The rally in the stock market is developing a parabolic look to it. It could have much further to rally (or not) but we all know how these end.

Market Stats

Today's session started in the hole following a dip in the futures in overnight trading. But as we've long accustomed to seeing, it was just another dip to buy. The bulls did some steady buying into a midday high but then let most of the rally slip away before a late-day buying surge pushed the indexes back near their highs. Trading volume was average.

This morning's economic reports were not good but that's not what the market cares about. It has long been disconnected from reality and the economy and is much more interested in how much money the Fed is feeding to the market and for how long they intend to do so. Even the hinting last Friday and in the Wall Street Journal report over the weekend, about the Fed thinking it could be time to start scaling back on their QE efforts. That was trial balloon by the Fed and not so much as a peep out of the bears. Sunday night's futures had sold off but it was just another buying opportunity for the bulls.

Since the U.S. Treasury Dept. has been flush with cash since April (higher tax receipts) they haven't needed to sell as many Treasuries. But the Fed keeps printing its $85B/month and that money has been looking for a home -- the stock market has been benefitting. And very likely that money makes into the bankers' hands each Monday and gets put to work on Tuesday, hence 18 straight up Tuesdays. So clearly the Fed's money is helping the stock market and in fact too much so. I think the Fed is now getting worried about the monster they've created.

Mr. Bubblehead, otherwise known as Mr. Bernanke, has created another bubble and now they're going to be looking for a way to let the air out slowly before someone finds a needle. They've been unsuccessful in letting the air out slowly from their previous bubbles and it's not likely to happen this time either. The more this market accelerates higher, into a parabolic climb, the less market-friendly will be the following decline. Bears don't want to get in the way of a blow-off top, which I believe we're now in, but by the same token bulls don't want to get complacent here.

Earnings season is wrapping up and about 95% of the companies have now announced. On average companies exceeded their (lowered) estimates, mostly missed on revenues and continue to issue negative guidance for future quarters. Negative:positive guidance is at a multi-year high of 4:1. Estimates continue to be above actual results but both have been declining since mid-2011. Sounds like a good reason to rally, no? It's another sign that the market simply doesn't care, yet, about fundamentals.

In another sign of bullishness, the IPO (initial public offering) market has been hopping. So far this year there have been 64 IPOs, which sucked up $16.8B out of the market. Last week alone there were 11 IPOs, making it the busiest IPO week since December 2007. Many look at an invigorated IPO market as a good sign for the market and while true, the caution is that it tends to get overheated about the same time the stock market is peaking. Time will tell if it was a warning or a green light for the bulls.

While it's hard to trust what VIX is doing during opex week, I find it interesting that it is rising with the stock market rally. VIX pulled back from daily highs yesterday and today but still closed higher each day. Options settlements can skew the direction but typically not for two days like this. Someone is buying lots of put protection as this rally progresses, which has me wondering if we're going to see more than just a small correction following opex. Food for thought and something to watch out for.

Tonight I'm going to start with the DOW's charts because I've got an interesting setup that needs to be watched carefully -- the rally pattern could complete this week. Since the rally off the March 2009 low began I've been saying it was going to be a correction within the secular bear market (a cyclical bull market within a larger secular bear market). From an EW (Elliott Wave) perspective corrections are very difficult to figure out in real time because they easily morph into a different pattern. Unlike one impulse (5-wave) pattern there are 11 different corrective wave structures. The challenge is figuring out which one is the more probable one and then base time/price projections off that pattern.

The move up from 2009 is a large 3-wave structure with the 1st leg up to the April 2011 high and then the 2nd leg up from the October 2011 low. Each of those legs is also a 3-wave move and the hard part has been figuring out what the upside projection will likely be. Looking at the DOW's monthly chart below the immediate impression is that the DOW will head for the trend line along the highs from 2000-2007, currently near 16300 (it could be why so many are predicting DOW 16,000, including Barron's and now the Economist is predicting higher).

The Economist front page from last weekend (another magazine-cover sell signal?):

That potential for DOW 16K+ certainly needs to be respected by the bears. We're in the end stage of the rally and we're seeing a melt-up in the market and an acceleration of the rally into a parabolic move. Final short covering and "everyone in the pool" could easily give us another 1000 points in the next couple of weeks (or less). But we all know what follows parabolic rallies so it's a time for extreme caution. You can see what happened following the accelerated buying into the 2007 high.

Dow Industrials, INDU, Monthly chart

I've been stating for years that I don't believe the secular bear market will end until at least 2016, possibly later. One more leg down, for wave-E in the big expanding triangle for the DOW, is what should be next. It will make the two previous declines look like just a small correction. I'm showing the resumption of the bear market before the DOW hits that upper trend line, which I think will catch too many traders leaning long just as they should be acting more cautious. But again, respect the upside potential.

