Last week's pullback into Thursday's low was once again a good setup to slingshot the market back up into opex week. It's a formula that keeps working. What happens after opex will be more important.

Wednesday's Market Stats

The game plan to pull the market down into a low on the Thursday prior to opex, followed by a short-covering rally into opex is again playing out. It's a pattern that has played out repeatedly and this opex appears no different. But the larger price pattern suggests there could be trouble following this week's bounce so don't get complacent about the long side.

Yesterday's choppy decline was followed by another rally leg this morning, which keeps the bulls in control for now. There's higher potential into Friday but a bounce to a lower high that looks like a correction to the decline should lead to a stronger selloff next week, which I'll lay out in tonight's charts. I'll also identify the key levels to the upside, which if broken by the bulls will tell us new highs are coming.

This morning's economic numbers were not market moving, although the disappointing retail sales numbers were a little disappointing. Retail sales were expected to stay roughly flat with June's +0.2% but instead dropped to zero growth. Sales excluding the auto component were expected to drop marginally from June's +0.4% to +0.37% but instead dropped to only +0.1%, just barely above zero growth. So it would appear the consumer is pulling back and that of course is not a good sign for the economy, which remains so dependent on strong consumer spending.

One of the more worrisome things throughout the 5-year bull market that we had (I'm assuming it finished with the July high until proven otherwise) is the fact that it's been so disconnected from reality. I've spilled a lot of virtual ink on the separation between Wall Street and Main Street. And now the slowdown in consumer spending is further aggravation of the split. One example of the slow recovery in consumer spending, labeled Personal Consumption Expenditures (PCE) is shown on the chart below. The red line is the current recovery from the trough and is compared to average fast and average slow recoveries. The current recovery is much worse than even the average slow recovery.

Personal Consumption Expenditures recoveries from recessions

Another way to look at this is to see how much the PCE declined during the last recession and the recovery since the bottom in 2009. The decline was much steeper than past recessions and the recovery after 5 years is only about half the loss.

Declines and recoveries in Personal Consumption Expenditures

I suppose one could look at the above charts and say, "The trend is up!" and that's true. But is it supportive enough of a stock market that has blown past the 2007 highs? The answer has been yes for many years because of the belief in the Fed's almighty powers to prop up the stock market. But all they've accomplished is propping up a risk-taking attitude. There's a huge disconnect between the market prices and reality. Bullish sentiment has created a worse bubble than we had in 2000 or 2007. The correction of this disconnect will not be pretty.

And just in time, the retail trader has bought into the rally, literally. A recent AAII Asset Allocation Survey of retail investors shows cash levels in July dropped to the lowest level since 1999 at only 15.8%. The chart below shows retail trader cash positions since 1996 and you can see how the peaks and valleys in cash positions have been closely aligned with important tops and bottoms. It's not a perfect timing method but it's certainly another warning sign.

Retail Investor Cash Allocation, 1996-July 2014, chart courtesy

I'll start off tonight's chart review with the NDX since it's showing a relatively clean price pattern and the potential for a reversal after today's rally. The blue chips suggest higher prices into the end of the week (and there's the same potential for NDX) so the short-term picture is a little muddy but it's important to keep the bigger picture in mind. Because the larger pattern suggests the July highs are important highs (potentially THE highs for the 5-year bull market) I think it's important to stay aware now of the downside risk.

Starting off with the NDX weekly chart, it's showing a good wave relationship that helps confirm the wave count, which is what I look at to help confirm when it's time to look for reversals. The rally from November 2012 is a 5-wave move and the completion of it suggests at least a larger pullback correction or more bearishly, the start of the next multi-year bear market. I have the price projections for the 3rd and 5th waves, which are based off the size of the 1st wave, which is the leg up from November 2012 to the May 2013 high (labeled wave-(i) on the chart). The 3rd wave is often 162% of the 1st wave, which is the projection near 3730 and the high was 3938. When the 3rd wave is 162% of the 1st wave it's common to see the 5th wave the same size as the 1st wave, which is the projection near 3973 and the high was 3997. Between July 23rd and July 30th there were only 3 days that managed to close above 3973.

