One look at the DOW's daily chart and you have to wonder if traders have any conviction. They react strongly one day but then give it back the next day. This has created a very whippy market with a direction that's unclear and the volatility is likely to be with us for at least a little longer.

Wednesday's Market Stats

The DOW rallied 331 points off this morning's low to close up +274 points. This follows multiple days of 200+ points in both directions as each side battle the other and the HFTs weasel their way in between and just trade the volatility. Traders love the volatility while investors are starting to get motion sickness. At least there was strong volume behind today's rally, which was not true for last Friday's rally, which had started with a big gap up but didn't have much follow through and the volume was lighter. Today's big-volume up day finally had what the bulls want to see.

In the 13 trading days since the September 19th high the DOW has seen more than half of them with 200+ points between the highs and lows of the day and today's 331 point swing was the largest move. In those 13 days the DOW has only lost 285 points from the September 19th closing price to today's closing price, which is basically one trading day's worth of points. That's a lot of volatility with not much actual price movement and usually an increase in the volatility like this is at the top of a rally is an indication of a trend change in progress. But the choppy pullback from the September high says the bulls can't be ruled out yet.

This morning was devoid of any market-moving economic reports and it wasn't until the FOMC minutes from the last meeting were released this afternoon that the market had something to spur the buyers into action. It was just a catalyst since the bounce off this morning's low was already in progress but it needed the excuse of the FOMC minutes to launch some buy programs, which then ignited short covering, which then launched the HFTs into the action as they tried to front-run all the buy orders coming in. Before the bears could ask "what happened?" the indexes were in strong rally mode, finishing at their highs for the day. The daily reversal of reversals, with strong moves, continues.

In the FOMC minutes there were two points that the market interpreted as bullish. One, the FOMC members expressed concern that their inflation outlook is in jeopardy (read between the lines and what they're afraid of is deflation). Two, the members believe it's important to err on the side of caution when it comes to removing any further accommodation, such as interest rates. The market reads this as evidence the Fed will not be in any hurry to raise rates as early as next spring, which some have been worried would happen. There's very little else the Fed can do to help the market, I mean economy, that it hasn't already done, all of which hasn't helped. But we can expect the Fed to "threaten" the use of "many tools available to them" to help stimulate the economy. Each promise of more will of course be met with a jubilant response from the market. At least until the market has lost confidence in the Fed.

The indexes closed at/near their highs of the day, which has it looking like the market will continue higher tomorrow. But this market should have taught everyone by now that the following day is not always a follow through to the previous day. In fact one could argue it's typically the opposite as the mini-capitulations into the close leave the market vulnerable to immediate reversals the following morning. I see that as a possibility again, especially since the rally off this morning's lows looks like a completed 5-wave move for the indexes. That suggests at least a pullback to correct the rally before heading higher.

The Thursday prior to opex week (next week) has typically been the head-fake day, pulling the market back and then letting it slingshot into opex with the help of short covering. Was that move done today instead of tomorrow? It's certainly possible since more traders are trying to game that pattern and it might be shifting a little. But a deep pullback tomorrow, to pull the shorts back in, is also a possibility, especially since the setup for a pullback looks good.

Back in June and again in early September I had used the NYSE (NYA) chart to show an upside target zone that I thought would cap off the bull market. I consider the NYA a very good index to evaluate for the "total market." The Wilshire 5000 is another good one but almost always looks just like SPX. At any rate, the upside target zone for NYA was fairly wide but not so much in relative terms and it was based on projections for extended 5th waves in the rally from June 2012. The idea for extended 5th waves is important because it shows how the rally literally extended beyond what is a typical move, which I think is a fitting description for the stock market.

In an EW pattern extended 5th waves often achieve 162% of the 1st waves and the two projections shown on the weekly chart below, at 10906 and 11148, are based on the 5-wave move up from June 2012 and then the 5th of the 5th wave, which is the leg up from February 2014. The pattern is a clean count and the relatively close correlation provided a good target zone to complete the rally. The July 3rd high was 11105 and the September 4th high was 11108.

