Stock market indexes have pressed up to resistance, including previous highs, and consolidating. Whether it's a bullish consolidation or topping action will be known shortly.
Wednesday's Market Stats
The market started off near the flat line this morning but with a slight bump up at the open. That was immediately sold into and the indexes quickly closed their gaps. The DOW and SPX tested yesterday afternoon's lows (higher lows for NDX and RUT) and that was all the dip the buyers would allow. But other than the RUT, which was the stronger index today, the indexes chopped sideways as they consolidate near the highs.
Perhaps the market is holding up in front of Yellen's Senate testimony on Thursday or perhaps there's simply an effort to hold the market up into the end of the month. The bulls see the consolidation as a bullish continuation pattern but the bears see a topping pattern. It's all in the eye of the beholder (and what position you currently hold). Only price can tell us which it will be and we've got some key levels to watch for direction.
This morning's economic reports included New Home sales and they came in better than expected. At 468K the sales were an improvement over the upwardly revised 427K for December and much better than the 400K that was expected. This helped the home builders and the DJ Home Construction index got a +2.9% pop today, driving it up closer to its May 2013 high.
The only "economic" report the market cares about this week is the upcoming testimony from Janet Yellen to the Senate Banking Committee on Thursday. The U.S. dollar was up and gold was down today, presumably on expectations Yellen will not change her message from two weeks ago to Congress, in which she maintained the Fed's plan to continue their QE taper program. The stock market is not the sharpest knife in the drawer and it isn't getting the message if the dollar and gold markets are correct.
Yellen's previous testimony, on February 11th, created a little hiccup in the stock market's rally as it pulled back on the 12th but it didn't stop it from continuing higher. Perhaps market participants think the same thing will happen although most are now anticipating (hoping) Yellen will have had more time to analyze the economic data and tell us that the Fed is prepared to hold current QE levels (stop the taper), and maybe even hint of increasing the QE.
Is the stock market pricing in the hopes for more QE? The market would blast higher on that kind of news but one must wonder if the recent spate of bad economic news has the market drooling with anticipation that the Fed will be offering more help soon. However, if Yellen's message stays the same as it was 2 weeks ago, in which she stated the Fed remains confident in its forecast for growth this year, despite the reports of a slowing economy recently, there's likely to be a hissy fit from the market. Many would actually worry more if the Fed does not see trouble ahead after receiving more bad news about the economy.
The Fed's economic analysis, and therefore prediction, is based on very faulty economic models. For a bunch of supposedly bright academicians they're not very smart about this. If any of them took the time to measure the success of their own forecasts, which have maintained a nearly perfect record of being wrong, you would think they'd do something different. It of course reminds us of Einstein's quote about the definition of insanity as doing the same thing over and over again and expecting a different result (this quote might actually have come from Benjamin Franklin). Therefore, if Yellen doesn't change her message on Thursday it could spook more than a few market participants.
This subject brings me to the point about market forecasts and whether or not we should attempt to be market timers. The Fed's economists and most stock market participants are in fact market forecasters. Whether you are an investor solely through your company IRA or an active day trader, you have an expectation for the market and your money. Day traders tend to be more technical in their trading and they make predictions for both long and short plays. Most long-term investors tend to consider fundamental questions, such as the longer-term expectations for the economy and therefore market. With a long-term uptrend, including the secular bear market cycles, it's not hard to understand the value of regular monthly contributions to an IRA, especially if your retirement is decades away.
When you get into shorter-term market cycles that's when market timing becomes a little more important, especially if you're nearing the time when you'll need to take money out of the market. Market timing has a bad name and in a secular bull market it's generally much better to keep investing regularly since dips are good buying opportunities. But in a secular bearish market, which I believe we're still in, market timing is better than sitting through horrendous drawdowns. But it's how you market time that becomes the bigger problem.
With bear market cycles, and the time it takes price to recover, it could be painful to take your money out near the bottom of the cycle. If an investor thinks he'll need his money within the next 5 years it's better to think protection of capital rather than return on capital. So how do you know when to move into protection mode? Most money managers use fundamental analysis (FA) and use metrics such as earnings and P/E ratios to make longer-term investment decisions about stocks and the market in general. But what most don't understand is that FA is typically wrong at tops and bottoms. The market is typically way ahead of these metrics and that's why technical analysis (TA) gives traders an edge. Use both and you'll have a better-than-even chance of being ahead of the crowd.
