European markets dragged the U.S. market down at the open and that was another invitation to buy the dip. Bulls are feeling like nothing can hurt them.

Market Stats

European markets sold off on Wednesday and that dragged U.S. equity futures lower during the overnight session and we started with a gap down. Never to let an opening decline go to waste, the dipsters jumped in and ran the market back up (which helped lift the European indexes off their lows as well). Part of the reason for the decline in European markets was blamed on a drop in the Economic Sentiment Indicator (ESI) for the first time in 5 months. It was only a small drop but it's further evidence a slowing economy in Europe even before the Cyprus event unfolded.

But Italy got most of the blame. The failure to form a coalition government, led by the election of Bersani, was not good news. If he does not pass the mandate to form a new government to Berlusconi, which is not expected, there will have to be another election. This may have been a contributory factor in Italy's 5-year bond auction not going all that well and yields hit a high not seen in 6 months. There's also fear of bank health, which could prompt a cash drain as Italians fear for their money based on what happened in Cyprus.

The S&P was down about -10 points at the opening spike down but then recovered all of its loss into the afternoon before giving up less than a point at the close. Not a bad recovery (again). There's a lot of buying power going into just keeping the market up although it's being done with very little volume (another very light day today) -- just enough to keep the bears in their caves.

We're coming into a typically bullish few days as we head into month-end and the beginning of a new month next week. We also have a holiday weekend with Friday closed for Good Friday. Holiday weekends tend to show some bullishness around them. The trend is up into this bullish period so the expectation is for the market to move higher. But as I'll review in tonight's charts, keep those stops on long positions very tight now.

There wasn't much in the way of economic reports this morning and certainly the disappointing Pending Home Sales report was not a contributory factor for the market's recovery this morning. The report came in with a disappointing drop of -0.4% in February vs. January's +4.5%, worse than the expected +2.0%. The annual rate is now +5.0%, down from January's +9.6% and below the expectation for +8.7%. There are lots of excuses for the drop but the bottom line is that a slowdown in the housing sector is not a good sign. On top of the new home sales of 411K in February vs. new-home builds of 917K, along with the banks' shadow inventory, we have a potential inventory glut, especially if home sales start to decline. As I've been showing for several weeks now, the chart of the home builders is not encouraging and suggest the housing bounce is about to turn down.

Demand for U.S. Treasuries showed an uptick today, dropping yields at today's open. Yields got a little bounce this afternoon (from some bond selling) but nowhere near what the stock market did. Yields look like they're headed lower (bond prices higher). Driving some of the buying in Treasuries could be capital leaving Europe and coming the U.S. but it's too early to tell. But certainly this past week and a half have been worrisome times for European bank account holders.

It's important to keep in mind that as a depositor of money into your bank account you are lending the money to the bank with the expectation that you will get it all back, with at least a tiny bit of interest, when you ask for it. But it's a loan and sometimes loans are not paid back. We have FDIC deposit insurance so most of us don't worry about a run on the bank or a bank failure. Just keep in mind how long your money might be tied up before it's returned to you. And if there is ever a monumental banking system failure there could be a declaration by the government that a "tax" will be levied on all bank accounts as a way to "help" the recovery. The die has been cast with Cyprus and more and more governments will learn to like the idea of making the banks and their lenders (that would be you the depositor) responsible for their own mistakes. Bottom line? Know the health of your bank but even that might not be good enough if we have a systemic failure.

John Mauldin covered this subject in today's Thoughts From the Frontline and I highly recommend reading the full article at You Can't Be Serious. In his article he quoted Jeroen Dijsselbloem, president of the eurogroup, as saying the Cyprus agreement "will force large losses on big deposits in the island's top two lenders." As Mauldin mentioned, the term "private investor" means anyone with more than 100,000 euros in their bank account. The problem with this interpretation is that it will include anyone, individual or company, and "tax" them accordingly. As Mauldin stated, "That has to be unsettling to anybody who has diligently saved for decades and is now retired and depending on those funds for sustenance. And for corporations that run a payroll account through a bank? The thought that you could see a lifetime of work building a business go down in an unelected bureaucrat's blink of an eye would keep me up at night. I do not think most corporate financial types see their deposits as an 'investment' in the bank."

