Tuesday's relief rally quickly fizzled to nothing but the buyers returned Wednesday to try it again and this time had better luck getting a rally to stick.

Market Stats

Tuesday morning's relief rally, which was a result of the Globex equity futures market gapping up Sunday night and holding through Monday morning and overnight into Tuesday morning, was given back the rest of the day. Today started with a whimper but built some steam to the upside as the sellers were pushed aside. Even though some of the rally was given back into the end of the day the bulls probably feel encouraged that it didn't sell off again.

There wasn't much in the way of economic reports today, other than the Fed' Beige Book at 2:00 PM. The Trade (im)Balance for July was a little worse than June (-$39.1B vs. -$34.5B) but in line with expectations. It's never a market mover anyway. The MBA Mortgage Index was at least positive, following a string of negative readings for weeks, but the home construction index was only up as much as the broader indexes today.

The biggest report today was the Beige Book, which of course had many analysts wagging their tongues as they predicted what it means the Fed will do at their next meeting (September 18th). As long as the market thinks the Fed will keep the pedal to the metal it will be happy. But the Fed has been giving us enough clues (jawboning, trial balloons, etc.) to prepare the market for tapering. We just don't know what that means although it's apparent that the Fed is now becoming concerned about owning a lot of Treasuries that have lost value in the past year, especially since May.

The Beige Book showed the economy grew at a "modest to moderate pace" in July and August. Consumer spending saved the day again, especially on cars and housing, along with housing-related purchases such as furniture and appliances. The report did mention that consumers are highly price sensitive. Back-to-school shopping also helped retail sales. Debt levels are growing while savings are declining, which of course is unsustainable, something we saw leading into the top in 2007.

Of the 12 Federal Reserve districts there were 8 that reported moderate growth, 3 reported modest growth and the last one, Chicago, merely said economic activity had "improved." Lending activity is flat to down and Chicago reported weak commercial development because of the higher interest rates. Overall one could say the report wasn't bad but as we've seen for the past few years it's not much better than John Mauldin's "muddle through" expectations.

Another example of people maxing out their credit is what we're seeing in the stock market. Again, like what we saw heading into the 2000 and 2007 highs, stock accounts are highly margined (more so now than in 2000 and 2007). There's been a high level of expectation by most that the stock market has a lot more rally left in it. There may be many who expect a pullback, especially in the historically weak September-October period, but most analysts I read say it's going to be a great buying opportunity. Very few believe we've seen a major high for the stock market, one that won't be seen for many years to come (NDX could still put in a new high but will likely be alone in doing so, if it does).

Moving on to the market, last Wednesday I had mentioned the day's low looked good for the completion of the first leg down for what should be a larger pullback from the August 5th highs (NDX still questionable in that regard). I was looking for a bounce to correct the August decline and so far we've got one, albeit a small one. It's been choppy, whippy and relatively flat. It supports the idea that we'll get at least another leg down to match the August decline and could be potentially a lot worse than that. But for the moment I'm looking for where we should look for the completion of the bounce correction so that we can get a good short entry.

I'll start off with the DOW's charts tonight since it's been a little weaker than the others and could give us an early clue for when the broader market might break down. If the DOW holds up then the rest of the market should do the same.

The weekly chart below shows the break of the uptrend line from November 2012 - June 2013 as well as the mid-line of its up-channel from October 2011. The mid-line is currently near 15060 and might be the extent of a bounce correction to the August decline. The correction over the past week has been more sideways than up, working off some of the oversold condition in time instead of price. The price pattern calls for another leg down and a preliminary downside target is near the 50-week MA at 14270 or the bottom of its up-channel, near 14100 by the end of the month.

Dow Industrials, INDU, Weekly chart

Besides the parallel up-channel from October 2011, which is shown with the arithmetic price scale (to keep the lines parallel), there is a longer-term uptrend line from the March 2009 low through the October 2011 low. This is shown on the daily chart below and you can see how price is using it as support. When this trend line breaks it's going to be a big deal. For now I see upside potential to the 38% retracement of the August decline, at 15103, possibly only up to its 20-dma, currently at 15082 but coming down fast. A drop below last week's low at 14760 would be immediately bearish otherwise a bounce into next week and a turn window on September 11th is the expectation.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,250
- bearish below 14,750

Moving in closer, the 60-min chart shows another common retracement level -- the previous 4th wave, which in this case is the August 26th bounce high at 15050. Between Fibs, price-level resistance and moving averages it seems to me the bulls will have a very tough time getting through 15050-1500 and I'll be watching for a setup in that area to get short. The bounce pattern depicted below is just a guess. The price patterns for corrections are very difficult to figure out in real time and I'm simply watching the intraday movements to help identify when I think a top for the bounce has been made or if there are higher expectations.