Most fundamental analysts see relatively strong metrics at the moment, which is why we heard the majority at the beginning of the year talking about higher highs for the year. Practically no one predicted a market decline and not much has changed. Most use forward guidance from companies for earnings expectations but that's just a forecast. If TA is used by fund managers it's usually just an extension of the current trend. But by using some metrics to gauge the strength of the current move it's usually a much better way to determine how much more the rally might have. Using TA will of course not guarantee you'll find every top and bottom but it at least provides a warning that is typically not found using just FA. Those who are truly surprised by market tops and bottoms are typically those who use only FA.
One gauge for the strength of a rally or decline, and when it might be coming to an end, is to see how many stocks are participating. Since we've been in a rally I'll discuss the signals that tell us when it might be ending. All tops are made following the deterioration in the participation of individual stocks. As the broader stock market indexes make new highs they tend to do so on the backs of fewer stocks. You can see this in the number of stocks above their 50- and 200-dma's, or the number of stocks making new 52-week highs as the indexes make new 52-week highs, or in the number of stocks advancing vs. declining.
Looking under the hood, as I like to say, will often tell you how well the engine is running. A car's engine that loses a cylinder will run rough but it will still push the car up the hill. But lose enough cylinders as the spark plugs start to misfire and pretty soon the engine won't produce enough power. If you listen carefully you'll know the car's performance is weakening but a passenger might be fat, dumb and happy that the car seems to be doing fine making the hills. You, the driver, know to be ready to pull over to the side of the road so that you don't get rear-ended when the engine finally loses one too many cylinders. I think that's where we currently are in this rally -- the loss of one more cylinder is all it will take before the car runs out of enough energy to drive it higher up the hill.
One metric for the stock market, to see if it's firing on all cylinders, is the number of stocks making new 52-week highs while the indexes are doing the same. The chart below shows the new highs by the NYSE since its October 2011 low and the corresponding number of individual stocks making new highs. Other than the higher spike in October 2013 the number of new highs has been deteriorating since early last year. The 10-dma of this measure made a lower high in December vs. the high in March 2013. We've seen a dramatic decline in number of new highs since last October while the NYSE has continued to march higher. The car is continuing to push up the hill and the passengers are feeling good but the engine is getting weaker as it loses more cylinders. This is obviously not a market timing tool but it does provide us a warning. When the top is in it is we who listen to the market who will have seen it coming.
NYSE vs. New 52-week highs
When we combine the use of market breadth measurements, such as new 52-week highs (or lows), with other technical tools, such as trend lines/channels, EW (Elliott Wave), Fibs, cycles, etc., we can get a better sense about the technical picture of the market. The chart of NYSE looks like a healthy rally and therefore bears need to stay cautious. But what's happening under the hood is a warning for bulls to get conservative in their trades and to be thinking about protection. When price breaks support we will have been warned to expect it and to make trading decisions based on expectations for something more than just a small correction and perhaps move away from the buy-the-dip crowd (who are utterly convinced by now that that is the winning trade).
Another under-the-hood measurement is to look at the number of stocks participating in the rally. How many stocks are even advancing vs. declining while the broader indexes climb to new highs? Tops are made when the number of stocks participating in a rally is outnumbered by the number of stocks declining. Many stocks are already in established downtrends before the broader indexes make their last high. Look at AAPL (its bounce correction peaked in December). But while AAPL is in a downtrend GOOG is pressing higher and helping NDX do the same. So we want to see how many stocks are helping vs. how many are hurting the bull's efforts. The chart below shows one way to look at it.
NYSE vs. Advance-Decline line
Similar to the chart of new 52-week highs, the chart above shows NYA testing its December-January highs while the a-d line makes lower highs. Fewer stocks are participating in the index's test of its highs. That negative divergence is another warning sign. The lower high on RSI also shows the slowing momentum of the move and the retest of the high by NYA has a good chance of failing and creating a double top if more buyers don't soon rush in.
