After starting the month in a bearish direction the indexes have been turned around since Monday's low and are making their way back into the green, except for the DOW Industrials and a couple of other indexes.

Market Stats

As can be seen in the table above, today's rally has provided the year's gains after yesterday's rally brought most of them close to breakeven. The DOW and OEX are two of the few indexes still in the red for the month. Is this an opex "adjustment" or are we headed for more new highs. At the moment it's looking like more new highs but the risk is a downside surprise.

We started the day with a small gap up this morning after futures rallied during the overnight session and then tacked on some more points for the first 90 minutes of trading. From there the day went flat but held its gains. Many analysts have been predicting SPX would reach 1850 and once that was done we saw a mixture of profit taking and more buying, which produced decent trading volume but it looked more like churning for most of the day. At least with the high-level consolidation it continues to look bullish.

The stronger sectors today were tech (again) and banking while the weaker sectors included retail, utilities and home construction. The DOW did some catching up today after lagging the other indexes this month but still has some work to do to get into new all-time-high territory as SPX and RUT have done, and multi-year highs for the techs (highly unlikely we'll see new all-time highs for the techs).

While prices are pushing higher, and the volume was decent today, we're seeing a continuation of the degradation in the market internals. As can be seen with the chart below, as the NYSE presses to new highs the peaks in the advance-decline line continue to produce lower highs and the 10-dma average is making a lower high. The number of 52-week highs is also declining and both of these indicators are pointing out the fact that the rally is happening on the back of fewer stocks, something typically seen at market tops as the buyers become fewer.

NYSE vs. Advance-Decline line and 52-week highs

Today's economic reports included the PPI numbers, which came in higher than expected at +0.4% vs. -0.1% in November. Economists expected +0.2%. The Fed is trying to stoke inflation and was probably pleased to see the higher number. The market should therefore have been displeased because it gets the Fed one step closer to removing more of their stimulus. They know (I hope) that once the inflation genie is let out of the bottle he/she is going to be fighting mad about staying in the bottle for too long. Trying to stuff him/her back in bottle is going to be a very difficult task for the Fed. At least that's what the market should have been worried about but this week it has a different agenda -- protect bullish options positions by driving the market higher.

The Empire Manufacturing index came in a lot stronger than expected and better than December. At 12.5 it was a significant jump up from 2.2, which was revised up from 1.0, and better than the expected 3.5. Again, the market should have been worried about what this will mean for the Fed's QE program but it has bigger short-term concerns. Next week will be different.

This afternoon the Fed's Beige Book was released and it showed the economy growing at a moderate pace from late November through the end of December. The Fed reported 8 of their 12 districts have seen increases in hiring. Some districts are reporting a slowdown in residential construction and home sales so the overall data is positive but not stellar, which is essentially what the Fed has been communicating to us.

While the new year started off weak we've seen a quick turnaround in the past two days and it's likely due to an effort to keep opex positive. Many trading firms sell naked puts and want to see them expire worthless so they can keep the premium. They have a strong interest in keeping this week positive and Monday's selloff looks like another successful head-fake move to pull in shorts and then use the short covering to help fuel another rally leg. Because of the manipulation in the market in this way it tends to leave the market vulnerable immediately following opex so we'll see how that's setting up by Friday.

I'll start off tonight's review with the RUT since it has a clear weekly pattern that says the rally could be ending soon. The pattern since the November 2012 low is a rising wedge and price is getting pinched between the top and bottom of it, now near 1181 and Monday's low near 1143. It's been a difficult wave count since there are a few options that work but I think the best fit is the one shown on its chart, which calls the rally from September the final 5th wave in the rally from October 2011, which in turn completes the c-wave of an A-B-C move up from March 2009. The 5th wave would equal the 1st wave at 1176.75, about 5 points above today's high. The risk for bulls holding on for more is that the pattern can be considered complete at any time.

Russell-2000, RUT, Weekly chart

The RUT's daily chart below zooms in on the final 5th wave (the rally from September 3rd) and with today's new high we've got a 9-wave move, which is an impulsive count (5 and multiples of 4 thereafter). That means the rally could be considered complete at any time. I show an expectation for a pullback and then final rally leg into next week with an upside target near 1185 but that won't become more apparent until we see whether or not the next pullback is corrective (pointing to another new high) or impulsive (pointing to a stronger decline developing from here).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1170
- bearish below 1130

The 5th of the 5th wave in the rally from October 2011, which is the rally from November, looks like a rising wedge within the larger rising wedge, which fits since the final 5th wave is often an ending diagonal (rising wedge) in a move that has gone too far for too long. It becomes a choppy move with all 3-wave moves as the bulls get tired and the bears get restless and itching for a fight. Each new high becomes weaker and momentum wanes, which is what we're seeing.