NYSE Composite index, NYA, Weekly chart

As you can see on the chart above, the bearish divergence at the September high vs. the July high was glaring. The double top has been followed by breaks of uptrend lines from 2011 and 2012 and now it's struggling to hold above the long-term uptrend line from 2009-2011, which coincides with the 50-week MA at 10538. Last week was an intraday break and again another one today but so far the uptrend line from 2009 is holding and the weekly closing price is the important one. It also came close to touching support at the 2007 high, at 10387, with today's low at 10421 and even if we're going to get just a correction to the decline from September 4th we could see it take up the rest of the month before setting up for the next leg down.

The NYA daily chart below shows a closer view of the price action around the uptrend line from 2009 as well as its 200-dma, at 10622, which it closed slightly above today. The bears see this as consolidation at support, which will break once it's finished consolidating. The bulls see this as support, including the 2007 high, holding and the next big move will be up to a new high. One EW pattern supporting the bulls is a large a-b-c pullback correction from July, which sets it up for another rally to a new high into November. The fight is on and it could go either way here.

NYSE Composite index, NYA, Daily chart

SPX swung 45 points from this morning's low to this afternoon's high, the largest range since December 18, 2013 when the Fed first announced their plan to reduce their asset purchases. Now the market positively reacts to just the thought that the Fed might delay raising interest rates. Talk about a desperate market! For the past two weeks SPX has been whipping around underneath its 50-dma after first breaking below it on September 25th. It's been in a downtrend since the September 19th high, defined by lower highs and lower lows. Today's rally brought it up to just below its 50-dma near 1974 and still below its last high on Monday near 1978. If the bulls can drive this above 1978 it would be a strong bullish statement, recovering back above both its broken uptrend line from November 2012 as well as its broken 50-dma (and just above that is its 20-dma). But if the bears smack the market back down again we could see a drop down to the 200-dma near 1904.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1978
- bearish below 1925

Because of the choppy pattern in the pullback from September 19th it's not at all clear what the next big move will be. From an EW perspective I'm looking at it as a corrective pullback and not something more bearish. We could still get another new low out of this but the corrective structure suggests we're going to get a new high in the coming weeks. That's why a rally above 1978 would be at least short-term bearish if not an indication the new highs are coming. Next week is opex and we all know how bullish they tend to be. Will it be different this time? If the bears show up in force tomorrow, I show another leg down to a price projection at 1917.77 for two equal legs down from Monday morning (and potentially down to the 200-dma near 1904. There's still bearish potential but at this point I'd be surprised to see SPX below 1900 (I'll turn more bearish if that happens).

S&P 500, SPX, 60-min chart

The DOW has been the wild one -- as can be seen on its daily chart below it's been whipsaw city for that index. Who would have thought the DOW would be the more volatile index. Above 17100 would be bullish while a close below 16720 would be bearish, although support might be found at its 200-dma near 16590. As with SPX, it's hard for me to turn longer-term bearish yet because of the choppy move down; it looks like a correction to the larger uptrend and therefore my expectation, for now, is for a rally to new highs in the coming weeks.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 17,100
- bearish below 16,720

NDX has the same overlapping choppy pullback from September 19th and looks like a bull flag consolidation. The overbought oscillators in late August have been relieved and are now in oversold while price chopped sideways/down. I might be bearish this stock market but I can't ignore a bullish pattern (hint: the market always wins when you try to fight it). It doesn't mean it can't go down from here and in fact a choppy move down that lets go to the downside is often followed by a powerful move. But if the bulls can get NDX above resistance near 4050 (price-level resistance and its 20-dma) it will be the market telling us new highs are coming.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4050
- bearish below 3938

The RUT has been a very good canary stock for us and when it's relatively weak or strong it's been important to follow its lead. Today's candle is a bullish engulfing pattern at support (the bottom of a parallel down-channel for its decline from July, price-level support near 1080 and a price projection near 1077 for two equal legs down from July. Today's rally should get some follow through to the upside although it's not clear yet whether it will be just a bounce to a lower high and then down hard (red) or if instead we've got an a-b-c pullback from July that will lead to new highs into the end of the year. For now it stays bullish above 1074 and then I'll be watching the price pattern for the bounce/rally (assuming we'll get it) to help determine whether it will be a bounce to short or dips to buy.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1140
- bearish below 1074

It's been a long while since I last discussed the TIPS market (Treasury Inflation-Protected Securities) and considering what the market thinks the Fed will do I thought it would be a good time to review what the bond market is thinking (it being a market that is much larger than the stock market and arguably much smarter). Yesterday I saw a chart posted by, shown below (article here: More Fed Easing, where the author, Priya Misra at the Bank of America Merrill Lynch, suggested the Fed will have to come up with another round of easing according to the TIPS breakevens chart that's shown below.

