This week's rally has been on slow and slowing volume and showing lots of negative divergences in market breadth and momentum. It should be reversing to the downside but the bulls apparently didn't get the memo.

Wednesday's Market Stats

When you look under the hood to see how the market looks it's not a pretty picture. Whether it's fast-slowing volume, deteriorating advance-decline line or bearish divergences on momentum indicators you could be forgiven for feeling bearish about the stock market. But if you look at just price, which is of course the most important indicator, you see bullishness and that's what keeps the buyers coming. But now throw in an overbought market and there are plenty of reasons why bulls need to again be cautious here. It might be time for the bears to get another turn at the feeding trough.

The market started with a gap down this morning, which was different than Monday and Tuesday, but the dipster crowd saw it as a buying opportunity and they pushed the indexes to new trading highs. The one fly in the bull's ointment today (and somewhat yesterday) was the fact that the RUT was not participating in the rally. It's flashing a warning sign but I'm not sure there are many bulls paying much heed. The dip following the FOMC minutes this afternoon was just another dip to be bought. Thursday we'll find out if those buyers might get a little buyer's remorse.

Other than the FOMC minutes this afternoon, letting us know how the last meeting went, there wasn't much in the way of economic reports to jolt the market one direction or the other. The geopolitical news was relatively quiet and that provided a benign environment for the market to continue floating higher into the FOMC minutes. The market finished mostly on a high note for the day other than a brief bout of profit taking in the final 15 minutes. But as I'll review in tonight's charts, that selling might have been the kickoff to what could become more severe selling in the coming weeks. How the market pulls back (impulsive vs. corrective) will provide the clues we'll need to figure out the odds for higher prices into September vs. the start of a more significant decline. For now I urge caution by both sides but feel the bears are getting ready to take control of the ball.

As for the Fed's FOMC minutes for the meeting held three weeks ago, it appears there is more of a shift in the bias toward removing policy accommodations at a faster rate. The feeling is that the employment picture is improving and inflation is ticking higher toward their 2% goal. There is no change of plans to wind down the latest QE program with the elimination of bond purchases after the October meeting.

What's interesting about all this is how well the stock market is taking this. There is a general feeling (acceptance) that the economy is improving, inflation is ticking higher and that both of these are good for the stock market. But what's been good for the stock market is the Fed being highly accommodative and without their monthly priming the pump I'm surprised the stock market isn't more worried. Removing liquidity is likely to cause more problems than the market is currently expecting.

Ironically, the Fed and BOE are moving closer to providing less accommodation and raising rates while the rest of the world (except Europe?) starts tightening the excess credit creation. The BOE reported this morning that some members are dissenting about keeping rates at zero and instead want to raise rates to 0.25% now, not later. Japan's monetary expansion is virtually on hold and China is aggressively reining in it credit expansion program. The world may be much closer to a deflationary cycle than an inflationary one.

So ironically, while the Central Banks of many of the developed countries start removing accommodation they could be doing so at the beginning of a deflationary cycle that will be the first one in 80 years. They could in fact trip the world economies into an unintended slowdown (you mean the Yale-educated economists could make an error of that magnitude? Say it isn't so) just at a time when they should be starting an accommodation program instead of ending one. The only thing I wonder is how quickly the Fed will reverse itself and start up QE5 (or whatever number we're up to).

Looking at the stock market's indexes, the broader averages, and most of the sector averages, have not made new highs yet above their July highs. The banking index hasn't made a new high above its March high, let alone its July high. The techs are out in the lead and that has most everyone feeling bullish again but we have to wonder if it's deja vu all over again, similar to what happened at the October 2007 high where the techs went on to make new highs into the end of the month while most other indexes made lower highs compared to their highs earlier in the month. SPX is the closest to making a new high, having missed by only 3 points today and it will only take a minor bump higher for it to join the techs. That would be important for the bulls to continue here but what a cruel joke on the bulls if today's high was it.

