Now that the green-Tuesday record has been broken the bears are now looking for 3 down days in a row, something that hasn't been seen this year.

Market Stats

Overseas markets were down and that dragged U.S. equity futures lower during the overnight session. There was a gallant effort to get the market to bounce in the morning but each little spike up was sold into, which continued the signs of distribution that we've been seeing since the May 22nd high. Now with two down days in a row the bears will be gunning for a negative Thursday so that they can break another bull run -- there have been no three-straight down days this year (something not seen since before 1900). That way they'll be able to claim this was the week for the bears (following the break of the green-Tuesday run with yesterday's negative day).

Not helping the stock market were some more weak economic reports, although that's actually been bullish for the stock market in our bizzaro world where bad is good since it means the Fed will keep its foot on the gas pedal. This morning's ADP report said there were 135K jobs added in May, which was better than April's 113K (revised lower from the previously reported 119K) but less than the 157K expected.

Factory orders improved from -4.7% in March to +1.0% in April (old news) but was less than the +1.6% expected. ISM Services came in at 53.7 for May, only slightly better than the expected 53.5 and marginally better than April's 53.1. At least it's still above 50.

The Fed's Beige Book was released at 2:00 PM and caused the bounce off the day's low to fail, which was followed by a minor new low before consolidating into the close. The report included a slightly less positive assessment of the economy, especially the weaker auto sales, but it did highlight the strength in housing numbers. None of today's economic reports were able to get the market out of its funk, which started with the morning decline, led by the overseas markets.

The Nikkei got a dead cat bounce yesterday but it gave that up today, plus a little more, and dropped into its gap up on April 4th. Its low at 12925 is a firm break of support near 13K and the 38% retracement of the rally from June 1, 2012, at 13072. The next support level will be 12500 and the 50% retracement at 12152. With a loss of 3125 points from its May 22nd high at 16050 it has now shed 19.5% of its rally, putting it within spitting distance of an "official" bear market (-20%).

The FTSE and CAC had a worse day than we did, down -2.1% and -1.9%, resp. The DAX was down -1.2%. So it was a rotten day for the bulls in the big global indexes. The markets are now in oversold territory when viewing daily charts and there are some potentially strong support levels nearby so if the bulls are to make a stand we should see them do so on Thursday, which would also prevent the 3rd straight day of losses. But as I'll review on the charts, there is the potential for the selling to accelerate and oversold can get a lot more oversold before it will be ready for a bigger bounce. And keep in mind that stock market crashes come out of oversold conditions. Hindenburg Omen anyone?

The Nikkei is a current example of how bullish sentiment can get away from traders and then turn around and bite them big time. Their rally was based largely on the anticipation that all the central bank stimulation would boost the stock market higher. The BOJ is still printing yen at a furious pace and yet their stock market is crashing back down. What gives? It goes back to what I've been saying for a while now -- the Fed's stimulus program is more effective on sentiment than it is on actual monetary contribution to the markets and when that sentiment turns sour there will nothing our Fed will be able to do either. In fact the whole stimulative efforts by the central banks have created a bigger problem than if the markets had simply been allowed to correct on their own.

John Mauldin's newsletter from yesterday included an article by John Hussman in which he discussed this phenomenon of central bank stimulation. The biggest stock market crashes since 2000 have occurred when the Fed has been the most accommodating. As Hussman stated, "...the last two 50% market declines -- both the 2001-2002 plunge and the 2008-2009 plunge -- occurred in environments of aggressive, persistent Federal Reserve easing." He goes on to further to state, "...the maximum drawdown of the S&P 500, confined to periods of favorable monetary conditions since 1940, would have been a 55% loss. This compares with a 33% loss during unfavorable monetary conditions. This is worth repeating – favorable monetary conditions were associated with far deeper drawdowns."

Jim mentioned the Hindenburg Omen last night and as he mentioned, these are warnings, not predictions of doom for the market. What can be said about them is that many occur and the market does not crash but it's also true that no crash has occurred without first being warned about it with an HO signal. Per Bloomberg's breadth data, yesterday made it four HO signals in a row. If Bloomberg's breadth data is correct, this would be the first 4-day HO signal cluster we've seen in the last 25 years. Again, this is not a prediction of an imminent crash but if one happens you won't be able to say you weren't warned.