Dow Industrials, INDU, 60-min chart

Last Wednesday SPX tagged its uptrend line from November-June. As expected it has bounced off this support line and today got a nice jolt to the upside following a very choppy few days following its low. With the 20-dma crossing down through its 50-dma, near 1660 and 1663, respectively, it could be tough resistance. It will close its August 26th gap down at 1657 and retrace 38% of its August decline just shy of 1659. From a short-term perspective I see the possibility for a quick high Thursday morning and then a pullback before hopefully another leg up into next week. But again, the long side is the riskier side right now.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1670
- bearish below 1627

NDX continues to bounce between support and resistance lines without any indication of direction. I could argue for a new high for this index as easily as I could argue for lower from here. It has tagged its trend line along the highs from September 2012 - May 2013, which held it down on a closing basis on August 23rd and 24th, and this line could continue to be tough resistance. We could see a pullback and then final attempt at a new high next week but this one is as clear as mud at the moment.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3150
- bearish below 3053

The RUT is holding support at its May high (1008) but is being held down by its 50-dma, currently near 1030. I show the potential for a rally up to its broken uptrend line from June through the August 19th low, which was back tested once already on August 29th. Next week's back test, if it gets there, could up around 1040-1045. The RUT's pattern is not that clear at the moment and therefore I'm watching the trend lines to see how price reacts. A drop below 1008, and especially below its November-June uptrend line, near 1005, should have the bulls scrambling to cover their positions.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1045
- bearish below 1008

Bond prices have been chopping lower for the past two months, following the steep decline in May and June. The choppy move lower looks like an ending pattern and as can be seen on the chart below for the 30-year (using ZB, the e-mini), it has formed a bullish descending wedge with bullish divergence for confirmation. I show a minor move lower in the next few days for a small throw-under below the wedge to tag the Fib projection at 128.774 (128'25), which is where the 2nd leg of a large A-B-C pullback from July 2012 would be 162% of the 1st leg down. I haven't given up on the idea that we'll then get a bond rally into 2014 and watch yields drop down to a final low (2% for 30-year and 1% for 10-year). I feel very lonely in that prediction so I could obviously be completely wrong. We'll need to see a strong impulsive rally off the coming low in bond prices to help support my view. But at the very least it's looking like we're setting up for a bond rally of some kind. Perhaps the September 18th FOMC minutes will spark something.

30-year Bond, ZB, Daily chart

Banks are in trouble globally and especially where they've been getting bailed out by the central banks. European banks are probably more vulnerable than U.S. banks but globally it's not going to matter who goes first; they're all so interconnected that even the troubles in the emerging markets put negative pressure on the larger markets (regardless of what Bernanke says to the contrary -- this from a guy who couldn't see the housing crisis coming and what it would do to the economy).

Back in the beginning of 2012 it was estimated that the European banks would have to sell about $1.8T in assets in the next 10 years in order to raise enough capital to remain solvent. That figure today is about $4.3T, more than twice what was thought only a year and a half ago. Not only has the amount increased dramatically but the time frame in which they need to do it has shrunk -- it's now estimated they need to sell these assets in the next 5 years.

In addition to the needed asset sales to remain solvent the banks have an additional burden -- Basel III. These regulations were issued in 2011 by the Bank of International Settlements and they require the banks to raise even more cash to meet capital requirements. You can see the trajectory it's taking here and it's not a pretty picture for the banks. I know, cry me a tear. But when this house of cards we call the banking system comes crashing down it's not going to be a good time for economies, currencies and certainly not the stock market. There's simply too much debt across the European economies (and the U.S. as well but not quite as bad, yet) and the banks do not have the ability to write off the loans.

The markets have been ignoring this banking crisis for a long time and everything has felt fairly stable for a few years now. It's the stability that fosters greater risk taking and everything remains stable until it doesn't. Stability breeds instability and it's probably not far away. When it becomes unstable, because of the excesses that have built up, it collapses quickly. The problem for us traders is knowing about the dangers but still trying to make money in the market, preferably trading both directions (more money can be made on the short side but it's almost always a wild and scary ride). Currently the banking indexes have pulled back but they're holding support. The chart of BKX below shows this.

BKX has been trying to bounce off support at its uptrend line from October 2011 - June 2012 (log price scale), currently near 62.70. Like the broader indexes, the bounce over the past week has been choppy and when we see a choppy consolidation on top of support it's typically followed by a break of support and that's what I'm expecting to happen. I show a little higher bounce first, possibly as high as its 50-dma at 64.41 (or maybe a little lower as its 20-dma has crossed down through the 50 and could be resistance), but I consider the long side to be the riskier side.