For indexes other than the techs it's still possible to call the bounce off the August lows a correction to the decline off the July highs. That would be a setup for a strong decline to follow, which makes this a very important inflection point for the market. And unless a strong catalyst enters the picture for the bulls to grab hold of and start buying with more enthusiasm I think the rally leg from the August lows is the final one. It has all the signs of being in a termination phase. How high it can continue to melt up with deteriorating market breadth is the big question at the moment. So let's see what the charts are telling us.

Kicking off tonight's chart review with the SPX weekly chart, the past three weeks have brought it back up near its July 24th high at 1991.39, only 3 points above today's high at 1988.57. The July rally attempted to punch up through the trend line along the highs from April 2010 - May 2011, but it was unable to hold even marginally above it. If SPX does push higher, it will again have to deal with the 2010-2011 trend line, currently near 2005. Other than a head-fake break above 2005, it would obviously be more bullish above that level but if it rolls over from anywhere in the current price region it will leave a significant bearish divergence on the weekly chart and likely a double-top completion to its rally.

S&P 500, SPX, Weekly chart

At the August 7th low, at 1904.78, SPX came within about 5-10 points of its uptrend line from October 2011 - November 2012 (using the log price scale and depending on how it's drawn). Most were watching the uptrend line from November 2012 - February 2014, using the arithmetic price scale, which is where SPX found support. Now a drop below the August 7th low would also be a break of the longer-term uptrend line from October 2011 - November 2012, which obviously would be an important clue about the longer-term pattern. In the meantime the uptrend continues to hold and any short plays are therefore by definition counter-trend plays and require greater caution. I like to look for reversal setups, which I'm seeing here, but the risk in catching rising knives should be obvious.

The daily chart below shows the trend line along the highs from April 2010 in gray and another one along the highs from March-May. In case this market is going to rally into September I wanted to see where SPX might be headed to. The first target is near 1995, where the 5th wave of the move up from February would be 62% of the 1st wave (the February-March rally). This would result in SPX making a final high as a double top (like the RUT did at its July high). But if the final 5th wave is to achieve equality with the 1st wave then as depicted on the chart, we could see a rally up to 2050 by mid-September where the projections crosses the trend line along the highs from March-May.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1995
- bearish below 1941

Because SPX has not made a new high yet above its July 24th high, there is still the possibility that the leg up from August 7th is a correction to the decline and not the completion of the rally. This is potentially important because a correction would be followed by a steep and strong decline in a 3rd wave. The DOW easily supports this interpretation and it makes it a dangerous time to be long the market because of this downside risk.

We can't know yet whether or not we'll get new highs into September or a steep decline instead. The next pullback/decline will be needed to help provide some clues. If the bounce off the August 7th low is a correction to the 1st wave down from July then the next decline will start to kick into high gear and it will be impulsive (sharp decline, small corrections) as the 3rd wave unfolds. But if we get a corrective pullback (choppy, overlapping highs and lows) then it will look like a correction to the rally off the August 7th low and point higher once the pullback is finished. While I lean short the market here, price is king and it will tell us after the next pullback/decline gets started whether to be looking higher or lower.

This week's rally for the DOW has it back above its uptrend line from November 2012 - February 2014, currently near 16825, and that's obviously bullish. But the trend line, using either the arithmetic or log scale, didn't seem to have the same influence as it did for SPX. So at the moment I don't consider it all that relevant. As can be seen on its daily chart below, the uptrend line from October 2011 - November 2012 (green) basically held on August 5th and 6th but then the August 7th close was a break below it. But it was only a 1-day break, which turned into a head-fake break, and there's been a strong recovery since. It closed slightly above price-level resistance near 16970 and 5 points below the 78.6% retracement of its July 17 - August 7 decline, at 16984, after trying to break through both this afternoon. The close correlation here requires close attention to see if it will turn the DOW back down on Thursday.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,985
- bearish below 16,575

Looking a little closer at the DOW, the 60-min chart below shows the bounce pattern. The wave count suggests the August 6th low was the completion of its decline and it's been in a correction of the decline since then. For followers of EW counts, I have a double zigzag for the bounce, which consists of two a-b-c's separated by an x-wave. The second a-b-c is the move up from August 12th and the c-wave would be 162% of the a-wave at 16991. Using the August 6th low as the completion of the decline raises the 78.6% retracement of the decline to 16985. Again, close correlation at this level means it could be trouble for the bulls. Between the daily and 60-min patterns we have a potential resistance zone at roughly 16970-16992. Today's high was 16994.89 but it closed at 16979. The DOW has been hugging the top of its up-channel from the August 7th low, which is usually an indication it's in its final leg and the breakdown, when it happens, is usually quick.

