Each morning this week we've seen morning declines bought but then the rallies have been used to sell into. It looks like a distribution pattern as we head for month/quarter-end.

Market Stats

This week so far we've seen morning declines followed by attempted reversals. But rallies into midday highs then get sold into and the market drops back down. Selling into rallies is not a good sign for the bulls, especially as we approach month/quarter end since it looks like fund managers are using the rallies to relieve themselves of inventory. That could be a bad sign for what the beginning of the next month might look like.

Many retail traders have been flocking back into the stock market as many analysts point to the great opportunity we have here to own stocks for a run higher into year-end. I can't help but feel they're like sheep being led to the slaughter house, again. Just keep playing nice soothing music (new highs by the end of the year!) and the people will stay calm and continue buying the stocks that are being offloaded to them in the rallies. Topping is a process and it seems to be a particularly long one this time but while retail traders are buying we see continuing evidence of selling by the funds.

Last week's highs for the indexes (those that made new highs or tested their August highs) are showing even more bearish divergence than the August highs compared to the May highs. This is a clear indication that the rally continues to lose momentum, which can also be seen in the market breadth numbers. We are not seeing the kind of rally strength that is needed to ensure it will continue into the end of the year. We should be mimicking the fund managers and using rallies to sell into and no longer looking for dips to buy.

The rally weakness does not prevent new highs from here, especially for the stronger indexes such as the small caps and techs, but each new high with continuing bearish divergence is a warning not to get complacent if you're playing the long side here. The flip side of the coin, for the bears, is that we do not yet have a clear signal that the top is in. It looks good for the blue chips and broader market indexes, as I'll review on their charts, but the dipsters are still active and there is a strong belief that the Bernanke call (a more aggressive market support than the Greenspan put) will not this market go down (or at least not down very much before the Fed will prop it back up).

The belief in the Fed has created a sense of entitlement for the bulls and certainly a sense of complacency. Even the week-long decline in the broader indexes has not budged the VIX much. There's simply no fear of a decline and that makes the market even more dangerous. Like generals fighting the last war, the Fed's monetary policies are fighting the last war as well. But as Didier Sornette, Professor on the Chair of Entrepreneurial Risks at the Department of Management Technology and Economics of the Swiss Federal Institute of Technology Zurich, argues, the Fed is now the problem, not the solution. Sornette's work is arguably some of the best in the field of risk management and how stability and complacency lead to less stable and more dangerous environments.

As Sornette has observed, each financial crisis that we've experienced since the 1980s has been "solved" by measures that have actually fueled the next crisis. Each market crash has been fought with an accommodative policy and each one gets more aggressive than the last. Last week's FOMC announcement has now made it clear that QE is a permanent structure which will likely only be increased or marginally decreased over time. As John Mauldin recently argued, QE is now a government program for supporting the market, I mean economy, which is not much different than other entitlement programs from the government -- once in place it becomes a permanent structure. The Fed has proven itself to be part of the government now and not an independent organization. This is a profound change of character for them.

The Fed has been using the same method to try to cover up real problems with more money. As Sornette observes, "Not only are crashes not any more mysterious, but the present crisis and stalling economy, also called the Great Recession, have clear origins, namely in the delusionary belief in the merits of policies based on a 'perpetual money machine' type of thinking." As Einstein once noted, "The problems that we have created cannot be solved at the level of thinking we were at when we created them." This is of course his definition of insanity.

All of this is to say that we're getting another step closer to a real disconnect in the stock market. The level of complacency and apparent stability are actually making the stock market even more dangerous. The next market crash will be worse the previous one and in fact the longer-term chart supports this view. We're forming a long-term megaphone pattern and the next decline is going to be very scary for most market participants. By the time the next leg down in the bear market finishes (below 6000 for the DOW), the Fed will be completely discredited and we'll hopefully have done away with them. The good news here is that once the next leg down finishes (2016-2018) we'll finally be done with the bear and set off on the next secular bull market. At least we're closer than where we were in 2000 (wink).

Dow Industrials, INDU, Monthly chart

This morning's economic reports included the Durable Goods Orders before the bell and New Home Sales at 10:00 AM. The durable goods orders, with and without transportation, were better than July's numbers but not as good as the market expected. Ex-transports the number was still negative (-0.1%), which signifies continuing weakness in the economy with two negative months in a row now. New home sales were better than July and slightly better than expectations. Nothing to write home about for either metric and the market largely ignored both reports.

I'll start tonight's chart review with the Wilshire 5000 index since it's a great study in trend lines with the use of the log and arithmetic price scales. The longer-term trend lines and big price changes make the use of both scales important when analyzing your charts. It might be helpful to print out the first 4 charts below, two weekly and two daily, and look at each as I compare the locations of the trend lines and what they signify.

The weekly chart below is using the arithmetic price scale and it shows a parallel up-channel for the rally from 2009. The May, August and September highs are up against the top of the channel and the July and September highs show bearish divergence, especially the September high. An uptrend line from October 2011 through the June 2012 low was briefly broken in November 2012 but then recovered back above it and it held as support at the June 2013 low. Another uptrend line from November 2012 through the June 2013 low has not been tested yet (but it has been tested when viewed with the log scale).

