buying the dips could turn around and bite the dipsters. So far today's move down looks like the start of the next major decline but we do not have confirmation yet. As mentioned for a couple of the indexes, I could argue for one final new high to complete the rally but this is not a good time to bet that way. I've missed major turns more than once while waiting for "one more new high/low."
The significance of this high is that the bearish wave counts call for the start of the next bear market and for that reason it is strongly suggested that you do not hold long positions. This market has trained investors to just hang on and the market will always come back. The coming decline in the next couple of years could prove why that's a very wrong tactic. Bear markets require market timing, not buy and hold. And right now the timing says get into cash and some short positions.
As always, I look for reasons why my analysis is wrong. As can be seen in the table at the top of tonight's report, the VIX shot higher today, up +19%. "What, me worry" changed rapidly to "Yikes!" (trying to keep it clean here, wink). Bears need to keep in mind that a rapid rise in VIX has oftentimes been followed by a strong reversal back up in the stock market. Too many traders start betting on the short side and a short-covering rally follows. That possibility can only be guessed but stay aware of it. As bearish as today appeared, including the rejection at important resistance levels and following the head-fake break to the upside on Tuesday, the patterns support the idea for one more new high in the coming week. That's not the way I'd want to bet my money here but I continue to respect the possibility. And the rapid rise in the VIX makes me a nervous bear (there should be no other kind).
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