Dow Industrials, INDU, 60-min chart

The tech indexes have made new highs, unconfirmed so far by the other indexes. At the moment we're left to wonder if the techs will drag the other indexes higher (SPX being the closest to doing so) or if instead we'll have a repeat of the October 2007 high where the techs made new highs at the end of October after the blue chips topped out on October 11th. The bearish divergence at the current high vs. the July high, as can be seen on the NDX daily chart below, suggests the wave count on the chart is correct. The leg up from August 7th fits well as the 5th wave in the rally from April and it equals the 1st wave at 4044.29 and that was achieved with today's high at 4046.97 before dropping a little into the close, at 4040.70. This level also coincides with the broken uptrend line from June 2013 - February 2014 (an internal trend line that was first broken in April) and the trend line along the highs from March-July. There's good correlation here for a top of significance.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4050
- bearish below 3950

The RUT's weekly chart is shown below to point out the importance of its August low as well -- like SPX, it bounced off its longer-term uptrend line but this one is from March 2009 - October 2011 (log scale). This is the line that defines the bull market since the 2009 low and a break of it would be a strong signal that the bull market has completed and the next bear market has started, especially since the wave count looks complete at its July 1st high. The trend line is still holding and therefore trend followers rightly suggest staying long but a drop below its August 1st low at 1107 would be confirmation of a trendline break (as well as its 50-week MA), in which case the trend will have reached the "bend at the end." Yesterday it was starting to telegraph greater weakness than the other indexes and that was further amplified today.

Russell-2000, RUT, Weekly chart

On the RUT's daily chart below I've added the uptrend line from October 2011 - November 2012, which is a little lower and currently near 1109. I have a key level to the downside at 1127 since that would be a break below the August 12th low at 1129 and the 2009-2011 uptrend line. That would be a good indication the bounce pattern completed and the next leg down is in progress. As I mentioned before, confirmation of a breakdown doesn't come until the RUT drops below its August 1st low at 1107.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1173
- bearish below 1127

Watching the tech indexes head higher this month, I've been curious why the semiconductors haven't been keeping up. With semiconductors in just about every product used today it's a very good economic indicator. If the techs were doing well, so too should the semis. But they haven't kept up and the SOX only today got above its 62% retracement of its decline from July. This is more bearish non-confirmation for the new highs for tech indexes. As can be seen on its weekly chart below, it's been cycling around the 38% retracement of its 2000-2008 decline, which is at 624. The August 7th low was near 598 and today's high was 636. The SOX is still holding inside its parallel up-channel from November 2012, the bottom of which is now near 620, so the uptrend is holding and it might make another stab at the price projection at 656.57. This is the projection for two equal legs up for an A-B-C bounce off the 2008 low and was just missed with the July 16th high at 652. But at the moment I'm thinking the high is in place and the bounce off the August 7th low is a correction to the 1st wave down.

Semiconductor index, SOX, Weekly chart

The banking index, BKX, made a lower high in July vs. its high in March and so far another lower high in August vs. its July high. That defines a downtrend but so far it's not clear what the longer-term pattern is telling us. As drawn on its daily chart below, we could be getting a bullish sideways triangle continuation pattern (the rally into it suggests it's a bullish pattern). Needless to say, this should make bears uncomfortable since a rally in the banks would surely be good for the other indexes as well. The bearish interpretation of the pattern is that it's not a triangle but instead a 1-2, 1-2 wave count to the downside and the next leg down will be a strong 3rd of a 3rd wave and then stair-step lower after that. A break below the triangle would leave a failed bullish pattern and failed patterns tend to fail hard. The bulls want to see a break above the July 3rd high at 72.55. If it is a bullish sideways triangle we'll see price consolidate inside it until at least October before it breaks out to the upside so we've got plenty of time to evaluate its bullish potential.