As already mentioned, with yesterday being a negative day for the DOW it broke the record of green Tuesdays at 20 but it will be interesting to see if traders still anticipate Tuesdays being generally bullish. As you can see from the chart below, Tuesdays in 2013 have been the day to be long the market. Buying Monday afternoon and selling Tuesday afternoon would have been the play. Of course by the time a trend is obvious it becomes obviously wrong and that's about where we are.

But green Tuesdays is not just a 2013 phenomenon. The next chart shows why being bullish on Tuesday is not a bad idea. Same for Fridays. The data is only for the past year but it says stay away from Mondays and Wednesdays and start legging into a position for a climb on Thursday and Friday (and then sell before Monday). It's hard to say why this pattern exists but it could be a result of money from the Fed flowing to the banks on Monday, being put to work on Tuesday and then the rest of the money being put to work on Friday before setting up to do it again the next week.

SPY daily performance in the past year, chart courtesy John Bollinger

Another negative signal about the market has to do with buying climaxes, which is when a stock hits a 52-week high and then closes lower for the day. Weekly buying climaxes can be a more significant signal. In the week ending May 24th there were 864 buying climaxes, which is the 2nd highest number in nine years. Like the HO, it doesn't mean we've seen the market top but it's a clear warning that we might have.

One of the reasons why I like the May 22nd high as THE high is because of the confluence of trend lines, timing and Fib projection. Obviously the market is the final judge as to whether or not these will matter but all we can do is identify the potential setups and either act on them or not.

The weekly chart of SPX below shows the high hit the tops of the up-channel from last November at a time and price projection based on the wave pattern for the move up from June 2012. It's a 3-wave move to complete a more complex 3-wave move up from October 2011, which in turn completes a larger 3-wave move up from March 2009. So I can add form as another reason to be looking for a top.

Referencing the chart below, the a-b-c move up from June 2012 has the c-wave (the leg up from November) 162% of the a-wave (June-September 2012 rally) at 1679.52 (the high was 1687.18). The vertical lines shows time projections based off the a-wave (June-September 2012 rally) and you can see the November low was only a week off from the 62% projection, the February consolidation started at the 162% projection and the May 22nd high occurred at the 262% projection. All these "62%" projections could be just coincidence but I've often found that Fib "coincidences" tend to be important.

S&P 500, SPX, Weekly chart

The pullback from May 22nd has SPX nearing potentially strong support -- the bottom of its up-channel from November and its 50-dma, both near 1604. Today's low was 1607 and there was a battle going on this afternoon as the bulls and bears duke it out for control here. The bears desperately want SPX below 1600 and start hitting all the stops that are undoubtedly parked there. The bulls desperately want support to hold and in fact the 50-dma has been support for pullbacks since November. If you're looking to buy the dip then that's the support level you want to buy.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1675
- bearish below 1600

There is support for SPX down to 1597, which is where the April highs are located. Below that there's not much support until 1555, which is the 38% retracement of the rally from November. If the selling gets really strong we could see a drop down to the 200-dma at 1493. A break below 1597 would likely hit a lot of stops and could trigger the stronger selloff. But if support holds there is still the potential for another rally leg up to about 1750 into July to meet an important cyclical turn window. I think we'll know which has the better chance of happening before the week is finished.

On the 60-min chart below I'm showing two down-channels for the decline from May 22nd, with the slightly steeper and narrower one from May 30th. It's the bottom of this down-channel that price dropped to today and it crosses the uptrend line from November tomorrow morning at 1604.80, a little less than 2 points below today's low. If SPX drops below 1604 look for possible support at the bottom of the wider down-channel, which crosses price-level support at 1597 later in the morning. Below 1597 would likely spark the stronger selloff.

S&P 500, SPX, 60-min chart

As I've been showing this week, the really bearish setup is the red wave count shown on the chart above. It calls the decline a series of 1st and 2nd waves to the downside, which calls for a steep and strong decline from here as it "unwinds" the multiple degrees of 3rd waves. This wave count says we could see a big gap down and a run lower so a gap down on Thursday and/or Friday, that doesn't immediately head back up for gap closure, would likely be the move that points down to 1555, if not 1493.

