The rallies are getting weaker but the pullbacks are getting bought, creating a market that wants to rally but one that's struggling to find new buyers.
Wednesday's Market Stats
The bulls snatched the ball away from the bears (again) this morning after the market started in the hole. The DOW finished marginally in the red and SPX was just barely in the green. But the techs and small caps did a little better as the dipsters went to work on their favorite higher-beta plays. As I'll get into below, that buying in the riskier stocks is actually a dangerous sign at this point but for now they're certainly frustrating the bears and that might not be finished yet.
I'm starting to hear more chatter about the numbers of retail traders coming back into the market. Most report this as a good thing since "it shows the health of the stock market." It helps the stock market when more people participate in the stock market since it certainly helps with trading volume and shows an overall higher level of bullishness (retail traders are almost universally bullish). But market professionals also know excessive enthusiasm from the retail crowd can be an indication that things are coming to an end. A spurt in retail activity typically comes from the late-to-the-party crowd and therefore can be used as a contrary indicator.
TDAmeritrade keeps track of retail trader sentiment with some proprietary measurements and then plots the index on top of the S&P 500 chart. They call it their Investor Movement Index (IMX), which is shown on their chart below and it's something they've been tracking since January 2010. While it doesn't include the complete cycle since the 2007 market high, it gives us a good idea how retail traders have been reacting over the past 3 years. And right now they're bullish to an extreme. The index closed February at 5.74, which is higher than the peak just before the May 2011 flash crash.
TDAmeritrade's Investor Movement Index (IMX), chart courtesy TDAmeritrade IMX
That little May 2011 flash crash scared traders and you can see the sharp decline in IMX into the end of the year, after the stock market bottomed in November. While SPX climbed above its May 2011 high back in March 2012 it took traders until December 2013 until they were feeling better about the market than they had at the May 2011 high. Now trader sentiment is at an extreme high as the market is pushing to marginal new highs and it's important to note that trader sentiment lags the market (traders are late to recognize a trend change).
TDAmeritrade noted that retail traders have been adding to their positions during the latest volatility. In other words they're fully on board with the dipster mentality. There is very little fear that the market will suffer any extended selloff and the retail traders are making maximum use of their margin accounts to buy more. With a chart like the one above and margin debt at all-time highs we have a dangerous cocktail that could quickly turn into a Molotov cocktail thrown by the bears.
I've recently discussed the extreme low in the percentage of bears in the AAII survey, a low not seen since just before the 1987 stock market high. Even at the 2000 high, with all of the dot-com craziness, and the 2007 high, when people were feeling very bullish about their housing prices, there were still more bears than at today's market highs. There's simply very little fear and retail traders are buying each small dip with no fear of the consequences.
Most probably think they can simply jump out of their long positions quickly if and when they have to. But what most do not appreciate is how quickly the market's liquidity can suddenly evaporate. When a massive number of sellers hit the tape all at once and there are not enough buyers to absorb the selling we have the setup for a flash crash where the computers go looking for the nearest buy order, which happens to be a few thousand feet below the current level at the time. Big air pockets suddenly develop and people stare at their screens in disbelief, wondering what caused it.
What many do not understand is that a significant decline is usually not the result of a major catalyst, although that could spark things to come unglued in a hurry. Instead, the market usually just peters out from lack of momentum when there are simply not enough buyers to keep things going. Some selling starts and that triggers a few stops, more selling and that triggers margin calls, much more selling follows as traders are now forced to sell and pretty soon what looked like an orderly pullback, one that was being bought on margin by the retail crowd, lets go with a bang. It's the Minsky moment.
Are we near a Minsky moment? That's the thing -- we never know until we see it in hindsight (although it's recognizable when the market enters freefall). But with bearish sentiment near all-time lows, retail traders flocking back into the market as the market presses to new highs with bearish divergence, and margin debt at all-time highs, it's not difficult to see now is not the time to be complacent about the upside.
Having said all that, I do see the potential for at least a little more upside and we might see the market hold up through another opex week but again, don't get complacent about it. If the market does not hold up through next week I think it's very vulnerable to a downside disconnect. If opex is not bullish it tends to be very bearish as the multitude of hedge funds who sell puts for the option premium are forced to frantically protect their positions. Either buying back the puts or hedging with a short sale, both add to the selling pressure and if all those in long positions are suddenly hedging/closing those positions it can lead to strong selling.
With the current vulnerability of the market, if stronger selling were to kick in next week, another flash crash is not out of the question. In other words, I see this current opex week as a particularly dangerous time for the market because of what opex selling could spark. Just be careful with your positions and remember that stop limit orders are no good if the market opens up with a gap below your stop. And stop market orders can hammer you with the worst fill of the morning. In other words, depending on stop orders to protect you might end up simply disappointing you. Buying some put insurance, at least through next week, is not a bad idea. Give up a small percentage of upside potential to enable you to handle some downside while working to get out of some of your long positions. Food for thought.
