The strong rally off the October 15th low quickly shot indexes up to potentially strong resistance levels and today's pullback will lead to an important test for the market. Who wins the test will dictate the market's direction into December.

Wednesday's Market Stats

The strong rally off the October 15th low has all the hallmarks of short covering. When the indexes started to break important support levels last week there was panic in the streets, as evidenced by the spike up in the VIX. Many traders started piling into puts and hedging their long positions with some short positions. When buy programs were initiated on Wednesday (it can be argued who initiated them) the shorts ran for cover and it didn't stop until today. Overnight rallies in the futures ensured the indexes jumped over solid resistance as a way to keep the short-covering rally going.

The rally had the indexes up to important resistance levels, as I'll cover in tonight's charts, and this time there was no overnight rally to provide a gap up and poke the bears some more in their eyes. Mission accomplished by the PPT and now they'll sit back and see how the market does on its own? We saw the strongest buying of the year in the previous 4 days and it certainly makes one wonder what could have prompted such a strong rally. Maybe I'm just being paranoid (wink).

Without another gap up to keep things going this morning there was little to no short covering at the open and while some more buyers tried to keep the rally going it became obvious early that the buying was exhausted for now. The market rolled over and the end result was the indexes were held down at important lines of resistance. What we don't know yet is whether last week's low was just another v-bottom reversal in a long string of them over the past few years, which led to new market highs, or if the strong rally was the first of many sharp spikes to the upside (short covering) that are more common in bear markets than bull markets. Some of the strongest rallies occur in bear markets but they tend to reverse just as quickly once the short covering finishes. We don't know if that's what we have here and we need more evidence in a pullback/decline that will provide more hints to tell us what the past week was all about.

It was a quiet morning for traders, which started out with a quiet pre-market session and very little in the way of economic news. The only economic report of note was the consumer price index, which was up +0.1% in September. This was largely a result from lower prices paid for energy products but they were offset by increases in food, shelter and health care. The year-over-year increase is currently running +1.7%.

What's interesting about that number is that it's only off by 0.3% from the Fed's target rate of 2%. But the way the Fed is talking about the need for more stimulus, to ensure we don't suffer from "disinflation" (as if to say we would suffer from lower prices), one would think the CPI rate was closer to zero. The Fed of course wants something north of 2% so that it will help debtors (think government) pay off their debts with cheaper dollars over time. And deflation would be bad for stocks (lower earnings for companies) and since the majority of Fed heads and Congress don't want to see a decline in their portfolios they have a vested interest in seeing the stimulus continue, regardless of the risks to the financial system

With the CPI rate (as the government currently calculates it) running at +1.7%, care to guess how much Social Security checks will be raised next year for their cost-of-living-adjustment (COLA)? Yep, 1.7%. Of course the real cost of living has risen considerably more and it's one reason why consumer spending continues to decline -- wages declining, costs rising and social security checks not keeping up with real cost increases. John Williams, who runs Shadow Government Statistics says the real CPI, when measured the way it was back in the late 1970s, is currently running about +9.4%.

The chart below shows the CPI and PCE (Personal Consumption Expenditures) rates since 2005 and following the bounce off the 2009 low (a 3-wave bounce correction I might add) the rates have been in decline. The PCE is more important to the Fed than CPI since it's a better measurement of what the consumer is doing. Considering how much the GDP numbers are dependent on a spending consumer it's understandable why the Fed is concerned about the lack of results from their massive stimulus program (or at least they should be concerned that it's not working, unlike all their textbooks tell them it should work). This is a reason why the Fed might decide to halt QE taper and it wouldn't surprise me in the least to see QE5 if the CPI and PCE numbers drop closer to zero. Of course more stimulus would just be more evidence of insanity from the Fed (doing the same thing and hoping for a different result). Expect the Fed to become even more creative in their next QE program (and expect an instant Pavlovian response from the market).

CPI and PCE, 2005-September 2014

Starting off tonight's chart review with a weekly view of SPX, you can see last week's bullish hammer on support. The tail was the intra-week break below the uptrend line from March 2009 - October 2011. This is a major trend line that identifies the 5-1/2-year bull market. The break of the uptrend line, as well as the 50-week MA, is one of the reasons the VIX spiked so high. Traders were rushing into put protection and entering short positions (for hedging and/or speculation). The strong rebound off last Wednesday's low was a result of a quick unwinding of all those short positions. The close at support was a very important accomplishment on Friday and I'm sure it was purely coincidental (wink) that Friday Fed President James Bullard came out with his opinion that the Fed should delay the end of QE. We've been hearing similar rumors about the ECB doing "something soon" and these statements are of course designed to support the market.

