A rally in the past couple of weeks had traders anticipating something positive from today's FOMC announcement. Without more drug money the market had a small fit this afternoon and now we watch to see if it's just another dip to buy.
The market started on a positive note this morning with a gap up and call buyers were busy. But almost immediately the selling began, which is continuing a pattern we're seeing recently where rallies are being sold into. As we've been approaching the end of the month (and fiscal year for some) it's been apparent that some fund managers have been liquidating inventory by selling into the rallies (more liquidity then and they can sell without killing the stock price. However, enough managers are now doing it such that prices are collapsing right after brief spikes to the upside. Those who bought calls this morning paid top dollar for them and went immediately underwater.
It's a busy week for economic reports and today's reports started with the ADP Employment report, which showed an increase of +130K jobs. It was slightly better than the expected +125K but a drop from September's 145K, which was as downward revision from the originally reported +166K.
The CPI numbers were benign, with the core CPI staying at +0.1% while the broader CPI ticked higher to +0.2% in September from +0.1% in August.
The big report was the FOMC announcement this afternoon and it was met with disappointment and worry from the stock and bond markets. The market had hoped for something a little more accommodative than what it heard, which was essentially unchanged from September. Always looking for another handout, the market was not happy that the Fed didn't promise even more drug money for the banksters. They of course kept the interest rate at 0.25% and that was no surprise. But the QE program stands at $85B/month and the weakening economic numbers recently have had many hoping for hints from the Fed that they might have to do more. But in fact the Fed leaned slightly the other way by removing one sentence from their statement -- they omitted the reference from last month that fiscal tightening could slow growth in jobs and the broader economy. That was enough to drop the DOW about 80 points before recovering some of that loss into the close.
The dollar spiked up on the news but then pulled back slightly into the close. Currency traders believed the statement (or the removal of the one line from the statement) was good for the dollar. The bond market had rallied slightly in front of the FOMC announcement but then sold off sharply, showing concern that a lack of demand from the Fed could be trouble for bond prices. This had yields spiking up into the end of the day. It will be interesting, and potentially very important, what bonds do from here since the economy is so dependent on rates staying low.
One reason why the Fed can't stop their asset purchases, primarily U.S. government Treasuries, is because they're becoming the buyer of last resort. If they stop providing demand for bonds the prices will decline and that will spike yields. The Fed's whole effort has been to keep rates artificially low as a way to prime the economy, especially the housing market. All will be for naught if yields start spiking now. The mere talk about a possible tapering of asset purchases had the market reacting negatively so the Fed has now successfully painted itself into a corner and everyone is watching to see how they'll get of the box they put themselves into.
As the chart below shows, foreigners are not doing their part to fund our profligate spending. As the bars show, the month-to-month change has slowed since 2012 and dropped into negative territory in 2013. The line shows foreign holdings in a nice climb until this year but the turn down could be trouble if it does something more negative than just level off. The Fed will need to make up the difference and with an extremely accommodative Fed-head in Janet Yellen, there's already speculation that the Fed may have to double, quadruple or more their bond purchases just to make up the difference. That would spook foreigners who would likely then purchase even less. The death spiral may have begun.
Foreign holdings of U.S. Treasuries, 2000-present, chart courtesy agorafinancial.com
Last week I discussed some measures of trader sentiment that indicate a very high level of bullishness. I showed a chart of the NYSE debt margin, which has climbed faster than the S&P 500 into an all-time high, and the Rydex Money Market fund showing a low level that has matched previous market highs. Now we've got options players showing more confidence than usual as they purchase call options in expectation for a higher stock market. The ISEE Index chart below shows the spike on Monday and while it's not a good market timing tool it does provide another warning sign when it climbs above 150 (Monday's peak was 172). A reading of 100 shows equal numbers of puts and calls being purchased. It was high again this morning but it dropped as the day progressed and started to show some worry (hedging) in front of the FOMC announcement.
ISE Sentiment index (measure of speculative option purchases) for 2013
Even though we might have seen an important high made today I'm going to start off with the DOW's charts tonight to show the bullish potential for at least one more leg up to complete the rally. Whether the final high was today or if instead it will be tomorrow/Friday, it's obviously not much of a difference to longer-term traders who are simply riding the trend higher until it breaks. But for shorter-term traders looking to maximize profits on long positions and/or looking to play the short side, today's high looks potentially important. Watching what the DOW does from here should provide the clues we need.