Wilshire 5000 index, $W5000, Weekly chart, arithmetic price scale

Now look at the same chart using the log price scale. The top line for the up-channel is of course no longer parallel so I took it off. The uptrend line from 2009-2011 is now much closer to current price action and the uptrend line from October 2011 through the June 2012 low has been support and resistance since June 2012, with the latest high is September finding it to be resistance. The uptrend line from November 2012 through the June 2013 is where the low at the end of August found support.

Wilshire 5000 index, $W5000, Weekly chart, log price scale

Now let's look closer with the daily chart and the two price scales. The daily charts below show the rally from November 2012 and the first one is using the arithmetic price scale. This time I've added an uptrend line from November 2012 through the April 2013 low and you can see how it became resistance in September, along with the trend line along the highs from May-August. Remember, this shorter-term trend line across the highs is actually the top of the parallel up-channel from 2009 that's shown on the weekly chart. It's clear how the June low found support at the October 2011 - June 2012 uptrend line (bold green). The last a-b-c of the complex wave count for the leg up from October 2011, which is the 3-wave move up from June, has the c-wave achieving 62% of the a-wave at 18365 (the September 19th high was 18409) and can therefore be considered complete.

Wilshire 5000 index, $W5000, Daily chart, arithmetic price scale

Now switching to the log price scale, the daily chart below shows how those trend lines shift. The longer-term uptrend line, from October 2011 - June 2012 (bold green) has shifted up and is the line that stopped the September rally, taking the place of the shorter-term uptrend line, from November 2012 - April 2013 (bold black) on the arithmetic price chart. The uptrend line from November 2012 - June 2013 is the one that acted as support for the August low.

Wilshire 5000 index, $W5000, Daily chart, log price scale

So after all this, what's the bottom line? While the top of the rally is much easier to see in hindsight we currently have a very good setup for it considering all the pieces of the puzzle that fit together here. The Fib projection to 18365 crossed multiple trend lines on different price scales (log and arithmetic) and the wave count can be considered complete. The bearish divergence, especially at the September high, is a clear warning of topping action. The "3 drives to a high" pattern can be considered complete (May, August and September highs). All of this does not guarantee that a top is in place but in hindsight many will be looking at the setup wondering why they didn't get more aggressive on the short side. They don't ring the dinner bell for bears at the top.

Now back to our normally scheduled program, SPX has the same pattern as the Wilshire 5000. I show the potential for a bounce back up this week, maybe even the start of another rally leg, but I think the greater risk is for the market to suddenly turn down hard. Below 1709 it stays bearish and above 1730 it would turn bullish. In between, mind the chop.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1730
- bearish below 1709

The short-term price pattern has me wondering which way the market will head on Thursday and into the end of the month. We know fund managers do some strange things into the end of a month/quarter and we could see the held up into next Monday. Or it could drop hard if fund managers start to worry about losing some of their profits for the quarter/year and suddenly start selling en masse. The different indexes give me different ideas for what's next but in total I see the potential for a bounce back up into Friday/Monday. On Thursday we enter the T+3 settlement window so fund managers could start to lighten up at any time.

I see the potential for a small descending wedge for the blue chips over the past two days and that's what I'm showing on the SPX 60-min chart below. A small drop Thursday morning followed by a rally (which it did Tuesday and Wednesday) could trap some bears for a bigger bounce. I show the start of a stronger decline next week but I'll be reviewing that potential very carefully on Friday if the bounce plays out. The risk is for a suddenly much stronger decline at any time.

S&P 500, SPX, 60-min chart

The bad news for bulls today is that the DOW broke and closed below its 50-dma. It could be just a one-day head fake and in fact I've been looking for a higher bounce since Tuesday morning's low (the short-term pattern looks like a small descending wedge pattern that could finish Thursday morning). It could find support near 15250, which is where it will retrace 50% of its August-September rally and then bounce back up to the 15500 area before setting up a stronger decline.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,750
- bearish below 15,300

Last week NDX rallied up to the top of a parallel up-channel for its rally from November 2012 and stopped a little shy of the price projection at 3253 where the 2nd leg of the 3-wave move up from June would be 62% of the 1st leg up, which is a common relationship inside a rising wedge pattern (which is arguably what we have with the bottom of the wedge as the uptrend line from June-August). It's been repeatedly testing the trend line along the highs from May-August but closed slightly below it today and that could be a bearish signal that more selling is coming. Back above Tuesday's high near 3237 should see at least another test of the top of its up-channel, which will be near 3262 on Monday and that would also be a back test of its broken uptrend line from August 30th. A break below price-level support at 3150, as well as its uptrend line from June-August, would be confirmation the top is in place.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3237
- bearish below 3150

A closer view of NDX shows the trend lines in play here. After tagging the top of its up-channel from November-April last week it tried on Monday and Tuesday to hold support at the trend line across the highs from May-August as well as its uptrend line from August 30th. It broke its uptrend line this morning and back tested it at today's midday high. The selloff from there looks bearish and it closed marginally below the trend line across the highs from May-August. But the whole pullback pattern from last week's high looks corrective and as shown on the chart below, we could see a final rally attempt into next Monday to finish the month/quarter on a positive note. From there it should be all downhill so don't get caught up thinking a new high would be bullish. The bounce is speculation at this point; a break below 3190 would suggest the high is already in place.