The values charted are calculated by subtracting the yield on TIPS from Treasury bonds of the same duration, which for the chart below are the 5-year bonds. The higher the spread between the yields the more investors are worried about protecting against inflation. The author of the report, suggested the chart shows why the Fed will have to figure out soon what their next easing program will be (and forget about raising interest rates) in order to fight "disinflation." I believe this is how most market participants interpret this chart.

5-year TIPS Breakevens, chart courtesy

I interpret this chart differently. I think it's a glaring example of how the Fed's programs are failing. As you can see from the chart, when it dropped below 2.2 in the past it prompted the Fed to start up another QE program. The QE3 program seems to have jumped the gun in this regard but interestingly, the declining highs following each QE program demonstrates how each program is having less of an effect on inflation worries by TIPS traders. A weekly chart of the TIPS bond ETF, TIP, is shown below and it's telling me to look for much lower prices, which means much lower inflation. The Fed's battle with deflation has been a losing one and the TIPS chart is confirming it.

Treasury Inflation-Protected Securities ETF, TIPS, Weekly chart

Off the December 2012 high there was an impulsive 5-wave move down into the September 2013 low. That identified the new trend – down. That decline was followed by an a-b-c bounce into the August high for a 2nd wave correction and we’re now in the early stages of a 3rd wave decline, one which should take it back down toward 90 and the 2008 lows fairly quickly before consolidating and then lower again, probably bottoming with stocks in 2016-2017.

Another strong indication of deflation is money velocity, which can loosely be defined as how many times a dollar bill is circulated, which in turn tells us how active people are in spending their money vs. saving it and taking it out of circulation. The more the same dollar is circulated and spent the higher the money velocity will be. Each dollar does work multiple times and that's an indication of a strong economy. But if someone along the line saves the money instead, essentially taking it out of circulation, money velocity declines. This will happen when consumers and businesses become more cautious and decide to save for a rainy day -- good for them, bad for the economy. The chart below shows how money velocity has done over the years, starting in 1960.

Money Velocity, 1960-present, chart courtesy St. Louis Fed

What's fascinating, and probably keeping the Fed heads up at night, is the fact that the massive amounts of money that's been printed in the last several years ($4+ trillion just in the U.S.) hasn't stopped the slide in money velocity. It's instead being horded by the banks (even Bernanke was turned down for a remortgage). As you can see in the chart above, money velocity has been declining since about 1996 and even with the massive printing (see chart below) the Fed has not been able to stop the slide. In fact the chart below shows the huge spike in dollars printed starting in 2009 and now compare that to the tiny little bounce in the chart above followed by a steep decline into the present. Money velocity is now well below where it was in 1960 into the 1980s. What's a Fed chairperson to do? Jawbone the market higher by telling it interest rates will remain low for a "considerable period of time."

Adjusted Monetary Base, 1960-present, chart courtesy St. Louis Fed

And here's the culprit: the American consumer is saving more and spending less. Up through 2007 it was close, with saving slightly ahead of spending. But since the market crash in 2008 we've seen the consumer go into hiding and saving much more (62%) than they're spending (34%). The Fed has tried as hard as they could to get the consumer to come out and play but he/she just isn't interested.

Saving vs. Spending by the Consumer, chart courtesy

It's not just the U.S. that's trying to deflate their currency (failing at the moment). Japan has been hard at work for decades and now Draghi is saying he wants to deflate the value of the euro. Last night South Korea made comments about deflating the value of their currency so that they can be more competitive with Japan. Their finance minister said the government "will begin introducing new measures to improve its stock market [emphasis mine] and support large exporters that have sizable amounts of exposure to Japan." Ah, the race for the bottom continues unabated...