Therefore the expectation for the final 5th in the move up from November, which is the rally from Monday, should be a 3-wave move. That means a pullback from today's high and then another and final leg up, which is what I'm showing on the daily chart above and the 60-min chart below. The price projection for this final 5th wave is near 1185, which is where it would be 62% of the 3rd wave (a common relationship in an ending diagonal) and it would have the RUT hitting the top of its rising wedge next Monday. The Monday following opex is often a down day and therefore this Friday could be the end of the rally if this plays out as depicted. Bulls need to keep in mind that holding on for more could result in a downside surprise at any time.

Russell-2000, RUT, 60-min chart

There are a couple of different ideas that I have for the longer-term wave count and it's difficult to come up with one that stands head and shoulders above the others. When this happens I find trend lines and channels to be an effective way to watch how price reacts around them. As shown on the SPX weekly chart below, price has been pushing up against the top of a parallel up-channel for the rally from October 2011, which was tested again at today's high near 1851. It's possible it will not make it much higher but the top of a rising wedge (ending diagonal) for the 5th wave in the move up from June 2012 is currently near 1870 and that's upside potential from here.

S&P 500, SPX, Weekly chart

For an ending diagonal 5th wave in the move up from June 2012, each of the 5 waves inside the rising wedge pattern will be a 3-wave move (or something more complex and corrective). I show a projection for the 5th wave of the ending diagonal at 1871.25, which is where it would be 62% of the 3rd wave, a common relationship inside an ending diagonal. The final 5th wave of this ending diagonal should be an a-b-c move up from December 18th and the c-wave would be 62% of the a-wave at 1865.86. It could extend to equality near 1897 but I like the correlation near 1870 and the top of the rising wedge pattern, all of which cross on Friday.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1843
- bearish below 1810

Zooming in closer to look at the final 5th wave inside the ending diagonal, the 60-min chart below shows the a-b-c up from December 18th and the depiction of a 5-wave move up from Monday to complete the c-wave. I'm currently showing the rally finishing by the end of the day Friday near 1870. Considering the fact that the Monday following opex is typically a down day, this is an interesting setup for a possible top. But keep in mind that the pieces are now in place for the rally to be considered complete at any time.

S&P 500, SPX, 60-min chart

For the DOW I've been showing longer-term price projections at 16686 and 16702, which is where the move up from 2009 would have two equal legs (16686) and from October 2009 the c-wave would be 162% of the a-wave (16702). There are a couple of other projections lined up at 16600-16617 so I'll be watching that area closely if reached since we could see a final high there.

But I'm looking at a couple of other projections, which I've noted on the daily chart below, that point to 16782-16787 for a final high. The rising wedge pattern and the relationships between the 3rd and 5th waves provide compelling evidence that that's where the DOW is heading. That projection crosses the trend line across the highs from September-December early next week. Bears need to keep this possibility in mind until we get some evidence that a top has been put in (with an impulsive decline instead of the constant 3-wave pullbacks).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,620
- bearish below 16,240

With the new high for NDX, following the 3-wave pullback from December 31st, the rally from Monday fits well as the 5th wave in the move up from October. Because the 3rd wave is shorter than the 1st wave (the projection shown at 3608.98) it's typical for the 5th wave to be 62% of the 3rd wave, which is the projection to 3668. That projection crosses the top of its up-channel from June next Tuesday. The risk for bulls who hold out for more is that the 5th wave, with the new high, can be considered complete at any time and therefore a sharp impulsive move down would be a shot across the bow of the USS Bullship.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3610
- bearish below 3480

Bond yields have bounce over the past two days and the selling on bonds has helped the stock market rally. As expected, TNX bounced off its 50-dma and uptrend line from May-October but it should be just a bounce that leads to lower, as depicted on its chart below. Another minor new low from here would create a 5-wave move down from the high on December 31st, which would confirm a trend reversal. That would then set up another bounce, possibly for a back test of its broken uptrend line, before heading lower. This is the road map for yields and I'll be watching carefully for any detours and "recalculating route" messages.

10-year Yield, TNX, Daily chart

One of the reasons given for today's rally was the strong 4th-quarter results from Bank of America (BAC). That helped lift the entire banking sector and in turn the broader indexes. It's a case of following the money. But looking at BAC's daily chart has me wondering if this morning's gap up might have been an exhaustion gap that will mark its high. It rallied up to its trend line along the highs from March 2012 - July 2013 and then pulled back for the rest of the day, leaving a shooting star at resistance. If it quickly closes today's gap it will confirm a reversal signal. The wave count also looks complete -- there's a 5-wave move up from December 18th, which completes the 5th wave in the move up from September, which in turn completes the larger 5th wave in the move up from December 2011. Note the bearish divergence against the November high. This is not a stock I'd like to own long right here and might even think about a short position if it rolls over (or right here with a stop above this morning's high).