So we have our warning signs (there are plenty more but you get the idea) but as always price is king. You don't make money (or lose it) on anything but by betting on a price move. So let's get to the charts and see what price is telling us. Following the weekly chart of NYA above, the daily chart below shows Monday's high at 10426 was a back-test of its broken uptrend lines, one from June-October 2013 and the other from October-December 2013. Those lines are slightly above the 2007 high at 10387 and the December high at 10406. Between the price-level resistance and the broken uptrend lines it's going to be a hard nut for the bulls to crack, especially after expending so much energy in the spike up from the February 3rd low. Obviously it would be more bullish if NYA can stay above 10400 but until proven otherwise it's a resistance level.
NYSE Composite index, NYA, Daily chart
Key Levels for NYA:
- bullish above 10,400
- bearish below 10,100
SPX looks very similar to NYA as it tests its December-January highs. At the same time it's pressing up against its broken uptrend line from August-December (which ignores the poke below the line in October). There's a projection to 1887 where the 5th wave in the move up from June 2013 would equal the 1st wave so if there's a jubilant response to Yellen's testimony we could see a flare-up and what I think would be a blow-off top on news, likely finishing early next week.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1850
- bearish below 1738
The 60-min chart below shows two different perspectives. The up-channel from the low on February 13th is still holding and a move up to the top of the channel by Friday could see SPX make it up to 1875. The wave count is a little challenging at the moment but another new high with a continuation of the bearish divergence would give us a high-confidence setup for a reversal. The bearish view here is that price action is forming a rolling top. A break below the last Thursday's low near 1824 would be a stronger indication that the top is in place, which would support the bearish view. It's bullish until proven otherwise but from here I see limited upside potential vs. significant downside risk.
S&P 500, SPX, 60-min chart
If we get the leg up to 1875, maybe 1887, by Friday or next Monday, we could see another market high on a new moon, which is this Saturday.
SPX MPTS daily chart
While most other indexes are testing/exceeding their December-January highs, the DOW remains the laggard. On Monday it came close to achieving a 78.6% retracement of its decline, at 16321, with a high at 16300. It's either consolidating for another leg up and could head for its trend line along the highs from 2000-2007, which is currently near 16600. I have my doubts about that happening but never say never with this market. The bears could start to pounce harder if the DOW breaks below 16100 and it would be more vulnerable to stronger selling below 16000.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 16,321
- bearish below 16,000
Since February 18th NDX has spent its time nuzzling up underneath its trend line along the highs from September 2012 - December 2013 and it did so again today. It has more red candles than white as it keeps testing the trend line, an indication that there is inventory distribution going on. Retail traders keep buying the highs while fund managers sell into the rallies. The waning momentum and bearish divergence at the minor new highs is another warning sign. It's not a guarantee for a decline from here since all it would take is a gap over resistance and take off to the upside as the shorts scurry with their fur on fire.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3711
- bearish below 3640
I've also been anticipating NDX will achieve its price projection at 3711, where the c-wave in the a-b-c move up from October 2013 would be 62% of the a-wave, and it has managed to work its way closer, rallying from a high at 3685 on February 18th to today's high at 3702. That's 6 trading days to climb 17 points so about 3 points per day. At that rate it should reach 3711 (9 points higher) in another 3 days, just in time for a final high on March 3rd (to get us through February and into the new month and a final high near the new moon). This is said tongue-in-cheek but it's a possibility.
Actually the possibility for NDX to make it higher took a hit this afternoon after it sold off and broke below a rising wedge pattern from its February 13th low. This pattern calls for a quick selloff back to the February 13th low near 3600, bounce and then a continuation lower. Of all the charts reviewed tonight, the NDX has me feeling the most bearish.
