The trend of a weak DOW against strong techs is highly reminiscent of what we saw in October 2007. Bulls need to prevent a repeat performance.
One look at the chart above and the Y-T-D performance and you get the picture. The Nasdaq is up +1.6% while the DOW is down -1.2%. That's not a healthy split as a bifurcated market like this is commonly seen in a topping or bottoming market. I could be wrong but I don't think the market is bottoming here.
One the one hand, a strong showing by the techs and small caps is very bullish. It means fund managers are feeling bullish and want more exposure to the riskier stocks. That's bullish for the broader market since it means they've got money to put to work. On the other hand, if the market is in fact topping and the late-to-the-party bulls are scooping up as much of the riskier stocks as possible, it's a sign of upside capitulation. The downside to that is those same riskier stocks could be dumped in a hurry if things start to go south. Lots of new buyers could turn quickly into strong sellers.
We of course can't know if the market is topping here but without the DOW, or even SPX and some of the other broader market indexes, participating we have a warning sign. We've seen this picture before, such as at the October 2007 high where the tech indexes topped almost 3 weeks (14 trading days) after the DOW and SPX topped. While SPX made a minor new high above its December high at 1849.44 (with a high on January 15th at 1850.84) it continues to struggle below 1849 and today's choppy rally looked weak, not strong. The DOW of course has still not been able to top its December 31st high.
The day was on the quiet side today since there were no exciting economic reports, no Fed statements and no big earnings surprises. So I'll simply jump into the charts to see what they're telling us.
With the DOW being the weak sister this month I thought I'd take a closer look at its charts to see where it might be heading from here. Its weakness reminds me of what we saw at the 2007 high and its early breakdown turned out to be a very good warning for the rest of the stock market. In fact NDX made a new high in October 2007 that was 14 trading days after the DOW's high and today is 14 trading days beyond the DOW's December 31st high. And the 1929 analog pattern for the DOW continues to hold (as long as it doesn't rally to new high in February). Bulls are complacent and the price patterns look close to completion and as I'll review later with the NDX charts, now is a dangerous time for bullish complacency.
The DOW's weekly chart shows how price appears to be consolidating beneath strong resistance at its trend line along the highs from 2000-2007, which was tagged at its December 31st high (it had closed above the line on that day but quickly gave it back the next day). The line was tested again on January 7th and Tuesday's high at 16520 it stopped about 40 points shy of tagging it again. As shown on the chart, there are two longer-term price projections based on the wave pattern that point to 16686-16782 so by those projections there is additional upside potential.
Dow Industrials, INDU, Weekly chart
The DOW's December 31st high at 15588 missed a lower price projection at 15599 by only 11 points. This is where the 5th wave in the move up from October 2011 equals the 1st wave (one of a couple of different wave counts for that rally leg), which was a reason I suggested the December high could be the final one. Now the question is whether the choppy price pattern since that high is a bullish consolidation pattern or topping action. We've seen many tops get put in place just like this -- the bullish consolidation (bull flag) suddenly fails to the downside instead (failed patterns tend to fail hard). We have no evidence yet as to which way this is going to go, hence my words of caution over the past couple of weeks. But I think downside potential is significantly more than upside.
As shown on the chart above, there is additional upside potential if the DOW is to rally up to the top of its parallel up-channel for the rally from October 2011, currently near 16800. And on the daily chart below there are a few projections ranging from 16603 up to 16787. A trend line along the highs from September-December will be near 16850 by the end of the month. So while trend lines and price projections are not correlating in a tight price range, there is clearly some upside potential remaining if the bulls can get the DOW above 16600 and keep it above. But if the DOW drops below the January 13th low at 16240, which would also confirm a break of its uptrend line from October-December, currently near 16290, I think the fat lady would be singing the blues for the bulls.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 16,600
- bearish below 16,240
One stock I consider a very good proxy for the economy, due to the breadth of its business (financial to manufacturing), is General Electric and right now it's not a bullish signal. It was down again today, making it the 12th down day out of the past 14 (since its December 31st high) and it's working on its 4th down week in a row. The December 31st high at 28.09 reached a tight price projection zone at 27.99-28.23, which I show on its weekly chart below. The projections are based on wave relationships in its rally from 2009 and the close correlation near 28 is a reason to take notice.
General Electric Corp., GE, Weekly chart
In the $28 target zone for GE is also the 62% retracement of its 2007-2009 decline (at 28.23) as well as the top of its parallel up-channel for the rally from June 2012, tagged at the December 31st high. A 5-wave move up from September 3rd has been confirmed complete with the decline below the pullback into the December 4th low at 26.20. The only thing needed by the bears now is a drop below 25.99, which is where the decline from December 31st would have two equal legs down for a possible a-b-c pullback, to be followed by another rally. That possibility can't be ruled out yet. GE closed at 25.99 today and the bulls will want to see an immediate rally begin on Thursday.