KBW Bank index, BKX, Daily chart

The TRAN had found support at its uptrend line from June through the August 15th low but then lost it quickly with the hard decline on August 27th. It then found support at its uptrend line from March 2009 - October 2011 (the same one as BKX above). It got a nice strong bounce today, up +1.2%, and might even run up to back test its previously broken uptrend line. Or it might get stopped by its 20- and 50-dma's currently near 6400. A drop below last Friday's low at 6237 would be a break of its longer-term uptrend line and clearly bearish when it happens.

Transportation Index, TRAN, Daily chart

The dollar got a nice bounce off its uptrend line from August 2011 - February 2013. Looking at the low on this line on August 8th, the lower probe on August 20th and the last test on August 27th, you can see how this can be viewed as an inverse H&S pattern. The upside price objective out of it is to about 83 so we could see a rally to that level, pull back and then continue higher into October-November. Dollar bulls would not be in trouble until it breaks below 81 and especially the August 20th low at 80.77.

U.S. Dollar contract, DX, Daily chart

After nearly tagging the 1441 target for two equal legs up from June, as well as the top of a parallel up-channel for the bounce, gold has started a pullback. What's not clear yet is whether the pullback is going to be just a correction to its rally, followed by another high before a deeper pullback (green dashed line), or if the 3-wave bounce off the June low completes an a-b-c correction to the longer-term decline. I'm leaning toward the bearish scenario, which calls for another new low in October in its stair-step pattern lower, but that would not become more certain until gold drops below its July 23rd high at 1348.70.

Gold continuous contract, GC, Daily chart

Silver has the same pattern as gold except for the fact that its 2nd leg up in the bounce off the June low was much stronger. Between the bottom of a parallel up-channel for its bounce and the 20-dma, at 22.98, I would expect them to hold if we're to see a 5-wave move up from June (green dashed line). That would set up a larger pullback but more importantly it would tell us the trend has changed to the upside. At the moment all we have is a 3-wave bounce off the June low and therefore is a correction to the longer-term decline. Hopefully in another week it will be clearer which side is going to win. Because gold is closer to its July 23rd high it could be the first to provide the answer. Silver bulls would be in more trouble if it breaks below 22 but there might be earlier clues if we see an impulsive decline from its high.

Silver continuous contract, SI, Daily chart

Oil is chopping all over the place and clearly reacting to daily news about what's happening in the Mideast. At the moment I see greater potential for at least a larger pullback before pressing higher (green) but the bulls are at risk here if the bearish wave count is correct, which calls last week's high as the completion of the bounce pattern off the June 2012 low. Last week's throw-over above the top of the up-channel from June 2012, followed by a collapse back into the channel left a very bearish dragonfly doji (more bearish version of a shooting star) so there's the potential for a lot more than just a pullback.

Oil continuous contract, CL, Daily chart

Thursday will be a bigger day for economic reports, as can be seen in the table below. The Factory Orders is expected to be poor but ISM Services is expected to stay comfortably above 50. The Fed wants to see productivity improvements and only small increases in Labor Costs. These are numbers used in their calculations for the need for more or less economic stimulus. Everything is of course viewed through the lens of how the Fed will react. As if what they've done for the past 4 years has worked.

Economic reports and Summary

As expected this time last week, support held and we got the bounce. This time next week could be an excellent opportunity to get back on the short side if the bounce pattern plays out as expected. We're a week into it and we're left wondering how much bounce we'll get. I still like the timing of September 11th for a high and depending on how choppy and whippy the bounce remains will determine how high the bounce gets. Short term I remain bullish but that's a relative term in this market. I believe we've seen THE high (except for perhaps NDX) and therefore bounces are to be shorted.

One way to play the next leg down, and not get hung up on timing the top of the bounce, is to get into some December puts and don't worry about how high the bounce will get. Start small and leg into a position so that if we do get an upside surprise you haven't risked more than you'd lose on a stop loss on a stock trade. When we get confirmation that the next leg of the decline has started we'll get small bounces to short so it will be easier then to leg into a larger short position. Don't rush the process and stay disciplined about your exposure. Don't do like all the happy bulls out there who are margined up to their eyeballs. When they have to cover their margined positions you want to have some exposure on the short side to take advantage of the fast move.

Look for a little higher in the coming week but have one foot holding the door open so you can quickly run out and jump onto a marauding bear once he starts charging the bulls.

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