Nasdaq-100, NDX, 60-min chart
As bullish as the RUT has been lately, including today's relative strength, its chart also has me feeling bearish here. It achieved the price projection at 1187.47, with a today's high at 1188.05, where it has two equal legs up from November 2012 (to complete the 2nd a-b-c in a double zigzag correction off the 2009 low). It then sold off in the afternoon back below its broken uptrend line from November 2012, an important trend line that broke in January. Its January 22nd high at 1182 was tested today as well and the combination of a double top with a back test of its broken uptrend line should have bears licking their chops here. Only in hindsight will we know if the setup will work for the bears but it's one of those setups that you almost need to take without thinking, set your stop and then let the market tell you whether you're right or wrong.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1188
- bearish below 1147
The U.S. dollar got a bounce today, presumably on expectations that the Fed will maintain their course heading in tapering their QE program over time, which reduces worries about inflation and in turn strengthens the dollar. We'll soon find out if the currency market has better soothsayers than the stock market and at the moment it could go either way. It remains below its crossing 20- and 50-dma's, which haven't been that helpful anyway, and its uptrend line from 2011-2013, which has been holding on multiple tests. Currently near last week's low at 79.95, that's a level that should not break if the bullish pattern is to remain alive.
U.S. Dollar contract, DX, Daily chart
On Monday gold hit its upside projection at 1335.90 for two equal legs up from December 31st. The c-wave, which is the leg up from January 30th looks like a completed 5-wave move and the 5th wave equals the 1st wave at 1344.10, also shown on its chart below. That level was achieved with this morning's high at 1345.60 and it then promptly sold off and closed near 1330. It fits as an important reversal and if the a-b-c bounce off the December 31st low is the correct interpretation of the pattern we'll see gold head for a new low, with 1155 a downside target.
Gold continuous contract, GC, Daily chart
Silver achieved the price projection at 22.12 with a high at 22.18 on Monday, which is where the c-wave of the a-b-c bounce off the December 31st low is 162% of the a-wave. The selloff from there, especially with today's strong decline, is the start of the next leg down if the bearish wave count is correct. But until it breaks below 20.40 there is the potential for just a pullback that will lead to another rally and above Monday's high would now be a bullish move.
Silver continuous contract, SI, Daily chart
Oil remains bullish as long as it stays inside its up-channel from January 13th, the bottom of which it tested Tuesday and again today. Currently near 102, that's the level it needs to stay above. Otherwise a break of its uptrend line could result in another swift selloff, similar to what happened after breaking its uptrend line in December. If the bulls push oil higher I continue to see the price projection at 105.77 as an upside target.
Oil continuous contract, CL, Daily chart
Tomorrow's economic reports include the unemployment claims and Durable Goods orders before the open and natural gas inventories after the open. With the brutal winter much of the country is experiencing, it will be interesting to see how much the inventories have been drawn down. There's an expectation for an improvement in durable goods orders but only "less bad." More than likely the only news the market will care about will be Yellen's testimony Thursday morning.
Economic reports and Summary
The only thing the market will likely care about Thursday morning is whether or not Yellen will loosen the purse strings by backing away from the current QE taper expectations. If there's no hint that she's on the verge of reversing the taper we could see a hissy fit from the stock market. A temper tantrum in the hopes of changing Yellen's mind is a possibility and it's a tool that will be used often in an effort to affect the Fed's policies. Keep in mind that more than half our representatives are millionaires and they're invested in the stock market. A stock market decline would get them excited and clamoring for the Fed to do something. The Federal Reserve is supposed to be apolitical but you know they hear Congress' whining and try to respond and keep the tight relationship between Wall Street and the government intact.
With the indexes pressed up against resistance and showing waning momentum it's not hard to see it as a topping pattern. But we've seen this before and have watched the buyers step back just in time to drive it higher and drive the shorts out. If we get another push higher into the end of the week I've shown some upside targets to watch for possible highs in the next few trading days. But keep in mind that many important highs in the past were created this way -- what looks like bullish consolidation suddenly breaks down instead.
The price patterns for NDX and RUT have me feeling tops got put in today and a down day on Thursday could be followed by a bounce on Friday but next week could be very weak if that pattern plays out. A rally into next Monday, especially if upside targets are achieved with a rally from here and into Monday, watch carefully for the possibility that it will be the last gasp for bulls before the bears stomp on them.
Be ready for either direction but if you're trading the long side I'd suggest keeping one foot propping the exit door open. I think it's going to get crowded when someone yells "SELL!" and a lot of traders are going to get stuck holding the bag and without a chair when the music stops.
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