S&P 500, SPX, Weekly chart

The bullish wave count on the chart above is based on nested 1st and 2nd waves up from the October 2011 low. That low is the b-wave in a large A-B-C rally off the March 2009 low and the c-wave is the rally from October 2011. There are a couple of different ways to count the move and there is an easy way to consider the September top as the completion of the c-wave. But so far the decline from September 19th leaves open the potential for one more new high to complete the final 5th wave, which is shown in green. A rally up to the trend line along the highs from April 2010 - May 2011 by the end of November would have SPX up to about 2070. Based on wave relationships, there's an upside projection at 2038 so we've got a wide upside target zone but if we get the rally in November I'll be able to start zeroing in on a higher-probability target.

Another rally leg is by no means a given. A larger bear-market decline from September might not be an impulsive decline and the small a-b-c decline so far could simply be the first leg down in what will become a corrective (choppy) decline. This is one reason why the uptrend line from March 2009 is so important. Currently near 1891 (the 50-week MA), this level needs to be defended by the bulls on a weekly closing basis. Back below price-level support near 1850 would be a strong statement by the bears.

The rally from last Wednesday has been very strong and for a final 5th wave to a new high it's possible we're going to see somewhat of a blow-off top. That's just speculation but it would be a typical move and the daily chart below shows how a quick rally to a new high could finish by mid-November. A rally up to crossing trend lines could see SPX up near 2050 by November's opex. But if a pullback from here starts to show impulsive qualities and breaks below 1877 I think it would be strong evidence supporting the more bearish price path, which suggests another 3-wave move down to equal the September-October decline (so down to 1750).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1930
- bearish below 1877

Yesterday SPX broke its downtrend line from September 19th. It was a marginal break but the close above it was a good sign for the bulls. Today the bears ripped down that sign and stomped on it. Granted, the price action around the downtrend line, as can be seen on the 60-min chart below, looks like noise but so far the inability to hold above the line has it looking like a head-fake break yesterday. It points to a larger pullback and potentially the start of the next leg down. A 50% retracement of the rally from last Wednesday is at 1885, which would be another test of the uptrend line from March 2009. That kind of test, if it happens, would then create a major decision point for the market. But if today's pullback is followed by another push higher we would then have a better-looking 5-wave move up from October 15th, which would be a strong bullish statement to expect new highs into November-December.

S&P 500, SPX, 60-min chart

The DOW has the same pattern as SPX and therefore there's not much to add. It had closed marginally above its 200-dma yesterday, near 16586, but it was not able to hold above it today. They were going for the stops just above the 200-dma and once hit there was no more buying power. The significance here is that the DOW bounced off the 200-dma back in early August but after breaking it on October 10th it's now back up for what could be a back-test. A bearish kiss goodbye could lead to a resumption of the selling so if we get anything other than a 3-wave pullback correction it could turn the rally attempt into just a quick bear-market short-covering rally. The jury is still out and we might not know what direction it will be for the next big move.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,720
- bearish below 16,000

Last week's bounce for the DOW off its uptrend line from October 2011 - November 2012 was a good setup for another rally leg to new all-time highs in November-December, and that's still the bullish potential. But with so many traders conditioned to believe dips, even scary ones, are to be bought, we could get a lot of traders chasing this move higher and today's dip could be just what they're looking for. But until the DOW can get back above price-level S/R near 16720 I'd say the bears still have the chance to show they're not done yet.

The NDX also has the same pattern as the DOW and SPX. It has had a stronger bounce and is not far from its 50-dma, near 4011, and its downtrend line from September, near 3997 (today's high was 3988). If we get just a pullback as part of what will be a larger rally, look for support near 3870 where it would close Tuesday's gap up and test its uptrend line from March 2009 - June 2013. A drop much below 3800 would start to look more bearish, especially if it's a strong decline rather than a 3-wave pullback.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4011
- bearish below 3800

The RUT has been in a different pattern since its July high, which was a near-perfect test of its March high (the double top). With the lower high in September and then the lower low in October we've got the definition of a downtrend. But the 3-wave pullback from July could be an a-b-c pullback correction that will be followed by new market highs into the end of the year, similar to the other indexes. In that case a pullback to support near 1080 would be an excellent opportunity to get long for a strong rally into November. But if the series of lower lows and lower highs is a nested 1-2, 1-2 wave count to the downside then the next leg down is going to be a whopper. A 3rd of a 3rd wave down is what the bearish wave calls for and that would essentially be a crash leg down. That's the risk for longs here, or if you try to buy the next pullback -- be sure to honor your stops because there will be no getting out of jail in the next decline. As has been true for a while now, watching the RUT for clues is going to be very important because whatever the next move is going to be, it's going to be big.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1130
- bearish below 1078

From a timing perspective, there was one tool that warned of a market reversal last week. The Bradley turn model predicts market reversals that are based on the change in behavior of us humans, which is based on astrology. Whether you believe in an astrological effect on us or not, the market seems to follow the model predictions fairly well (but not all the time). The October 15th low happened a day before an important turn date on this model, as shown on the chart below. And considering the next turn date isn't until November 22nd it says the current reversal to the upside could see some follow through. Keep in mind the direction of the turn on the model is not a predictor of the direction of the market; it only provides turn dates so you need to figure out from the direction into the turn date what kind of reversal you're looking for.