The DOW's weekly chart shows upside potential to the trend line along the highs from 2000-2007, which will be near 16180 by mid-November. There are longer-term price projections near 16700 and that level crosses the top of the parallel up-channel from October 2011 at the end of the year. While I don't see that happening, it's a reminder (especially for bears) to keep it in mind as a possibility. This week I started thinking the DOW might top out in 15725-15760 area and this morning's high was 4 points shy of the lower end of that target zone. In the 5-wave move up from June 2012 the 5th wave is 62% of the 1st wave at 15725 and therefore the wave count can now be considered complete at any time.
Dow Industrials, INDU, Weekly chart
A trend line across the highs from August-September is currently near 15760 so that's the upper end of my target zone but in reality I don't think the trend line is that meaningful because of the wave count that I'm using (it's not a rising wedge pattern for an ending diagonal). But it's a guide line that many traders are watching. At this point I consider the risk too high to be thinking about the long side (the downside risk is much greater than upside potential, at least until it gets above 15800) but we don't have any evidence yet that the DOW has topped and therefore shorting it here is risky as well. We need another day or two to help determine whether or not the uptrend is still intact.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 15,760
- bearish below 15,366
Shorter-term we've been watching the up-channel from the October 15th low, as well as an uptrend line from October 9-23 and a smaller up-channel from October 23rd. The broken uptrend line from October 9-23 and the tops of the two up-channels all intersect near 15785 on Thursday, which is only slightly above the trend line along the highs from August-September. So from a trend-line perspective I see the potential for a rally to that area on Thursday before topping out. A common pattern following an FOMC announcement is for the post-FOMC reaction to get reversed the following day, so this afternoon's selloff could lead to another rally leg Thursday morning. But notice the DOW broke its shorter-term up-channel from October 23rd this afternoon and then bounced back up to it, leaving a back test and kiss goodbye. A drop below this afternoon's low, at 15574, would create a stronger sell signal.
Dow Industrials, INDU, 60-min chart
While the DOW is still working to reach its trend line across the highs from August-September, SPX has already climbed above its trend line, now near 1750. If SPX drops back below that line it's going to look like a failed breakout attempt and that would have many traders selling. A 5-wave move up for the rally from October 9th means the top could occur at any time now, at least for a pullback to correct the rally. But this top has the potential to be THE top as the final 5th wave of the rally from October 2011, which completes the c-wave of a big A-B-C move up from March 2009. Bernanke call or not, the market may soon call the Fed's bluff.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- stay bullish above 1750
- bearish below 1740
The 5-wave move up from October 9th is shown in more detail on the 60-min chart below. The 3rd wave was a tad shorter than the 1st wave, which means the 5th wave has to be shorter than the 3rd (EW rule saying the 3rd wave cannot be the shortest). Typically the 5th wave in this case is about 62% of the 1st wave, which is the projection at 1780.40. The very narrow up-channel from October 23rd was showing weak market breadth and only enough buying to keep the narrow up-channel intact (fitting well as a 5th wave). This morning's high was a quick throw-over above the top of the channel but it could not hold and then this afternoon it broke down from the channel, giving us a sell signal. While the DOW says we could go higher, SPX says we should be looking down now. The bottom of its up-channel will be near 1770 Thursday morning so any bounce up to that level that fails (back test followed by kiss goodbye) would be a good shorting opportunity.
S&P 500, SPX, 60-min chart
For the past 7 trading days NDX has been struggling near the top of its up-channel from June as well as the trend line along the highs from December 2012 - May 2013. It is leaving a series of red candles after making an early-morning high but then closing lower. It's a distribution pattern where we're seeing the rallies being sold into. Today's candle is a bearish engulfing pattern and looks vulnerable to reversal back down from here.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3440
- bearish below 3300
Watching the leaders of a rally is a good way to find clues as to how the rally is doing. If they continue to lead then it's wise to follow the trend. But when the leaders start to crack, typically on earnings or other announcements, we know there's profit taking occurring and that's often a signal that the market in general is close to topping. We've seen some of the high flyers start to crack and AAPL joined the group yesterday after a disappointing reaction to their after-hours earnings announcement on Monday. It was jammed back up and it gapped up Tuesday morning but was then immediately sold into and it finished with a bearish engulfing candlestick. Today it bounced but only made it up to its broken uptrend line from October 9th for what looks like a back test and kiss goodbye. The trend line will be near 531 Thursday morning if the bulls take another crack at it. If it drops from here we'll likely see the 20-dma and uptrend line from September 17th, both near 505, tested next.