The second half of the rally from 2009, the leg up from October 2011, is a 3-wave move and I've been playing with some ideas for how to count this corrective wave structure. I've got a lot of correlation for a top in the 15330-15360 area that will be important to watch (if reached), potentially tomorrow, maybe into Friday. As for the 16K potential, a rally above 15400 would leave few options other than the upper target on the monthly chart.

Moving in much closer to the 2nd leg up from 2009, the weekly chart below shows the 3-wave move, labeled W-X-Y. I've got a parallel up-channel from October 2011 because these tend to do very well in identifying where the top of a correction will be. The top of the channel is near 15360 tomorrow. Also near this level is where the move up from October 2011 will have two equal legs, shown on the chart at 15364. A trend line along the highs from late January is slightly lower, near 15335 tomorrow.

Dow Industrials, INDU, Weekly chart

Now zooming in to look at the leg up from November, I'm showing the latest count idea, which is a corrective wave count rather than an impulsive (5-wave) count. If the corrective count is correct the high that gets put in for this leg will be the final one (instead of a 3rd wave in the move up from June 2012). But that will become clearer once we get the next pullback/decline. As labeled (double zigzag with an a-b-c-x-a-b-c wave count), two equal a-b-c moves up from November points to 15332. For the 2nd a-b-c it would have two equal legs at 15344. The intersection of the trend lines mentioned above and the multiple price projections in the 15330-15360 area should be more than just coincidental and that's why I think it will be the completion of the rally, especially if tagged and then drops strongly.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,370
- bearish below 15,038

Now we move in much closer and look at just the final leg up from April 18th (wave-c of the second a-b-c in the move up from November), which needs to be a 5-wave move. It's not a clean count but it fits the 5th wave, which is the move up from Monday also needs to be a 5-wave move. Ideally that means just one more small pop higher to complete the pattern and the projection to 15344 would also be have the DOW tagging the trend line along the highs from late-January. A drop below Monday's midday low near 15064 would tell us the top is in place (although that should become obvious once we get an impulsive decline off the high).

Dow Industrials, INDU, 60-min chart

On the SPX daily chart below I've kept the impulsive wave count for the move up from November since it still fits. In fact for the final wave of the pattern, which is the move up from April 18th, it doesn't matter. It only matters for what follows next. SPX is now close to the top of its parallel up-channel from November, which is near 1566 tomorrow. It has popped slightly above the top of its up-channel for the rally from June 2012. The completion of the 5th wave of the move up from November will result in at least a larger pullback so the risk is high if your chasing this higher.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1670
- bearish below 1593

The 60-min chart of SPX, below, looks essentially the same as the DOW's. It did achieve the first upside target for the 5th wave, where it equals 62% of the 1st wave, at 1661.72 (it actually missed it by 23 cents). It also tagged the top of its up-channel from April 18th and the tops of its two channels intersect near 1566 tomorrow. If the DOW achieves its target zone of 15330-15360 we should see SPX hit that intersection. And it will be a very good setup for a short entry if achieved and then rolls over. Just remember how dangerous it is trying to catch rising knives in a market like this.

S&P 500, SPX, 60-min chart

NDX has climbed above its up-channel from November as well as a trend line across the highs from April-September 2012. Now it's battling the millennium 3000 level so a rollover from here and a close back below its trend lines (so below Tuesday's close at 2996) would create a sell signal. RSI is now as overbought as it was at its September 2012 high, which led to a nasty pullback into the November low.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2993
- bearish below 2993

The RUT's weekly chart below shows the wave count for its rally from October 2011. I've got it labeled as an a-b-c move up (the second a-b-c of a double a-b-c move up from 2009) and the c-wave, which is the move up from June 2012 is an ending diagonal (rising wedge) with the requisite 5 waves. That's a long-winded way of saying the pattern is complete once the leg up from April 18th completes. Two wave projections are shown on the chart, pointing to 984-988 for an upside target. Today's high was 991.55 but it closed at 988.53. It's also a minor poke above the top of the rising wedge so a close back inside (below 985) would create a sell signal. I've noted on its MACD the wave count for the move up from June 2012 to show that we have bearish divergence at the 5th wave position, which increases the probability that the wave count is correct.

Russell-2000, RUT, Weekly chart

Key Levels for RUT:
- bullish above 988
- bearish below 924

Treasuries have been selling off since the highs on May 1st and the 10-year Note has retraced almost 62% of its March-April rally while the 30-year bond has retraced a little more than 62%. The pullback in prices of course has led to a bounce in yields and the TNX (10-year yield) weekly chart below shows it has made it to slightly above its downtrend line from February 2011. Unless it gets back over its March 8th high at 20.86% I believe yields will be heading lower.