Nasdaq-100, NDX, 60-min chart

Like the NDX I've been thinking the RUT will push marginally higher and it has been the stronger index as those who believe the market will rally higher into the end of the year buy up the riskier stocks. Either that or fund managers are trying to show how smart they are by loading their books with the high-flying stocks. Once we get past this month that could change in a hurry. At the moment the RUT is bouncing between two parallel lines that mark the top of an up-channel from October 2011, which it did back in July and August as well. This time it's doing it with bearish divergence at new price highs. It could be now or just a matter of a few days but I think the RUT is getting ready to break down.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1085
- bearish below 1063

Continuing with the 30-year bond, which I've been updating for a few weeks now, we see it has now made a clear break out of its small descending wedge after a small throw-under of it into its September 6th low. Whether it will be just a bounce before heading lower again or the start of a new rally leg into 2014, we should get at least a larger bounce. Believing it's the start of the next rally leg I would anticipate seeing a rotation out of stocks and into bonds. A scary stock market selloff would certainly prompt some of that and it could start with some rebalancing following the end of this month.

30-year Bond, ZB, Daily chart

The banks have been weak since the August 28th low and the bounce has been very choppy. At last Wednesday's high, following the Fed's promise to keep giving banks more money to play with, BKX managed to back test its broken uptrend line from April-June, which was broken with the strong decline on August 27th. That back test and kiss goodbye was clearly bearish and it subsequently broke what could be interpreted as a H&S neckline from June through the August low (this is more apparent on some of the big banks such as JPM). Monday's strong break of the neckline was followed by a bounce off a retest of its August low and could give us a back test if it bounces a little higher to its 20-dma, both near 63.25 on Thursday. It's showing bullish divergence compared to the August low so perhaps there's a bigger bounce in store but clearly a drop below today's low at 61.94 would be bearish.

KBW Bank index, BKX, Daily chart

The dollar bounced off Fib support last week, at 80.18, which is where the 2nd leg of the decline from July is 62% of the 1st leg down and that could lead to the start of another rally in the dollar. But so far the bounce off last Wednesday's low is hardly impressive. We might instead see a continuation lower to the H&S neckline near 79.52 by next Monday before setting up a rally.

U.S. Dollar contract, DX, Daily chart

Last week gold bounced off Fib support near 1302 (50% retracement of its 2008-2011 rally) and managed to make it back up to its broken uptrend line from June-August and its 20-dma. It gave both of them a kiss goodbye and fell right back down. So far it's at least a higher low than last week's (just before the FOMC announcement) and it's holding support at its broken downtrend line from February-April. But it's now dealing with a band of resistance shown on the chart at 1336-1345 (today's high was 1338). It would be at least short-term bullish above its 20-dma, currently near 1356, and more bearish below last Wednesday's low near 1291.

Gold continuous contract, GC, Daily chart

Last week I showed an expectation for oil to pull back to support near 102.50 to be followed by another rally leg into October, perhaps testing its August 28th high at 112.24, before pulling back again. Basically it would be one large choppy pattern into the end of the year, trading between 100 and 115. Today's low at 102.20 fulfills the pullback and it could start back up from here. But it's threatening to break support at its broken downtrend line from 2011-2012 and its uptrend line from April-June. A break much below today's low would be more immediately bearish, which might coincide with a stock market selloff. Forced to choose here I'd side with the bears but either way we should find out quickly.

Oil continuous contract, CL, Daily chart

Tomorrow's economic reports include unemployment claims, the 3rd estimate for GDP (no changes expected) and then after the bell we'll get pending home sales, which are expected to show a worsening picture for the housing market.

Economic reports and Summary

Depending on which index I look at I could argue the need for one more new high (the tech and small cap indexes) or at most a bounce before heading lower in a stronger decline (blue chips). Since at most I'm looking for a minor new high I don't think the long side is the place to be. We could see an effort to hold the market up into the end of the month/quarter (and maybe get the new high for NDX and RUT) but with the rallies now being sold into I think it's providing evidence that fund managers will have little desire to stick around as we head for October.

With the retail crowd showing enthusiasm for the stock market and fund managers showing the opposite it's a strong signal that we should be looking to play the downside. While I'd hardly call the downside the path of least resistance (not with this choppy market), the downside risk for longs is far greater than the upside risk for shorts. Short-covering rallies are short-lived and that may be our clue that there are not many shorts left in the market who are nervous enough to cover on bounces. That makes the downside more vulnerable.

Bernanke's "gotcha" stunt last Wednesday fried a lot of shorts (in bonds as well as stocks) but the short covering in stocks got no follow through (what's your encore Mr. Bernanke?) while bonds continue to see buying. The bond market is of course the Fed's primary concern and they want to see a bond rally and lower yields. They might get their wish if my read of the charts is correct. I think we're close to a rotation out of stocks and into bonds so stock players get ready to rumble to the downside.

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