Nasdaq-100, NDX, Weekly chart

The July high for NDX was also up against the trend line along the highs from April 2012 - March 2014. The turn down from this trend line and the price projection for the completion of the 5-wave move up from November 2012 is what had me feeling bearish about the July high. That was then followed by a 5-wave move down into last week's low, which is the first short-term indication we've seen a trend change. It's possible we saw a larger pullback correction from the July 3rd high so further upside still needs to be respected. The proof the bears need to confirm a top of importance is in place is for the current bounce to make a lower high and then have it followed by a break below last week's low. Hence the key level to the downside at 3845, shown on the daily chart below.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3965
- bearish below 3845

Today the NDX was bullish and was able to jump up over its broken 20-dma, near 3924 today. But it has run into its broken uptrend line from April-May, near 3946, with a high at 3948.70. This was also a test of the top of its gap down on July 31st, at 3948.90. It pulled back a little but then chopped its way higher this afternoon and kept itself pressed up against the trend line, which looks like a small ending pattern and it had me thinking short for Thursday morning to see what kind of pullback/decline we get.

Nasdaq-100, NDX, 60-min chart

This is opex week and I've been looking for ways the pattern would support a higher bounce into the end of this week. Based on the start of the bounce pattern off the August 6th low (as opposed to the lower low on August 7th) I think there's a good chance NDX will pull back and then head higher into Friday, as I've depicted on the chart above. It would stay trapped below its broken uptrend line from April-May but make it up to its 78.6% retracement (a very popular retracement level for years now) at 3965 by next Monday morning. This is obviously a guess but it's something I'll be tracking this week.

Last week's low for SPX held support at the important uptrend line from November 2012 - February 2014, near 1904 at the time. That is a trend line the bulls must defend and any break of it, currently near 1910, confirmed with a break below last Thursday's low at 1904.78, would be a strong reason to be short (certainly a reason to exit long positions). A 3rd wave down is expected to be the next leg down (assuming we'll get it and not a new high from here) and it will very likely be accompanied by strong selling.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1973
- bearish below 1904

I have the key level to the upside for the bulls to break above at 1973 because that would get it through several levels of resistance. The broken uptrend line from April-May is near price-level resistance at 1955 (the shelf of support in July) and the 20- and 50-dma's surround this level at about 1952 and 1956, resp. The 62% retracement of its decline is near 1958. Two equal legs up for an a-b-c bounce off the August 6th low points to 1961.74. It would close its July 31st gap down at 1970.19. And then finally, the 78.6% retracement is at 1972.30. So if the bulls can get through all that, we'll be heading for new highs. I'll believe it when I see it happen.

S&P 500, SPX, 60-min chart

The DOW's pattern is the same as SPX except I'm starting its bounce projections from the August 7th low. There's a subtle difference in the wave count for each on the way down and when I look at its bounce off the August 7th low I get a higher projection for two equal legs up, which is just above 16800. This coincides with its broken uptrend line from November 2012 - February 2014 (log price scale) and its 2000-2007 trend line, both of which cross tomorrow near 16785. The bulls would be in trouble with a drop below yesterday's low at 16518 and it would be confirmed bearish below last week's low near 16330.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,880
- bearish below 16,330

The RUT does not have a clear pattern at the moment and that leaves too many options on the table. The decline into the August 1st low looks like a 3-wave pullback and suggests higher prices (or maybe it will be stuck in a large sideways consolidation into October/November before it will be ready to rally again). A rally above its July 24th high near 1164 would leave a confirmed 3-wave pullback and I'd be looking at it more bullishly, especially since it would be a recovery back above its broken 50-dma near 1160. The bearish interpretation of its decline is a 1-2, 1-2 wave count to the downside and the next leg down will be as if the bottom dropped out in a 3rd of a 3rd wave decline. Take a break below the August 1st low near 1107 seriously if it happens.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1164
- bearish below 1107

I've been watching the banks the past few weeks to see if they support one side or the other but the pattern has remained unclear. I could easily argue a bearish case based on a 1-2, 1-2 wave count to the downside since the July 3rd high, which portends further selling, but it's not clear enough to feel strongly about it. If we have started a new bear market I would expect the banks to be one of the sectors to lead the way down. The weekly chart below shows a rounding topping pattern and especially with the break of the up-channel from 2012, back in April, followed by a bounce back up to back-test the bottom of the channel, into the July 3rd high, it's not hard to argue the bearish case here. Stronger evidence of a top would come with a break below price-level support at 66-67, followed by a break of its uptrend line from 2009-2011, currently down near 64. But as long as 66-67 holds as support, the "resetting" of MACD back down to zero while the index trades sideways can be viewed as bullish. So I'm waiting for the banks to show some leadership.