Why all this discussion about inflation and efforts to devalue currencies? Because in a deflationary environment almost all asset classes decline in value -- stocks, commodities, metals, real estate, you name it, a stronger dollar and declining asset values is the result. Cash is king in a deflationary time; debt is bad (because the value of the debt increases relative to the asset). The stock market has been ignoring these signs for a long time but when ill winds blow and the market starts to get it, look out below.

The U.S. dollar has had a strong reversal from last week's high and this week's candle, so far, has produced a bearish engulfing candlestick reversal pattern with last weeks' big white candle followed by this week's larger red candle. Last Friday's high was only pennies away from its downtrend line from March 2009 – June 2010, which fits as the top of a large sideways triangle since the 2008-2009 highs. The triangle pattern suggests the dollar is going to be range bound between 76 and 87 through the rest of this decade before finally crashing and burning. We might see another pop back up for a test of last week's high but I'd be surprised to see it break its downtrend line. The parabolic rally off the July low could get quickly retraced if it follows the pattern of typical post-parabolic moves.

U.S. Dollar contract, DX, Weekly chart

Gold is also looking good for a reversal of its decline. The downside targets for gold were 1194.40, for two equal legs down from March, and about 1185 where it would reach the bottom of a sideways triangle that's been playing out since the June 2013 low. Monday's low was 1183.30, which is close enough to the lower target to call the decline finished. The triangle pattern calls for a rally back up to the top of it, perhaps back up to about 1325 by the end of January 2015 where it would also back-test its broken uptrend line from 2001-2005. That would then be a setup for a stronger decline into 2015, which fits the deflationary cycle we'd be into at that point.

Gold continuous contract, GC, Weekly chart

Oil dropped down to 86.83 today, 10 cents above the projection at 86.73 for two equal legs down from August 2013. A little lower is its uptrend line from 2011-2012, currently near 85.25. If oil is going to be heading lower sooner rather than later it's first due a bounce to correct a portion of the decline from June before heading strongly lower later this year and into next. But if the larger sideways triangle is the correct pattern we could soon be setting up for a rally leg out of the triangle. In either case oil is due at least a bounce and I think the short side for oil is the riskier side. It would turn more immediate bearish with a weekly close below 85 but at the moment it's a setup for a bounce/rally.

Oil continuous contract, CL, Weekly chart

Thursday will be another quiet day for economic reports. But there will be several speeches by Fed members so the market will be listening carefully for the hidden messages (you know, did the sentence have the correct punctuation, did he/she have a twitch when something was said, that sort of thing). As discussed earlier, the Fed is fighting a losing battle against deflation and there's really very little else they can try. But it won't stop them from trying to jawbone the market higher with promises of "whatever it takes." The big question is when the market will stop believing it but until then we can expect large price swings in reaction to what the Fed heads say or don't say. Today was just one more example.

Economic reports and Summary

Violent price swings at the top of a long-term rally is usually a good sign of instability and instability usually leads to market reversals. This suggests we'll soon some strong down days that see very little relief in the way of bounces. Unfortunately I currently don't see enough evidence in the price pattern to support that expectation. It's simply something to be aware of and don't get complacent about the upside.

At the moment I'm leaning into the bull's camp with an expectation we'll see another rally to new highs in the weeks ahead. I'm betting small in that direction but not willing to carry much if any risk overnight. For Thursday I can see the potential for a reversal of today's rally and at least a minor new low, such as one to test the 200-dma's for the DOW and SPX. But in reality, as of tonight, it's flip a coin for direction and I don't trade coin flips. There are times to trade and more importantly there are times to sit in cash. That's the 3rd position that most traders hate but oftentimes the best position.

Opex is typically a bullish weak and we got a strong reversal on a full moon. As can be seen on my MPTS chart below, important lows were made in April and August on full moons. Play it again Sam?

SPX MPTS daily chart

Trade carefully if you must but realize risk has increased significantly with the volatility. Catch the direction right (each day) and there's good money to be made. Catch it wrong and don't stop out and you'll feel some pain.

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