The stock market was short-term oversold heading into this morning and the sharp bounce off the morning low is either a dead cat bounce or it could be the start of the next rally leg. We should find out which in the next couple of days.

Wednesday's Market Stats

Tuesday afternoon's choppy decline, with the indexes finishing at their lows (except NDX), was a good setup for a reversal for at least a bounce to correct the decline from last Friday. The jab lower this morning likely pulled in a few more shorts and then the match was lit with a few buy programs to torch the bears and use the short-covering fuel to propel the market back up. The techs led the way with a +1% rally. Now the question is whether today's rally is just a dead cat bounce or something more. Depending on which index I'm looking at I can easily answer that question differently.

It was a relatively quiet day and there was only one important economic number this morning that had the potential to move the market. It was a positive report on new home sales with July's number revised higher from 412K to 427K and today's number showing a big jump up to 504K, quite a bit higher than the expected small jump up to 435K. Following the small decline in existing home sales the overall increase in home sales for August is a welcome sign. I don't think it will last for the longer term but it's at least good for now.

An improving housing market is needed to help improve the economy since there's so much economic activity around home buying. It's certainly a good sign when people are feeling confident enough to commit to a house although we know that can backfire on people, just as excessive bullishness can backfire on investors in the stock market.

I continue to look for other economic signs for a fundamental feel for the market (not that it has helped since the market has only cared about how much QE the Fed is doing) and then try to tie that in with my technical analysis. One of the indicators I've used is commodity prices since they're largely driven by demand and of course demand tends to increase when the economy is booming. Watching China's economics provides another source of information since they've become the manufacturing house for much of the world. But there have been many signs that China is slowing. One of those is shown below for iron ore prices.

China's Iron Ore Prices, chart courtesy

As you can see above, prices have chopped their way lower since the start of this chart in 2011, with a drop to new lows in the past month. This is not a good sign about their economy and in turn the global economy. China has been encouraged to do more QE kinds of things to help their economy but so far they've resisted doing too much for fear of stoking inflation. That has not been a concern of the Fed or ECB.

The ECB has been threatening to do more QE for a long time and it could be getting close to where Draghi is going to have to stop threatening and actually start doing. BTW, his promise to buy $1T worth of bonds is more of an attempt to blow smoke up, I mean jawbone the market higher. Even if the ECB shoved out all other bond buyers there isn't a trillion available for them to buy. But I digress. The chart below shows the inflation picture for Europe.

European Inflation, 2009-present, chart courtesy

Inflation expectations by bond buyers have dropped back down to or below levels last seen at the beginning of 2009. This is a very scary chart to central bankers and it shows Europe is within spitting distance of dropping into "disinflation" territory (dare I say deflation). The only ones who should be scared by this are those who have huge debt obligations (hmm, who might that be). The U.S. will likely be not far behind Europe and keep in mind that deflation is very bad for stock markets.

In the meantime the stock market continues to ignore all these signs of slowing and "disinflation," in spite of the multiple years the central banks have tried to stop the slide. Even with all of the money pumping by the Fed the money velocity (how much the money is turned over through lending) has continued to slow at a steady pace since 2000. The Fed is the perfect example of the definition of insanity. One of these days even Paul Krugman is going to have to eat his words.

Getting into the stock indexes, the SPX weekly chart below hasn't changed much in the past month as price has chopped up and down in about a 25-point range. This follows a couple of years now where price volatility has been decreasing. I don't show the Bollinger Bands on my charts (too crowded) but we're now at a point where the DOW has the narrowest band width seen since October 1964. That's certainly one for the record books. That doesn't tell us which direction the next big move for the market will be but it does give you sense of how little volatility we've had. It's my opinion that the narrowing price range, creating a long-term rising wedge pattern, is going to be followed by a violent breakdown. For the moment, the weekly chart is not indicating whether it's going to start down or hold up higher into October.

S&P 500, SPX, Weekly chart

The daily chart below shows Monday's break down through the 20-dma and Tuesday's break down through its uptrend line from November 2012 - February 2014 (log scale). Today it recovered back above the trend line near 1992, leaving a head-fake break, but stopped at its 20-dma, near 1998. If this is a back-test of the 20-dma that's followed by a bearish kiss goodbye on Thursday and a drop below this morning's low it could result in a stronger decline to follow. It's possible we'll see a decline to the 1966 area before heading back up. The pattern for this is discussed more thoroughly a little later with the ES chart.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 2011
- bearish below 1966

Today's bounce is a sharp 3-wave move up and it would have two equal legs at 2004, only slightly above the 62% retracement of its decline, at 2003.74. A rally to 2004 and a rollover from there would be worthy of a short play but keep your stop tight since we have bullish potential into October. We might get a larger a-b-c bounce (red dashed line on the 60-min chart below) so be careful about shorting a rollover -- don't get complacent about it since it might whip around and spike higher before rolling over for good. A 78.6% retracement, at 2010.57, is also where it would close Monday's gap down at 2010.54. Nice correlation there for a possible reversal if tested and rolls back over.