This gets right to the heart of the matter of trust in the global financial system. Individuals and corporations who cannot risk the loss of their capital will be thinking of alternative ways to park their money for at least the next few years until this blows over. A mid-sized company with a 500,000 euro account that suffers a 40% "tax" will bankrupt the company if it is unable to get its hands on its money. Will these large account holders start moving money into U.S. Treasuries or banks? Or will they be just as concerned about the U.S. government's profligate ways and dollar devaluation? Will they move money into more stable countries which have solid natural resources backing their economies, such as Canada and Australia? Or perhaps into countries with a more stable banking system such as Switzerland. I would imagine there are many large account holders scrambling for what's the best option.

It's anyone's guess what happens next in Europe but most banks can ill afford a significant cash drain. Japan and then the U.S. are not invulnerable to the same problems but I think it's safe to assume there's likely to first be a steady drain of capital from Europe, which will only exacerbate the financial strains in the banking system, especially since the health of the banks is judged on how much leverage they're using against their deposits (and it's huge leverage, such as 60:1, including in German banks). With a drop in deposits will that force the banks to liquidate much of their derivative holdings? What if they need to exit those derivatives in a hurry? Don't forget, at a "mild" 50:1 leverage ratio it only takes a 2% decline in value to wipe out the bank's entire investment. Oh the web we weave...

The European financial leaders are demonstrating they're not the sharpest knives in the drawer and the unintended consequences of their decisions will very likely cause more harm than good. What we're witnessing is a slow-motion train wreck and it's certainly going to be a good history lesson when all is said and done. I can just imagine poor Bernanke, head in hands, muttering to himself "what are these idiots doing?"

But one man's loss is another man's gain. In a world where money is no longer considered protected and safe from government thieves, leave it to entrepreneurs to come up with a solution. Instead of hiding cash under your mattress you can now hide it IN your mattress, under lock and key: Safe in your mattress. This would be pretty humorous if it wasn't such a sad commentary on the global banking system. I wonder if the mattress comes with a pillow top...

Another area that has been growing is alternative currencies. This was a growing area and got a lot of publicity during the last financial crisis in 2008 (a time of loss of faith in the financial market) and will very likely expand as governments around the world race each other to the bottom in devaluing their currency's value (despite the assurances to the contrary from our Devaluer-in-Chief Bernanke). Some towns have come up with their own "currency" that can be spent in their town.

One of the effects from a distrust of banks and government currencies can be seen in the price of bitcoins. If you haven't heard of these, it started in 2010 (at least the earliest price data I can find) and is essentially electronic money that you trade. A chart of the bitcoin value is shown below and the month of March has been good to bitcoin holders.

Bitcoin (in U.S. dollars), 2010-present

Since January the value of a bitcoin has increased from about $15 to today's closing price of $88.50. It has almost tripled in March and of course the worrisome thing when you look at the chart is how quickly it's going to come back down. That's a rocket ride if there ever was one. But it does show the fear about the current state of affairs in the global financial system and bitcoins are acting like gold has done in the past when fear of financial calamity ran the price of gold higher. Now it's bitcoins.

But never let fear get in the way of a stock market rally. That's certainly the feeling of the bulls right now. There's certainly plenty of trust in the Fed's policies and the "Bernanke call" (similar, but better, than the "Greenspan put") but this week it probably has more to do with end-of-month/quarter window dressing. The concern of course is what might happen when they start undressing their windows. But countering the worries about what might happen after quarter-end is the notion that European money is going to come flooding into the U.S. as a perceived safe haven (maybe even AAPL, GE, MSFT and many other companies might think it would be safer to take the tax hit now and bring the money into the U.S.). Whatever the fundamental argument, it has caused a fair amount of daily volatility in the last half of March.