As always, there's an alternate interpretation of the wave count that needs to be considered until it's proven to be wrong. The chart above shows a possible bullish wave count (light green), which calls the pullback from May 22nd an a-b-c correction to the rally. If it holds support near 1600 this potential must be respected by the bears.

The 30-min chart below shows a little closer view of the decline from May 28th, which would be the c-wave of an a-b-c pullback from May 22nd. It's a 5-wave move down but has a slight overlap between the May 29th low and Tuesday's high, which is allowed in an ending diagonal (descending wedge). It's a bit funky for a descending wedge but definitely a possibility. It calls for a spike back up to the beginning of the wedge, so back up to the May 30th high near 1662 and then likely a continuation higher into July. A rally above 1635 would have me out of short positions and looking to buy pullbacks.

S&P 500, SPX, 30-min chart

The DOW broke its uptrend line from November today, which had held Monday and Tuesday. Tuesday's high was a back test of a short-term uptrend line from April 18th (hard to see the light gray line on the chart below). The uptrend line from November, now near 15210, should be resistance, if back tested, if the bears stay in control. Today's selloff is giving the decline the appearance of the start of a waterfall decline but before we see any serious selling from here the bears first need to break the 50-dma at 14915, 30 points below today's low.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,400
- bearish below 15,100

The tech indexes and small caps remain relatively strong relative to the blue chips when looking at their 50-dma's. As can be seen on the Nasdaq's chart below, the bears have some work to do before it will even be tested down near 3346 (today's low was 3397). It's the same pattern for the techs as for the blue chips -- it's either in a very bearish wave count, calling for a strong decline from here (forget support at its 50-dma) or it's completing an a-b-c pullback and will head higher into July. The low is only slightly below the projection for two equal legs down at 3405. If the bulls are going to make a stand, this is where it will be.

Nasdaq Composite index, COMPQ, Daily chart

Key Levels for NDX:
- bullish above 3515
- bearish below 3340

The RUT broke down from a sideways triangle that I had been tracking as a bullish alternative to the bearish wave pattern I have on the other indexes. But now it's in synch with the others as far as having a potential a-b-c pullback. Two equal legs down for it is at 967.82 an today's low was 967.67. Again, if the bulls are going to take the reins back, tomorrow should be the day. A rally back above 1000 this time should take the RUT higher, potentially into July. But any further selling on Thursday would begin to support the appearance of a waterfall decline that could take it to much lower prices (below 950).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1000
- bearish below 980

Treasury bonds have reversed off the May 31st lows and the bounce has resulted in yields pulling back from resistance. It's too early to tell whether or not we'll be looking at a multi-week/month reversal but at the moment that's the setup. As shown on the TYX (30-year yield) weekly chart below, it has pulled back from the top of a potential rising wedge pattern and we could see a decline over the next several weeks before another rally attempt to complete the corrective wave count shown on the chart. There is the potential for yields to decline from here for the rest of the year and a drop below the May 1st low at 2.81% would signal that's what we should expect.

30-year Yield, TYX, Weekly chart

I have followed HYG, the High-Yield Corporate bond fund, for many years because I view it as a very good indicator of investors' desire for risk. It's obviously riskier owning high-yield bonds (junk bonds) than regular bonds and there are two ways to evaluate how investors are feeling about the risk of owning junk bonds. One is the yield spread between them and Treasuries and the other is simply by looking at the chart of HYG.

As Bernanke has encouraged, investors have been forced into riskier asset classes in the pursuit of yield, and bond investors have been no different. The higher demand for the higher-yield bonds drives up their prices which in turn drives yields down. When there's a lot of demand for the riskier bonds and the yield spread between them and "safe" Treasuries shrinks it's a good indication that investors are feeling more secure about the added risk. From a contrarian perspective, like any other sentiment measure, too little fear about the risk is usually not a good thing for investors.

The yield spread can be found at the St. Louis Fed site (FRED), which is shown inversely against SPX on the chart below. After hitting a low of 4.23% in the middle of May it's currently printing 4.79% (so the lower line on the below chart is starting to drop and has now broken its uptrend line (downtrend line when not viewed inversely) from the end of 2011. Breaking the trend line is a potentially important signal to the stock market bulls that the desire for added risk is waning and may not support further stock market rallies.