S&P 500, SPX, 60-min chart

I was looking over the ES chart (continuous contract) without all the wave counts in an attempt to look at just trend lines/channels, MAs and oscillators to see what patterns jump out at me. I noticed that it has testing its 50-dma at 1971.50 (the after-hours low on Tuesday was 1968.25 and this morning's RTH low was 1970.50), whereas the 50-dma for SPX is a little lower, near 1977 and about 2 points below this morning's low. Other than a few breaks this year (Jan-Feb, Apr, Jul-Aug) the 50-dma has held most pullbacks, as can be seen on the ES daily chart below.

S&P 500 e-mini, ES, Daily continuous contract

It was looking at these tests of the 50-dma that I noticed a repeating pattern that led to breaks of the 50-dma, starting with the December 2013 - January 2014 highs. The initial highs (Dec 2013, Mar, Jul and Sep) were followed by marginal new highs (Jan, Apr, Jul and Sep) with bearish divergence. These are shown with the brown lines across the price highs and lower RSI highs. These led to breaks of the 50-dma but then were repeatedly followed by recoveries back above the 50-dma.

For the latest pattern, if it leads to another break of the 50-dma and is an expanded flat a-b-c pullback off the September 3rd high (instead of something more bearish, and one of the options shown as a possibility on the SPX chart), we could see the leg down from September 19th achieve 1945, which is where it would be 162% of the first leg down from September 3rd. Interestingly, that would coincide with a test of the uptrend line from October 2011 - June 2013, which supported the previous decline into the August 8th low. The 1945 projection crosses the uptrend line on October 1st. If this repeating pattern follows through we'd then have another buying opportunity near 1945. It will certainly be something to be thinking about if it plays out.

The DOW's strong bounce today brought it back up to its trend line along the highs from May-November 2013. This is one of those "internal" trend lines and it's not as strong a trend line as others but you can see how price has reacted around it and today it closed on it. If last Friday's high was THE high, this is a good setup for a back-test/bearish kiss goodbye, to be followed by a stronger decline. With today's high at 17226 it was only 3 points shy of achieving a 62% retracement of its decline with a sharp 3-wave bounce. A drop back below this morning's low near 17034 would likely bring in a flood of selling. But the larger trend remains to the upside and therefore bears need to play it cautiously.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 17,150
- bearish below 16,970

I see bullish possibilities for NDX. Looking at the rally from April I've got the 5th wave as the leg up from September 16th and a possible completion of the rally at last Friday's high. But the 5th wave in this case appears too short (possible but not probable until NDX drops below its September 16th low near 4010). I see the potential for NDX to chop its way higher in an ending diagonal (rising wedge) and potentially make it up to the 4209 projection by mid-October where the 5th wave would then equal the 1st wave. While RSI is warning of trouble for the bulls, with the significant bearish divergence at recent highs, if MACD turns back up from the zero line it will have "reset" itself in the sideways chop and now ready for another rally (likely to a lower high if price makes a new high).

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4120
- bearish below 4010

I also see bullish potential for the RUT. It's been such a weak index this month and it's hard to start thinking bullish about this one but I want to point out the pattern that supports another rally leg and potentially a strong one (not a choppy one as depicted on the NDX chart above). Since first climbing above 1100 in October 2013 (a year ago) the RUT has been a very whippy pattern, with highs and lows roughly 140 points apart. But since March high we've seen a contraction in price swings and this has created a sideways triangle pattern, the bottom of which is the uptrend line from May. It's a messy daily chart below but so is the price action.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1164
- bearish below 1124

Yesterday's decline and close dropped the RUT below the bottom of the sideways triangle and it was very important for the bulls to see a recovery back inside the triangle today, which it did and that actually creates a buy signal based on this pattern. The trouble is we have competing patterns. Its broken uptrend line form October 2011 - November 2012 was broken yesterday and today's bounce didn't quite make it back up to the trend line, which is near 1132. It's possible we'll see just a back-test followed by a bearish kiss goodbye and a drop below this morning's low at 1116 would create a sell signal.