KBW Bank index, BKX, Weekly chart

At today's high at 8236 the TRAN retraced 50% of its decline from July 24th, on the nose at 8236. At the same time it is now back-testing its 20- and 50-dma's, as can be seen on its daily chart below. The risk for bulls is a turn back down from here and the start of the 3rd wave down, which would likely take it down quickly for at least a test of its 200-dma, currently near 7615. If we've got a bearish move down we'll likely see the 200-dma only become a speed bump on the way down to the April low at 7346. But for this week, if it holds up bullish, two equal legs up from last week points to 8380, which is a little shy of the 78.6% retracement of its decline, near 8395.

Transportation Index, TRAN, Daily chart

The U.S. Dollar is working hard to break out of its sideways trading range by getting above 81.50. It's still not clear if we'll get another pullback inside the range before breaking out but at least for now the dollar's pattern remains bullish.

U.S. Dollar contract, DX, Weekly chart

Gold has been chopping around for the past two weeks and hasn't strayed far from $1300. In fact it hasn't strayed far from that level since first dropping below it in June 2013. I'm still looking for a minor push higher in the coming month, up to about 1350, to complete a sideways triangle consolidation pattern since June 2013 low. That should then lead to lower prices for the shiny metal. Based on this pattern it could be the end of the year or early 2015 before we'll have a good buying opportunity for the metals.

Gold continuous contract, GC, Weekly chart

Oil has been chopping sideways since its hard drop at the end of July and has so far created a little star doji this week at trendline support (uptrend line from June 2012) and its 200-week MA. As long as it holds above 96 I'm expecting another rally leg up to the 113-115 area before it will be ready for a stronger decline. At 113.05 it would have two equal legs up from January and a little throw-over above the top of its rising wedge pattern would get it close to its May 2011 high at 114.83.

Oil continuous contract, CL, Weekly chart

One headwind for oil is the lack of demand by the U.S., which in turn could lower global prices further from here. The chart below shows how much the U.S. has imported, in Mbbl/day, since 1920. It peaked in 2008 near 11 Mbbl/day and since then a lackluster economy combined with new domestic supplies has dropped the number to about 7.2 Mbbl/day, which is the lowest number we've seen for the past 19 years (1995). U.S. consumption is currently 20.3 Mbbl/day and is well below pre-recession consumption levels.

U.S Oil Imports, chart courtesy

There will be nothing from tomorrow's economic reports to drive the market one way or the other so it will be left to react to geopolitical news.

Economic reports and Summary

I tend not to pay too much attention to historical averages or patterns for the stock market because they're not reliable enough to trade. With that said, there is one pattern that supports the idea that we're about to get another leg down for the market following this week's bounce. The chart below was published by Tom McClellan and it shows the average pattern for stock price in the 2nd year of a 2nd term president, which is what 2014 is. As you can see, it's not a pretty picture as the average decline is back to the beginning of the year, which for SPX is down near 1750. A 200-point drop from about 1950 would be a 10% "correction."

Average Performance of SPX During 2nd Year of 2nd Presidential Term, chart courtesy

The EW (Elliott Wave) pattern suggests this week's bounce is a correction to the previous decline from the July highs and therefore it's a good opportunity to short the bounce. The big question, as always, is where the bounce will end. My crystal ball is a little cloudy but I could argue the NDX and a couple of other indexes up against resistance for a back-test are ready to start down now. But I also see the potential for a continuation higher (maybe after a pullback Thursday morning) into the end of the week. Considering this is opex week I am also inclined to give the bulls the benefit of the doubt that I have here.

The bottom line is that the long side seems particularly vulnerable right here but the short side could be painful for a couple more days. If we get a sharp decline, and especially if last week's lows are broken, short the bounces. In the meantime, give the market a little more room to the upside this week and then look for a rollover to short.

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