Apple Inc., AAPL, Daily chart
The RUT was the weak sister today and that's not a good sign for the bulls. Fund managers have been chasing performance this month and getting into the more volatile small caps was a good way to capture some upside gain, all in the hopes they'll be able to get their funds to beat the S&P 500 (otherwise risk losing their jobs). But with the month/fiscal year coming to an end, those stocks will be the first to go and that's what we saw today. The RUT gapped up this morning and immediately sold off and sold off strong. As can be seen on its chart, today left a nasty-looking bearish engulfing candlestick and created a key reversal day. Doing so at trend-line resistance (and its 1119.49 projection for two equal legs up for its big A-B-C rally off the March 2009 low) and with a completed wave count has "SELL!" written all over this. Bounces should be sold and use today's high for your stop for now. Once we get a decline and then lower high you'll then be able to lower your stop to the lower high.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1124
- bearish below 1102
Bond yields have been consolidating since the lows on October 23rd and TNX (10-year) is sitting just above support near 2.46%. This afternoon's low, just before the FOMC announcement, was 2.473 but it jumped up to a high of 2.549 just after the announcement. The bond market was also a little surprised the Fed didn't use more soothing and accommodating language. If the Fed doesn't buy more then who will? That's the question bond traders are asking and they're obviously feeling a little nervous about it. But I continue to believe bond prices will climb back up and yields will drop. The question in my mind is whether yields will drop from here or after a higher bounce. We could see TNX bounce up to resistance at the top of its down-channel from September and its broken H&S neckline, both crossing near 2.63 around November 7th.
10-year Yield, TNX, Daily chart
With the DOW's closing high yesterday it finally made a new closing high above its September 18th closing high but it did not exceed its intraday high at 15709. That was accomplished today and that at least confirms the TRAN's new highs since October 18th. Just in time for a reversal in the TRAN. Like the RUT, the TRAN gapped up and then immediately sold off and closed lower, creating a key reversal day with its bearish engulfing candlestick. It's a common theme among several indexes today. The TRAN has failed at the top of a parallel up-channel from June, which makes for a very nice setup for the bears. Will they take advantage of it this time?
Transportation Index, TRAN, Daily chart
As mentioned earlier, the dollar spiked up following the FOMC announcement, banged into its declining 20-dma and then pulled back some. It left a long-legged doji for today's candlestick and it's sitting just above support at its H&S neckline at 79.61 (briefly broken last week) and just below resistance at its 20-dma at 79.92. I continue to expect a dollar rally but still waiting for proof.
U.S. Dollar contract, DX, Daily chart
Gold has stalled at its downtrend line from February-August, now near 1360 so the bulls need to break above that level and then hold above the line on any back tests. But there remains bullish potential if we see gold pull back and then launch higher (light green dashed line). I'm still leaning to the downside for gold, with an expectation it will drop to at least the 1155 area, but remain watchful for something more bullish into November.
Gold continuous contract, GC, Daily chart
I thought we'd get a bounce by now in oil, especially off its 200-dma, currently at 98.71, but now the 200 is acting as resistance (back-tested on Monday). That points lower still and the uptrend line from June 2012, near 91.80 by mid-November looks like a good downside target.
Oil continuous contract, CL, Daily chart
The large number of economic reports continues tomorrow, which includes before the bell the Challenger Job Cuts, unemployment numbers, personal income and spending and PCE prices, and then the Chicago PMI shortly after the opening bell. The market has been pretty much ignoring these reports but we're still in Bizzarro World where bad is good so we'll see how the market reacts to them.
Economic reports and Summary
On several indexes we have key reversals today, shown on the daily charts with the bearish engulfing candlesticks -- gap up, make a new high and then close below yesterday's prices. The indexes are up against potentially strong resistance and showing signs of weakening momentum and weak market breadth. At the very least we should see a pullback before the bulls try assaulting the lines of resistance again, with charged-up batteries after letting the poor bears eat something.
The longer-term pattern supports the idea that the high made here (wherever "here" is) will be the final high for the rally from 2009. I've said that before but we now have a "3 drives to a high" pattern following the August high. The new highs are showing bearish divergence and we're overbought on all time frames (monthly, weekly, daily). Bullish sentiment is near historical highs as they convince themselves that even if we do get a pullback it will be another good buying opportunity. Fear of a major decline is almost non-existent and that kind of complacency has been a dangerous time for the bulls in the past.
The July 16, 2007 high was followed by a minor new high on October 11th, which was 62 trading days later. We had very similar sentiment, overbought and market breadth readings as we have today. The market doesn't always repeat patterns but they often rhyme. This year's August 5th high has been followed by a minor new high, which is currently 61 trading days later. Is that close enough to mimicking 2007? That's the setup and now we wait for confirmation. In the meantime the bears should be getting ready just in case and the bulls should be very defensive.
Good luck and I'll be back with you for the weekend wrap to fill in for Jim who is currently tied up in knots with a move.
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