10-year Yield, TNX, Weekly chart

The expectation for lower yields (a continuation in the bond market rally) goes counter to what Bill Gross said last weekend (saying the bull market in bonds completed on April 29th) and what Warren Buffett believes but I just go with what the chart tells me. I think the 10-year will be down to about 1% by the fall (the 30-year should hit about 2%) before the bond's bull market completes. A reversal in yields here, with a sharp drop in a 3rd wave, would mean money flooding back into Treasuries. That would likely mean traders got scared of something and rushed back into bonds and very likely out of stocks. So the picture I have for bonds here supports the idea that we're on the cusp of a major reversal in the stock market.

Similar to the RUT's weekly chart above, the banking index weekly chart below shows an a-b-c move up from October 2011 and a 5-wave move up from June 2012. We're in the 5th wave now and it has made it up to the top of an up-channel for the 5-wave move. All the pieces are in place to suggest BKX is going to reverse any day now. If it doesn't reverse in the next day or two and pushes higher then we could see a strong rally up to the top of the larger up-channel, the top of which is currently near 65.60, about +8% higher.

KBW Bank index, BKX, Weekly chart

The dollar got stronger earlier than I expected to see and could be just a head-fake move before pulling back again but at the moment it appears the next leg up is underway. I see the potential for a rally up to its downtrend line from 2009-2010, near 87.50 by the fall. A drop back below its May 1st low at 81.37 would obviously turn it at least short-term bearish.

U.S. Dollar contract, DX, Weekly chart

With a rally in the dollar there's been some downside pressure on commodities and you can see that trend has been in place since the dollar's low in early 2011. You can also see there's a relatively close inverse relationship between the dollar and commodities and that continues. But interestingly, as the dollar has closed above its July 2012 high the commodity index has been holding above its June 2012 low. It's possible the relative strength shown here in commodities will lead to a reversal back up but not likely unless the dollar starts back down.

DJ UBS Commodity index, DJUBS, vs. U.S. dollar, Weekly chart

The next chart is a comparison of SPX and the commodity index, showing the huge split between the two. They typically track closer than what we've seen since 2011 and that has many scratching their heads while trying to figure out what it means. Stock market bulls naturally view this as bullish since it means investors have abandoned commodities for stocks. Bears view this as an accident waiting to happen in the stock market. We know the commodity prices are beholden to what the dollar does but their prices are also affected by supply and demand and right now with a slowing global demand we've seen commodity prices dropping. Fundamentally I can make the argument that commodities are the better reflector of reality and that the stock market will soon be forced to deal with that reality.

DJ UBS Commodity index, DJUBS, vs. SPX, Weekly chart

Gold is outpacing commodities to the downside and it looks like it's heading back down after its bounce off the April 16 low and up to resistance. I show a stair-stepping pattern lower into the fall and will update the pattern as it develops further

Gold continuous contract, GC, Weekly chart

Following silver's nested 1-2's to the downside from its October 2012 high, like for gold, should see an unwinding of the rest of the wave count in a stair-stepping lower pattern into the fall. I've depicted how it might look in the next several months as it heads for the first downside target that I have for silver near $18. That's the level of the apex of a previous sideways triangle continuation pattern back in 2010 (and the 2nd wave of its extended 5th wave rally into the April 2011 high, a common retracement level in an EW pattern). Again, I'll update the depicted pattern when the wave count tells me to but for now this is the roadmap to follow.

Silver continuous contract, SI, Daily chart

As shown on oil's weekly chart below, it has been chopping sideways since early 2011 -- over two years and price action continues to contract. And it's formed a contracting triangle within a larger contracting triangle. I can't figure out if it's going to break to the upside or downside. I'm leaning to the downside (I think oil will trade more in synch with the stock market and a slowing global economy) but the large sideways consolidation following the 2008-2011 rally certainly looks bullish. The bullish pattern calls for a continuation of the larger sideways triangle through most of this year before breaking out to the upside next year. Nothing to trade here folks, move along.

Oil continuous contract, CL, Weekly chart

Tomorrow morning will be busy with some potentially market-moving economic reports. Other than the usual unemployment claims we'll get the latest CPI readings, housing starts and permits, and the Philly Fed index. No big changes are expected other than a slowing in home construction but housing starts was getting a little overheated so it's actually a good thing if it will be coming down some.

Economic reports and Summary

The rally has been accelerating higher, forming a parabolic arc to the upside (a melt-up) and it's always a challenge to figure out when the music will stop. We could see the DOW add another 1000 points in just a couple of weeks or we could see the market make a final high tomorrow, maybe Friday. I've shown the setup for a top this week, which I think has a very good chance of happening. But price is the final arbiter and it doesn't pay to argue with it. It will always win.

If we get a new high tomorrow and then a close back below this afternoon's lows (e.g., SPX 1650) it should be confirmation that the final high was made. Use that as a trigger to get short and use the day's high for your stop (I'll be updating triggers and stops intraday). In the meantime, respect the upside since the market is currently running very bullish. I'm merely trying to identify when that bullishness could come to an end.

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