Earlier I mentioned margin debt exceeding levels seen in 2000 and 2007 while bearish sentiment hits near all-time lows and another sentiment indicator can be seen in the number of stocks going public that are not making any money. Jason Geopfert, sentimentrader.com, recently wrote an article stating 74% of companies that went public over the past 6 months were not profitable. This is the highest percentage since March 2000, at the peak of the dot-com bubble when about 80% were not profitable. We of course know what happened after that bubble burst.
Last Thursday, March 6th, we celebrated the 5th anniversary of the bull market. From the March 6, 2009 low at 666.79 to last Friday's high near 1883, that's a 182% gain in 5 years. Not bad. Of course the same gain was made in half the time when SPX rallied from its spike low at 855 in October 1997 up to its March 2000 high at 1553. In fact the 5-year rally from March 1995 to March 2000 was about 1070 S&P points for a +224% gain. Now THAT was a rally. This one from 2009 has been pretty good but most of it only gained back what it lost in the 2007-2009 decline. Since the March 2000 high we've seen March as an important turn month so it will be interesting if we see a market high before the end of the month. I think the top that's coming will likely last for many years. Here is a list of previous March turns:
2000 -- completion of 1982-2000 rally
2001 -- significant low followed by large spike back up before continuing lower
2002 -- significant high followed by the strong decline into the 2002 low
2003 -- low that led to rally into 2007 high
2007 -- low followed by spike up into July 2007 high
2008 -- last dip in 2008 that led to strong bounce into May 2008 and then down hard
2009 -- significant low that led to the current 5-year bull market
2014 -- completion of cyclical bull market?
We've also got an interesting alignment of days from the market lows to the completion of the cyclical bull markets. The previous cyclical bull, from the October 2002 low to the October 2007 high, lasted 1827 calendar days (5 years + 1 day), which was 1259 trading days. Now we've got a March 2009 low to a potential March 2014 high and the same 1827 calendar days and 1259 trading days from March 6, 2009 gives us March 7th. So far that high still stands and the next day or two should tell us whether it will have a good chance of standing for a long time or not.
Along with some sentiment measures that tell us to be cautious about further rally expectations, there are several market breadth measures that are also warning us that the rally is running on fumes now. The 3 charts below show a weekly view of the NYSE Composite index at the top, the number of 52-week highs in the middle and the number of advancing stocks at the bottom. Significantly, the number of new annual highs as well as the number of advancing stocks are both declining as the rally heads for a high (if not already there). Fewer and fewer stocks are participating in the new price highs. The wave count on the NYA says we're in the final 5th of the 5th wave and by that count suggests we should be looking for a high. The waning market breadth says we should be looking for a high. And the sentiment provides the contrarian perspective that says too many have turned too bullish just as the market is running out of steam. The pieces of the puzzle fit for a market top and then only thing we have to do now is find it!
NYSE vs. 52-week highs and Advancing Issues
So with that background, let's get to the charts and see what's setting up in front of opex week and where that elusive top might be. The DOW is lagging the others by not yet making a new high above its December high but it's looking like it might be able to finally do it if the market stops its pullback here. I'll start off with its weekly chart to remind you of the dual price projections pointing to the 16700 area, which I thought might get hit back in December. These projections are based on wave relationships in the rally from 2009 and the leg up from October 2011. But the December rally stopped at its trend line along the highs from 2000-2007, which is currently near 16615. It gives us a relatively wide target range of roughly 16600-16700. From a weekly perspective the bulls are not in trouble until price drops below the February 5th low near 15340. Note the current warning from the significant bearish divergences on MACD and RSI.
Dow Industrials, INDU, Weekly chart
The daily chart below shows a depiction for a rally up to the 16700 area next week (or it could go slower and chop its way higher into the end of the month). But based on the break of its uptrend line from February 5th, currently about 60 points above today's close at 16340, we might have seen the high last Friday (which would fit the 5-year turn date mentioned above). The bulls need to keep up the buying pressure and today's little bullish hammer candlestick could be pointing the way for the bulls. They certainly need to reverse the oscillators from rolling over here, especially with the bearish divergence noted on the weekly chart. We should find out in the next day or two which team is going to pull the strongest.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 16,460
- bearish below 16,070
Moving in closer to look at the rally from February 5th, the 60-min chart shows clearly how it's "bending" over and creating what looks like a rolling top. Between the appearance of a rolling top and today's break of the uptrend line from February 5th (and the little bearish back test this morning), this is vulnerable to a breakdown from here. Today's short-term pattern suggests we'll get at least another leg up for its bounce off today's low but two equal legs up at 16403 would coincide with another back-test of its broken uptrend line so watch for a possible selloff from there. The bulls need to drive the DOW above 16400 and keep it above, and then drive it back above its broken uptrend line. A drop below 16320 would be a break of the uptrend line from February 13th, which is the bottom of a possible expanding triangle ending pattern, as well as the bottom of a parallel down-channel for the current pullback. So that's the level the bulls need to strongly defend.