Getting to the charts to see what they might tell us, I'll start off with the SPX weekly chart. Price continues to push up underneath the trend line along the highs from May 2012 and trying to hold above its long-term uptrend line from 1991-1994-2002, currently near 1551. I see upside potential to the trend line along the highs from 2000-2007, currently near 1595, but vulnerable to a breakdown at any time. The wave count for its rally from November can be considered complete so there's a high risk for anyone chasing this higher.

S&P 500, SPX, Weekly chart

The daily chart below shows the trend line from 2000-2007 is just above a price projection near 1590 where the 5th wave of the move up from November would equal the 1st wave. That remains a good target as long as it stays above 1539.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1563
- bearish below 1539

The choppy pattern for the move up from March 19th is one of the reasons I'm thinking it's not going to make it up to the 1590 target. It looks like an ending pattern for the final 5th wave of the move up from February, which in turn will complete the 5th wave of the move up from November. The projection at 1563.49 (5th wave equals 62% of the 1st wave) has been achieved and the next projection is to 1578.90 (5th wave equals 1st wave). In between, near 1570, is the top of a potential rising wedge pattern for the final 5th wave. Below this morning's low near 1552 would tell me the top is in place. From this perspective I see the potential for a final high on Thursday.

S&P 500, SPX, 60-min chart

For the DOW's 5th wave in the move up from November it would be equal to the 1st wave at 14678 and then higher, near 14760 early next week, is the trend line along the highs from February 1st. There's even the potential for it to rally to the top of its up-channel from February, near 15K next week. I have a hard time believing that's possible but then I'm surprised the market is still up this high. The pattern stays bullish until it breaks the lows of the recent trading range, at 14382.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,550
- bearish below 14,382

As opposed to the choppy ending pattern I showed on the SPX 60-min chart I wanted to show an alternate count on the DOW's chart, shown below. This calls for an impulsive rally into next week that achieves an upside projection to 14758 where the 5th wave of the move up from February equals the 1st wave and it would hit the trend line along the highs from February 1st. The SPX chart says look for a reversal after a new high tomorrow whereas the DOW's chart says keep looking higher into next week before a reversal. Stick with the long side but be very careful now.

Dow Industrials, INDU, 60-min chart

"Squeeze me tight and don't let me go" is what the Nasdaq is saying right now. Squeezed between its uptrend line from 2009-2011 and the trend line along the highs from March-September 2012 it sure seems like it needs to break one way or the other real soon. I think it's chopping up and down since its March 19th low in an ending pattern and will soon break down. This one supports the SPX pattern instead of the DOW's pattern. By its chart and pattern I see upside potential only to about 3271 but it might not even be able to get that much.

Nasdaq Composite index, COMPQ, Daily chart

Key Levels for COMPQ:
- bullish above 3270
- bearish below 3205

The RUT's pattern was showing clarity up until the low on March 19th. From there I expected (hoped) to see a nice little 5-wave move up to finish the 5th wave of the move up from November. That was wishful dreaming on my part because the pattern since the 19th is anything but clear. To me it looks like it could break down any minute now. As shown on its daily chart, I see upside potential to 983 but I'm having a hard time believing there's enough energy left in this rally to achieve that level. Just keep it in mind when considering risk management.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 954
- bearish below 936

Whenever the price pattern becomes such a mess that I can't make sense of it I think 4th or b-wave, both of which tend to be choppy messes. The b-wave idea doesn't fit but a 4th wave does fit, as shown on the RUT's 60-min chart below. This interpretation calls this morning's spike low the completion of the 4th wave correction that started from the March 15th high. It's much larger than the 2nd wave correction in the move up from February 26th, which is a reason I don't like it but it doesn't violate any EW rules. The 5th wave projects up to 961.94 where it would equal the 1st wave but could be stopped near 954 where the 5th wave would be 62% of the 1st wave. That would result in just a test of the recent highs near 954 and says we should get a final high between tomorrow and Monday.