SPX hasn't been as weak as the DOW but it hasn't been as strong as the techs and small caps. Following the 3-wave pullback from December 31st into the January 13th low it had an impulsive rally into the January 15th high and a choppy consolidation since then. This kind of pattern points higher and I've remained short-term bullish because of it (at least not bearish). But if you're in long positions I'd be sure to keep your foot holding the exit door open and be ready to bail at any moment. For now I've been suggesting the January 13th lows as stops on long plays since below that level would turn the pattern bearish.
The price pattern I'm considering for SPX calls for just one more leg up from January 13th to complete an a-b-c move up from December 18th (to complete the 5th wave in the move up from August). The c-wave would be 62% of the a-wave near 1866 and the 5th wave in the move up from August would equal the 1st wave at 1870, which gives us a price target zone at 1866-1870. A trend line along the highs from September-November will be near 1885 by the end of the month, which provides a higher target if there will be an effort to close the month at a high. The bears want to see SPX break its January 13th low at 1815 and then price-level support near 1811, both of which would confirm a top is in place.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1843
- bearish below 1810
Notice also on the daily chart above how price is struggling at the top of its parallel up-channel from October 2011 (green line). It briefly popped above it in late December and tested it again on January 15th.
Moving in closer, the 60-min chart below shows another price projection near 1868 for two equal legs up from January 13th, which coincides nicely with the other projections for a target zone at 1866-1870. We'll have to see how the price pattern develops over the next few days to see if higher potential is warranted. The first sign of trouble for the bulls would be a break below Tuesday's low at 1832.
S&P 500, SPX, 120-min chart
The techs have been on fire for a while, as I'll review with the relative strength charts following the Nasdaq's chart below, which is warning a top could be at hand. Shown with the green trend line on the COMPQ daily chart below, it starts from the April 2010 high and runs across the February 2011 high. It was tagged today at the high at 4246. At the same level is the top of its parallel up-channel for the rally leg from June. The bearish divergence against the late-December highs, as it's hitting potential trendline resistance, is not a time I'd want to be adding to long positions. If anything, a rollover from here would have me testing the short side. One more upside target, if the bulls keep up the buying, is at 4271, which is the 78.6% retracement of the 2000-2002 decline (not a bad recovery, even if it's taken more than 11 years to do it).
Nasdaq Composite index, COMPQ, Daily chart
Key Levels for COMPQ:
- bullish above 4285
- bearish below 4098
I mentioned a setup is at hand for the bears to short the techs. The first question to ask is why you'd want to short the techs since they've been exhibiting the most strength, and that's a very good question. But when I look at the relative strength charts of the COMPQ vs. the DOW (the weaker index), I see the potential for the techs to start leading to the downside, assuming of course the market is ready for a more serious decline, which is yet to be determined.
The weekly chart below is a relative strength (RS) chart of the COMPQ vs. the DOW. You can use technical analysis tools on RS charts the same way as any other symbol. The takeaway here is that the new highs in RS since October are showing significant bearish divergence, which means the RS of the COMPQ could be close to reversing.
RS of COMPQ vs. DOW, Weekly chart
Looking at the move up since the pullback into November, when the Nasdaq pulled back faster than the DOW, we have two equal legs up that was achieved today and the 2nd leg (up from January 6th) is a 5-wave move, which means it can be considered complete at any time. It tagged the top of a little parallel up-channel from November at the same time. The setup here is for the RS chart to at least pull back.
RS of COMPQ vs. DOW, Daily chart
If the RS chart is setting up for a pullback it means the DOW will either start to outperform the Nasdaq to the upside or the Nasdaq will outperform to the downside. If the broader market is nearing the point of reversing to the downside then the Nasdaq will outperform to the downside, which is the reason I stated above why shorting the techs could work nicely when the market turns back down. But keep in mind that this is only a setup -- we have no indication yet that it's going to turn back down from here, just a warning it could happen.
Looking through a few tech stocks in after-hours I noticed NFLX is up big -- about +60 to 393 after reporting earnings. Somebody liked what they heard (or more likely some shorts didn't like what they heard). EBAY also jumped up about +7 to 61 but pulled back and is trading about +3. This has the NDX futures up in after-hours so the march higher could easily continue on Thursday (just be careful of another gap n crap as fund managers sell into the rallies).