Yield spread between junk and Treasury, chart courtesy

Looking at a weekly chart of HYG shows the same picture. The last time I showed the weekly chart of HYG I had pointed out the rising wedge pattern from 2011 and the multiple Fib projections lining up in the 95-96 area. The final high was 96.30 on May 22nd, the same day as the high for the stock market. Rising wedges get retraced quickly and this one should be no different -- I would expect a drop back down to the November 2011 (2011, not 2012) low near 82.50 sometime this year and it could be sooner this year than later. Short term, I would look for support at its uptrend line from 2009-2011, near 91 next week. The declining price for HYG of course drives yields higher and there's a good chance we've seen both the high for HYG and the low for the yield spread.

High Yield Corporate bond fund, HYG, Weekly chart

Looking over some of the bigger banks I'm seeing a similar pattern where each looks to have achieved an important level and have now turned back down. The banking index has also dropped back into a rising wedge pattern for its climb up from June 2012. It's only a small drop back inside the pattern but it can now be viewed as a throw-over above the wedge, which is the trend line along the highs from September 2012 - March 2013, currently near 60.10. It takes a drop below the bottom of the wedge, near 55.80, to confirm a reversal but that's currently the setup.

KBW Bank index, BKX, Weekly chart

Today's decline in the TRAN was a firm break below support at its uptrend line from November-April as well as its 50-dma. The broken uptrend line is currently near 6295 so watch to see if it turns into resistance if back tested.

Transportation Index, TRAN, Daily chart

The dollar has dropped harder in the past week than I expected to see and it's now near support at crossing trend lines near 82.25-82.40. Much below 82 would have me cautiously bearish the dollar but at the moment I'm expecting the dollar to turn around and start heading higher again.

U.S. Dollar contract, DX, Daily chart

The declining dollar hasn't helped commodities in general nor the metals. Gold has been chopping marginally up from its low on May 20th but "chop" is the operative word. I don't see anything bullish about its bounce and continue to expect lower prices for gold. As depicted on its chart, I'm looking for a decline to the 1150-1155 area by September. The only caveat about expecting lower is the very bearish sentiment about gold right now, not to mention the large difference between commercial traders who are long the metal vs. speculators who are short. That's usually a good setup for a rally. Maybe it will rally if and when it drops to support near 1300.

Gold continuous contract, GC, Daily chart

Have I mentioned before that oil is a choppy mess and directionless for now? Just checking. Move along.

Oil continuous contract, CL, Daily chart

The big day for economic reports is Friday because of the Payrolls report. Thursday could be rudderless unless something happens overseas.

Economic reports and Summary

The stock market is perched on the edge of a cliff when I consider where we are in a potentially bearish wave count. Indexes have either broken support levels or have dropped down to them. A one-day break could be quickly recovered with a rally on Thursday. The bullish interpretation of the wave pattern says an a-b-c pullback from May 22nd has completed and at most we should see one more minor poke lower Thursday morning and then a strong reversal. Once we get through Thursday morning we could have our answer to what we should expect into next week.

With the Payrolls report coming out Friday morning it's going to be interesting to see what sets up on Thursday. If we see prices consolidating near the current lows (sideways/up bear flag kind of pattern) it would be a bearish setup for a hard breakdown on Friday. But if the market starts to rally back up on Thursday I would expect at most a pullback Friday morning and then a continuation higher. It might not even pull back and instead get bulls chasing the market higher and bears jumping out the windows. That's if the a-b-c pullback scenario is the correct one -- the Payrolls report could be the catalyst that helps launch the next rally leg.

Just be careful in the next day or two, especially trying the long side off support, as tempting as it will be. With the very bearish wave count, Hindenburg Omens popping off like firecrackers and breakdown signs from other indexes like HYG, the Nikkei and many others, there is a relatively high risk at the moment for a disconnect to the downside. We know what happens when the HFTs (high frequency traders) step away from the market in a decline, as they're programmed to do. Without their liquidity the market dries up and sellers go begging for buyers. You don't want to be one of those sellers. It's a good time for caution by both sides until we see where price leads us in the next two days. Carrying a small short position with put options keeps your toes in the water as a JIC (just in case) trade. Trade smart, not aggressively.

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