Russell-2000, RUT, 60-min chart

Interestingly, the 962 projection for the RUT lines up with a potentially important level on its Gann Square of Nine chart. Back in mid-February, when it topped at 932, I had mentioned the importance of 931 on the Sof9 chart, pointing out that it was 6 squares up from its 2009 low at 343. This is the same relationship as the 2002 low for SPX (768) and its 2007 high (1576). The next level of importance is 90 degrees away and as shown on the Sof9 chart below (might be hard to read the small numbers), that level is 961-962. So we've got Mr. Fibonacci and Mr. Gann pointing to 962 as an important level. Now we wait to see if the bulls can achieve it.

RUT Square of Nine chart

The dollar rallied today, thanks in part to the euro dropping, and it was able to achieve two upside targets for its rally. The 2nd leg of the rally off its September 2012 low achieved 162% of the first leg at 83.43. For the 5-wave move up from February 1st the 5th wave equals the 1st wave at 83.50 and today's high was 83.52. It could press higher to the top of its expanding triangle pattern, near 83.80 by the first of next week, but it's a setup for at least a pullback at any time now.

U.S. Dollar contract, DX, Daily chart

Silver has been much weaker than gold in its bounce attempt off the March 1st low and even though gold has made a higher bounce I think they're both in corrective patterns for their bounces and will head lower again once the bounce has finished. But I see the potential for a spike up in silver and for gold to climb up to its downtrend line from November, near 1647 early next week.

Gold continuous contract, GC, Daily chart

The COT (Commitment of Traders) data for gold shows a large percentage of commercial traders are net long while speculators are net short. This bodes well for a rally in gold, which would be helped if the dollar pulls back. But the dollar and gold both rallied today and moving counter to each other is not always a given. The dollar's value may be driven more by what's happening in foreign currencies while gold's value may be driven more by deflationary concerns (ask those Cyprus account holders how much their accounts are worth right now and multiply that by more investors in Europe).

Oil has had a nice rally in the past 4 days and has achieved a price projection at 96.35 for two equal legs up from March 4th. Slightly higher, near 97.30, is its downtrend line from September 2012 which is likely to turn oil back down. What kind of pullback/consolidation follows will tell us whether or not to expect higher prices.

Oil continuous contract, CL, Daily chart

Thursday will be a little busier for economic reports, starting with the unemployment claims and then the GDP numbers and Chicago PMI. A slowdown in those numbers is expected and so traders will be asking if the economy supports ever higher stock prices. Not that it has mattered so far but soon it will.

Economic reports and Summary

We're entering a typically bullish few days ahead -- the end of the month and beginning of a new month. The market is also typically bullish around a holiday weekend, which we've got this week (Friday is a market holiday for Good Friday). So we've got some bullish reasons to believe the market could press higher. But the wave pattern suggests extreme caution about the upside now. We could see a quick high followed by a strong selloff (for a key reversal day). Or we could see a strong morning drop but not enough buyers to lift it back up. Each week that this market holds up but doesn't make much progress (the buying power has been going into market saves rather than getting more points for their dollars) increases the vulnerability of the market. The wave pattern suggests we should be watching for a reversal at any time.

We've heard and seen plenty of indicators showing how bullish traders are right now. People worry about a pullback and keep forecasting one but most are looking for a pullback so that they can buy. My feeling is that you should be careful what you wish for because you might get it in spades. Once the market starts down and if it has a bad day or two we could start seeing some big margin calls, which would of course just exacerbate any selling.

The chart below shows the S&P 500 at the top and the NYSE free credit available at the bottom, shown inversely to show how it matches up with the stock market. Peaks in the free credit line are actually lows, which mean major market highs have been associated with lows in free credit. This of course makes sense -- when traders are bullish they use up their margin capability to buy stock on leverage so as to maximize their gain.

SPX vs. NYSE free credit, chart courtesy

The risk now is that traders are running out of money to buy more stock. Worse, they're vulnerable to a margin call when the stock market starts back down. It's why the chart above is just one of many warning signs. Stick with the trend (up) but be aware we're likely close to the bend at the end. The market remains bullish above this week's lows and bearish below them.

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