Bank of America Corp, BAC, Daily chart

The TRAN looks like it has a small rising wedge within a larger one, matching the broader indexes. The 5th wave in the move up from September would equal the 1st wave at 7553 and that's the level I'm watching to see if it's achieved and holds it back. The bearish divergence supports the rising wedge pattern from September and the smaller one from December. Keep in mind that rising wedge patterns tend to get retraced quickly.

Transportation Index, TRAN, Daily chart

The U.S. dollar's bounce off the December 18th low achieved two equal legs up to 81.32 (with a high of 81.33) on January 8th, pulled back to its crossing 20- and 50-dma's at 80.67 and today got a big bounce back up. If the bullish pattern is correct we should now see a strong rally into the end of the month before consolidating and stair-stepping higher. The dollar would turn bearish below 79.80.

U.S. Dollar contract, DX, Daily chart

Gold's bounce off its December 31st low made it up to price-level resistance near 1250 and its 50-dma near 1247 (currently near 1243). It could try for one more poke higher and tag the top of its down-channel from February-August, currently near 1260 but the pieces are in place to see another leg down, one which could drop gold down to about 1150 before finding a tradable bottom (one that could last for months if not longer).

Gold continuous contract, GC, Daily chart

Silver has the same pattern as gold -- a 5-wave move down from August with an even better defined 4th wave correction off its December 4th low. On Tuesday it briefly popped above price-level resistance at 20.50 and almost tagged the top of its down-channel, near 20.75 (currently near 20.65). The 4th wave pattern looks complete and should lead to another leg down. The 5th wave in the move down from August would be 62% of the 1st wave at 17.89 and for now that's my downside target. I'm using a shorter 5th wave because the 3rd wave is shorter than the 1st wave down. As with gold, once the downside target is reached I'll be looking for a buying opportunity in the metals.

Silver continuous contract, SI, Daily chart

Oil dropped down to its broken downtrend line from August, near 91.50, and is getting a little bounce, which could continue higher but I'm thinking oil's decline is just getting started. If it can get back above its soon-crossing 20- and 50-dma's, near 95.45 in a couple of days, I'd turn at least neutral but for now I'd watch that level for resistance if reached.

Oil continuous contract, CL, Daily chart

It's interesting to look at oil's chart with the log price scale instead of the arithmetic scale as above. Whereas on the above chart price dropped down to its broken downtrend line from August and is back above its uptrend line June 2012, notice the difference on the chart below. It dropped below its downtrend line from August and now back above it but it has run into its broken uptrend line from 2012 for what could be a back test, to be followed by a kiss goodbye and selloff.

Oil continuous contract, CL, Daily chart, log price scale

Tomorrow's economic reports include the weekly unemployment claims numbers, CPI data, the Philly Fed index and some housing data. Friday will be the big day for economic data but as always, it's difficult to tell how the market will react to any of it since it's a matter of trying to figure out whether or not it's Fed-friendly.

Economic reports and Summary

Monday's decline finished an a-b-c pullback correction from the December highs for the broader indexes and all except the DOW, OEX and maybe a couple of others have made new highs above their December highs. But while the pullbacks are becoming smaller, as traders jump the gun in buying the dip, each dip-buying episode is on weaker and weaker market internals. The dip buying is sucking the market dry of buyers and soon there won't be enough to lift the market higher. That's how tops are put in and sometimes the selling is not sparked by anything in particular but everyone starts to join in as profit taking begets more selling. That's what I think is close to happening.

This being opex week there has once again been a strong effort by trading firms to protect their bullish options positions. From a price pattern perspective we have the minimum form and price objects met to be able to call a market top at any time. That's what bulls need to be careful about. I see higher potential but the new price highs above December's are showing the kind of bearish divergence I would expect to see -- the momentum high in December followed by a test/minor new highs before strong selling takes hold. I see the potential for the market to rally into Friday and maybe even a couple of days into next week, although the Monday following a bullish opex tends to be a down day and that could trigger stronger selling.

Trade carefully here and don't let new highs make you complacent, especially if SPX makes it up to 1870-1875 and rolls over from there. That would be a good setup for the bears, which means a good setup to pull stops up tight on long positions. A break of the series of higher lows would be enough reason to get out of long positions at this point and therefore stops should be no lower than Monday's lows. Profit protection is key here.

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