Dow Industrials, INDU, 60-min chart
Like the DOW, SPX left a hammer candlestick today with its low very close to strong support. The price-level support near 1850 and the 20-dma near 1852 provided a reason for traders to buy today's dip and it looks like it should be able to make it at least a little higher, if not drive to a new high in the coming week. But first, assuming we'll see a bounce Thursday morning, watch for possible trouble near 1877. That's where the bounce off today's low would achieve two equal legs up and it would be a back-test of its broken uptrend line from February 5th. If that is followed by a drop below today's low at 1854 I don't think support will hold. The bears need to see SPX below its March 3rd low near 1834 to confirm we've seen the top. In the meantime there's upside potential to at least 1887 and potentially up to 1900-1910.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1885
- bearish below 1834
The pullback from last week for NDX looks like a correction to the rally but it means it should continue rallying from here to a new high. I show only a minor new high, targeting the 3777 area, but that will be closely watched if and when it gets there. The more bearish interpretation of the pullback says look out below if it drops below its March 3rd low and price-level support near 3634. We should know better in the next day which way this will go.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3726
- bearish below 3634
Today the RUT dropped down to support at its 20-dma, near 1177 and its uptrend line from November 2012, which it had broken in January, back-tested it before falling further into the February 5th low and then climbed back above in mid-February. Since then it used the line as support on March 3rd and came close to tagging it again today, currently near 1175. It's a good setup for another run higher but not if it breaks below 1175 and a drop below its March 3rd low near 1164 would be strong confirmation that the high is already in place.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1215
- bearish below 1164
The RUT's chart above is using the arithmetic price scale but notice where the uptrend line from November 2012 is located on its chart below, which is using the log price scale. Instead of looking at the uptrend line as support, now it's resistance near today's high and a little higher, near 1194, on Thursday. The bulls need to see the RUT get back above that line otherwise it's the 2nd break following the March 3rd break. The 2nd mouse (bear) might get the cheese here if the RUT drops away, especially since it would leave a bearish kiss goodbye following the back test.
Russell-2000, RUT, Daily chart
The 10-year yield (TNX) is also holding at support at its 20-dma, near 2.72%. After achieving two equal legs up from February 3rd, at 2.798 (with a high at 2.82 last Friday), the a-b-c bounce correction looks finished. Not shown on the chart, last Friday's high was also good enough to achieve a 50% retracement, at 2.81, of its January decline. It's a good setup for a 3rd wave down, one which should easily exceed its January decline. That would of course mean strong buying in bonds and likely as a result of a flight to safety. This is just another piece of the puzzle that fits a pattern suggesting we should be looking for a stock market top.
10-year Yield, TNX, Daily chart
The U.S. dollar pulled back from the little bounce off last Friday's low, which still holds, and it remains below its uptrend line from May 2011, as can be seen on its weekly chart below. This looks like a bearish break and could certainly lead to another leg down, one which could see it drop down to its uptrend line from 2008-2011, near 75. But the leg down from January 21st looks more like a descending wedge (hard to see on the weekly chart) and more than likely a completion of an a-b-c pullback from November 2013. Two equal legs down from the November high is at 79.44 and last Friday's low was at 79.44 (close enough, wink). There might be at least one more minor new low for the dollar but I continue to lean to the long side on the dollar. A break below 79 would turn me more bearish.
U.S. Dollar contract, DX, Weekly chart
Gold turned bullish this week with this week's rally, taking it to new highs for its bounce. The leg up from December 31st now looks like a 5-wave move and it's into its 5th wave, starting from Monday's low. I see upside potential for gold to 1436 (two equal legs up from June 2013) to 1449 (back up to the 38% retracement of its 2008-2011 rally). I've circled the fractal pattern for the current a-b-c bounce (as I'm interpreting it) off last June's low, comparing it to the a-b-c bounce from December 2011 to September 2012, which lasted 9-months. The current a-b-c bounce is also a 9-month bounce correction if it completes by the end of this month (which the stock market might do at the same time). In other words, be careful chasing gold higher here.
Gold continuous contract, GC, Weekly chart
It's looking like oil also finished an a-b-c bounce correction off its November low. I had a price projection for the c-wave, the leg up from January 9th, at 105.77 but the March 3rd high finished a little shy of the target, at 105.22. The subsequent decline looks like it should be the start of the next leg down for oil, one which should drop below 80. But a rally back above last Friday's high at 102.91 would put it back on a more bullish path.
Oil continuous contract, CL, Weekly chart
Following this morning's quiet time for economic reports we'll get hit with a few more Thursday morning, including the usual unemployment numbers. Retail sales are not expected to change much and if they come in less than expected it will simply be blamed on the weather. Nothing market moving is expected.
Economic reports and Summary
I see the potential for another high for the stock market, especially as we head for opex week, a typically bullish week. But if it looks like the market is struggling to make new highs, with more evidence of a lack of participation (fewer new 52-week highs, fewer advancing stocks, bearish divergence on the oscillators, etc.) we need to be aware it could break down at any time, perhaps with a nasty downside surprise some morning. If the market is held up through opex I think it could get rough for the bulls following opex but we'll be able to evaluate that possibility more carefully next week.
The pullback from last week's highs looks corrective and that's what keeps me thinking about the potential for new highs. So that's the way I'm leaning at the moment. But keep a tight leash on long positions and be ready to jump out quickly. I'd rather miss a small upside potential than caught in a big downdraft. Trade very carefully in the coming week.
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