A look at the RUT's weekly chart below shows an idea for a larger ascending triangle (flat top, ascending bottom), which would mean choppy price action into the end of the year to complete a larger consolidation pattern before heading higher into early next year. That's enough to give bears some severe agita even thinking about it. But it's important to see the potential, even if it seems unbelievable.

Russell-2000, RUT, Weekly chart

Bonds sold off today, which helped provide some funds to rotate into stocks, and that could continue. The chart of TLT, the 20+ year Treasury ETF, shows the breakdown from its up-channel, on September 11th and yesterday it made it back up to the bottom of the up-channel, which coincided with a back-test of its crossing 20- and 50-dma's as well, all near 115.50. I'm looking for a multi-month correction of the rally we've had this year before bonds head higher next year. How much the selling over the next few months will help the stock market is debatable.

20+ Year Treasury ETF, TLT, Daily chart

With the September highs the TRAN finally rang the bell at its projection to 8590.98, which is where the c-wave in the a-b-c move up from 2011 equals 162% of the a-wave. It doesn't mean it is obligated to drop from here but that's the EW setup. It also poked one more time at the trend line along the highs from April 2010 - July 2011 as well as the shorter-term one from May 2013. The wave count can be considered complete at the test of the trend lines and with weekly bearish divergence I would not want to be long the Trannies now. A drop below its uptrend line from June 2013, currently near 8275, would also be a strong break of its 50-dma and reason enough to believe the top is in place.

Transportation Index, TRAN, Weekly chart

The U.S. dollar has run almost straight up for about 3 months now. One would think it's due a restful pullback. It is currently testing its July 2013 highs near 85 but it appears to be consolidating instead of getting ready for a larger pullback. There could be a lot more short covering if it rallies above 85 and starts heading for its 2009-2010 downtrend line, currently near 86.92. A strongly rallying dollar is another sign of deflation.

U.S. Dollar contract, DX, Weekly chart

Just as I've been waiting for a pullback in the dollar, I've been waiting for a bounce in gold. I'm still waiting for both and they might not happen, especially if gold also drops below 1194. That's where the decline from March would have two equal legs down and it would hit the bottom of a descending triangle, which I've been showing on the gold weekly chart for weeks. If it is a triangle pattern it needs one more leg up to complete it, which is what I'm depicting. A rally back up to the intersection of the top of its triangle and its broken uptrend line form 2001-2005, near 1330 by the end of January, would be a good long trade followed by an even better short trade.

Gold continuous contract, GC, Weekly chart

A big strike against gold's short-term bullish pattern is what's happening in silver. Last week it snapped support near 18.60, which fit as the bottom of its descending triangle. At best I would expect a bounce back up to the 18.60 area for a back-test and then continue lower. A good downside target for now is price-level support near 14.65 but very likely lower prices into 2015 in another A-B-C down from the x-wave high in July.

Silver continuous contract, SI, Weekly chart

Oil's pattern remains a mystery because of the big messy pattern since its May 2011 high. It could be a large bullish sideways consolidation or it could be a much more bearish pattern that's looking for a bounce and then crash lower. If it does bounce in the next month or two, I'll be looking for a rally up to its broken uptrend line from 2012-2014, near 100 by the end of November.

Oil continuous contract, CL, Weekly chart

Tomorrow's economic report of interest will be the Durable Goods, which is expected to show a significant decline of about -16.3% but after the +22.6% in July it evens out a bit. Ex-transportation the number is much less volatile and is expected to be +0.7%, which would negate July's -0.7%.

Economic reports and Summary

Today's bounce will be viewed differently depending on the color of your glasses. Bears see a dead-cat bounce whereas bulls see the start of the next rally. The repeating pattern I showed on the ES chart certainly supports the bulls, although that might mean a further pullback first before the next rally leg gets going. NDX shows the idea for a choppy rally over the next couple of weeks while the indexes make minor new highs in an ending pattern. SPX supports the idea for only a minor new high tomorrow morning followed by the start of a strong decline.

Needless to say, there are too many opposing possibilities, especially with different patterns on different indexes. That means it's a time for caution while we wait for at least a few ducks to get in a row. Right now all we're doing is trying to herd cats and they're not being cooperative. Know when to trade and more importantly when not to trade. Right now I think it's the latter. Stay safe.

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