KBW Bank index, BKX, Daily chart

At its July 23rd high the TRAN did a little throw-over above its trend line along the highs from April 2010 - July 2011 and then declined sharply after that, leaving a head-fake breakout attempt. Now it looks like it wants to at least back-test that trend line again, currently near 8494, which is close to its July 23rd high at 8515. The closing highs around that date were near 8468 and a back-test of this high and the trend line could be too much to break through in an overbought market.

Transportation Index, TRAN, Daily chart

Yesterday we got some good news from the home-building sector with the better-than-expected new starts and permits. And the home builders have enjoyed a strong rally off the August 7th low. As can be seen on the daily chart below, the DJ US Home Construction index (DJUSHB) has made it back up to its 50-dma near 483 and only slightly higher is its broken uptrend line from August-September 2013, near 487. So we've got a setup here for a reversal in the home construction stocks.

DJ US Home Construction index, DJUSHB, Daily chart

The strong home building that was reported yesterday might be a bit of a "build it and they will come" hope and since the chart above suggests we could see a sharp reversal of the high bounce this month I'm wondering if the hope will soon turn to disappointment. The idea of building it with the hope "they" will come hasn't worked too well in China as entire cities remain unoccupied. The chart below shows the steady decline in homeownership rates since 1995 and the decline since 2005 is not encouraging for home owners and builders. Much of the decline in homeownership rates has to do with many Americans opting to rent instead of buy (some by choice, others having been forced into it). Ownership rates have returned to the level last seen in Q3, 1995. Like China, we could end up with a lot of inventory but not enough demand, which will of course depress prices (something I expect to see anyway). I see a fundamental and technical link here that does not bode well for the prices of home construction stocks nor for home prices.

Quarterly Homeownership rates, 1995-July 2014, chart courtesy

The U.S. Dollar has confirmed its breakout from the trading range it was in since October 2013 by firmly breaking above 81.50 this week. It might pull back and test 81.50 but it now looks good for at least a run up to the downtrend line from June 2010 - July 2013, currently near 83.40. I think it will head higher into the end of the year but we'll first have to see how it does with the downtrend line.

U.S. Dollar contract, DX, Weekly chart

Gold is acting weak (the dollar's rally is not helping) and I'm wondering if it will break down from here or after a bump higher. I've been showing an expectation for a bump up to the top of its sideways triangle that has formed since the June 2013 low, which is currently near 1358, before heading lower but a drop below its June low at 1240 would confirm the next leg down is already in progress. One indicator that tells me gold is going to decline from here is the fact that I've been emailed offers in the past week to buy China 1/10-oz gold coins at spot price. This tells me they're trying to offload inventory and it's a good sign prices are heading lower. That's said somewhat tongue-in-cheek but there's probably an element of truth in it.

Gold continuous contract, GC, Weekly chart

I thought oil would hold its uptrend line from June 2012 but it has now been decisively broken with more than a head-fake break. This suggests we'll likely see a test of the January low at 91.24 sooner rather than later. That should be good for a bounce but the pattern has turned bearish for the longer term (sooner than I expected).

Oil continuous contract, CL, Daily chart

We have a couple of reports after the opening bell tomorrow that could move the market. Existing home sales will be an important message following the improved housing starts and building permits. The Philly Fed and Leading indicators will give us some more data points about the economy.

Economic reports and Summary

This week has been bullish in price but bearish in market breadth and momentum, which is usually not a good combination when it comes to the longevity of the rally. Volume picked up significantly with the selling in July and down to the August low but it's been drying up as the rally has progressed. That by itself is not a rally killer; all the rally needs is for the sellers to stay away. Bears are very discouraged and bullish sentiment is again high, just as I had said would happen before the rally off the August 7th low got started. The pieces are now in place for the bulls to get sucker punched and dash their hopes and dreams for a higher stock market. We could still get higher prices but there are a lot of cracks in the dyke and not enough fingers to plug the leaks. And just in time, the central banks are causing some waves that are going to put even more pressure on the dams holding back the water. Be careful out there.

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