The small caps have been on fire as well as the techs and the RUT is now once again approaching the trend line along its highs from September 2012 - July 2013, which stopped the rally at the end of December. It will be near 1185 Thursday morning and considering the bearish divergence showing up against the late-December high I think there's a good chance the trend line will hold as resistance. On its daily chart below I show a continuation up to a price projection at 1192.72 but the upside target zone is 1177-1193 and with today's high at 1182 it's in the zone.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1170
- bearish below 1142
For the RUT's rally from November I'm counting it as an ending diagonal 5th wave, which means each of the 5 waves is a 3-wave move. The only reason this is potentially important now is because the leg up from January 13th should be an a-b-c and that means the leg up from last Friday is the final one. The 2nd leg (wave-c) would be 62% of the 1st leg (wave-a) at 1185.23 (equal at 1196.64, shown below on the 60-min chart as well). The 5th wave in the move up from November would be 62% of the 3rd wave, a common relationship in an ending diagonal pattern (rising wedge), at 1184.47. So we've got nice Fib correlation near 1185, which is also where the trend line across the highs from September 2012 - July/August 2013 is located on Thursday. Heads up because this is a net setup for a reversal. Not a guarantee, just a setup.
Russell-2000, RUT, 60-min chart
Bonds look to have confirmed their reversal after a 5-wave rally off the December 31st low, as shown on the TLT chart below. This calls for a pullback to correct the 5-wave move up but then another leg up. It's too early to tell if we'll get just a larger a-b-c bounce or the start of a more significant rally. I lean toward the latter but we'll have to see how the pattern develops into February.
20+ Year Treasury ETF, TLT, Daily chart
The TRAN is another index that needs to be watched carefully from here. Its new highs in January have so far produced a bearish non-confirmation with the DOW and if the DOW can't do some catching up in the next few days we could see the TRAN turn back down instead. A 5-wave move up from September can be called complete at any time, especially since today it achieved 7553.79, with its high at 7554.97. This is the projection where the 5th wave equals the 1st wave and at the same time it tagged its trend line along the highs from August-December. Not shown on the daily chart below is another trend line along the highs from late-December and January 13th, which crossed the other trend line this morning. Once again, this is a very good setup for a reversal and the only thing the bears need is confirmation with an impulsive decline, something which the bulls have prevented in every pullback. A drop below last Friday's low near 7405 would be the first sell signal.
Transportation Index, TRAN, Daily chart
It's been a choppy rally so far off its December low but its 20- and 50-dma's held as support on last week's pullback and now it's testing its 200-dma at 81.56. It should push above that and challenge the first price projection at 82.02, along with the top of an internal up-channel near the same level (light green on the chart). It takes a break below its 50-dma at 80.72 to turn the pattern potentially bearish (at least a lot choppier).
U.S. Dollar contract, DX, Daily chart
Gold's bounce off its December 31st low made it past its 50-dma and up to the top of its down-channel from February 2013 on Tuesday. But that's as far as it got and now it's back below its 50-dma near 1237. The larger pattern suggests another low is coming, potentially down to at least 1150 (maybe 1100) before setting up a larger bounce/rally.
Gold continuous contract, GC, Daily chart
Oil successfully back-tested its broken downtrend line from August and has now made it back above its 20- and 50-dma's near 95.50. The bounce off the January 9th low has two equal legs up for what is so far just a sharp a-b-c bounce correction to its decline. If the pattern is to remain bearish we should see oil head back down from here. A rally above its 200-dma, that stays above it, currently at 98.93, would be a bullish move.
Oil continuous contract, CL, Daily chart
Tomorrow's economic reports will be a little busier than this morning's single report but other than the existing home sales there's probably not much there that will move the market. Earnings is the biggest mover right now.
Economic reports and Summary
Thanks to NFLX and EBAY and possibly a couple of others that I haven't looked at this evening, it's looking like we'll start the day with another gap up on Thursday. Just be careful of these gap moves -- it's looking like some fund managers are taking advantage of them to sell into in an effort to unload some inventory to the excited retail traders (which includes a lot of mutual fund managers). And if there is no rally out of the gate, leaving new highs in the futures but not the cash index, that would be one of the first bearish signs.
Continue to respect the upside for this market since the bulls haven't done anything wrong yet. But at the same time I trust the bulls about as far as I could throw one that's been fattened just before slaughter. The month of January is critical -- if we make it past the first week of February with no significant pullback (more than a couple percent) I think we will have passed the danger zone. But until then I see too much lined up right now, in time, price projections, trend lines/channels and wave counts, that suggest a major high is close at hand (one that will stick for many years to come).
If you're long just keep pulling your stops up below the previous higher low of the price pattern. My only concern, until we get past the danger zone, is that some morning could open with a wickedly nasty gap down (and over your stops). Downside risk is huge, imo, compared to upside potential. But bears do not have any kind of green light to enter into short positions yet. To do so is pure speculation, which is fine with something like put options where you know exactly how much you're risking. But not shorting stock or futures without stops. There will plenty of opportunities to play the short side and there's no reason to rush trades. There are plenty of reasons right now why flat is a good position; boring but good. Trade carefully for the next week since it's looking like it could be pivotal.
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