Bradley Siderograph for 2014, chart courtesy

Information about the Bradley turn model can be found at and the chart above is from their site, with SPX prices updated just before the October 15th low. As you can see, the model called for a market turn on October 16th so it was only off by a day. According to some who follow this model, the October 16 turn date was expected to be one of the sharpest of the year and that's exactly what we've had. The expectation was for an increase in volatility around this time and the spike in VIX to a high of 31 on October 15th was certainly affirmation of that.

If the market does rally into the November 22nd turn date, which would likely mean new highs for the indexes, we could then see a turn back down into December. The three turn dates from November 22nd through December 26th warns us to expect some whipsaw moves at the end of the year. If the market continues to decline from here, the October 16 turn date, and its expected increased volatility, will have been a warning for the strong reversal followed by another one.

The banking index, BKX, got a bounce where it needed to last week. Other than the intraday break of support near 66 last Wednesday it is holding above price-level support and its uptrend line from March 2009. Between the shelf of support and the uptrend line, the bulls really need to defend this level. Another break below it might not be met with the same buying enthusiasm (unless it's the PPT behind saving the banks here).

KBW Bank index, BKX, Weekly chart

On October 1st the TRAN broke its uptrend line from June 2013 - February 2014, a trend line that held the April and August declines. It was quickly recovered with the big up day on October 3rd but when it broke again on October 7th it was every bull for himself as traders bailed en masse. The sharp decline into the October 13th low, which was retested on the 15th was a break of its 200-dma and things were looking nasty. But then strong buying propelled the index back up to, and slightly above, its broken uptrend line from June 2013. Looks like a perfect back-test followed by a bearish kiss goodbye today, no? That's the bearish setup on this index and we'll see if it becomes one of the leaders to the downside (along with the RUT). But if a pullback is followed by a push above this morning's high at 3490 there will be nothing to stop new highs from coming. At that point the bulls would only need the DOW to also make new highs to get a bullish Dow Theory confirmation.

Transportation Index, TRAN, Daily chart

After peaking at 86.87 on October 3rd the U.S. dollar has pulled back from its downtrend line from March 2009 - June 2010. I wonder if the trend line will be broken if the stock market indexes confirm a breakdown from their uptrend lines from March 2009. The pullback from the high is only a 3-wave move so far and there's the potential for at least a minor new high to complete a 5-wave move up from May. The dollar could continue to consolidate in a large sideways triangle that it's been in since the 2008-2009 highs and lows, which means we could see the dollar trapped between 75 and 87 for another couple of years before breaking down. Only if we get a decent pullback followed by new highs (light green dashed line) will we have something more immediately bullish for the dollar.

U.S. Dollar contract, DX, Weekly chart

A stronger pullback in the dollar would help gold rise up to at least the top of its sideways triangle that it's been in since June 2013. As I've been showing for months now, my expectation is for one more leg up inside the triangle, up to about 1325, and then the resumption of its decline. The e-wave of a triangle is often a throw-over (above the top of the triangle in this case) but with commodities in particular I've seen many "stunted" e-waves, which means traders have to be alert to the possibility the bounce off the October 6th low could fail at any time. A drop below 1194 would be more immediately bearish. Note RSI has bounced back up to its broken uptrend line so a turn back down would be a sell signal from this indicator.

Gold continuous contract, GC, Weekly chart

This morning's report on crude inventories showed a higher level than had been expected and that prompted another selloff. Oil futures dropped -2.6% today and CL made a new closing low, at 80.32, for the current decline. There's a Fib projection for the 2nd leg of the decline from August 2013, at 74.60, where it would equal 162% of the 1st leg down. So that remains a downside target until we see a stronger bounce. Until CL can get back above its broken uptrend line from October 2011, near 85.40, it remains bearish.

Oil continuous contract, CL, Daily chart

Tonight and tomorrow morning the market will get to digest a lot of global manufacturing data with PMI reports out of China, Germany, the EU and then the U.S. All eyes will be watching for evidence of further slowing in the global economy, which is especially concerning for Europe. If Germany continues to slow it's going to be hard for Europe to evade a deeper recession. But hey, that could prompt Mario Draghi into promises of more "whatever it takes."

Economic reports and Summary

The stock market suffered some serious technical damage last week. For the first time since the March 2009 and/or the October 2011 lows we've seen a break of uptrend lines, 200-dma's and some strong price-level support lines. Many of the indexes did a quick recovery by last Friday and the weekly closing prices "saved" the indexes from suffering a weekly sell signal. Amazing how that happened.

The indexes are now at a point where the bulls have to keep up the buying pressure and not allow even a retest of last week's lows. Another break of strong support would not likely see the same kind of bullish response. But there is the potential for a pullback to higher lows in the next day or two and then push higher, in which case the short-term pattern (into November) would be bullish. And that would mean we'd very likely see new highs for the indexes. The pattern of the pullback/decline will provide some clues about what to expect into November.

Continue to keep an eye on what the RUT is doing. Today's bearish engulfing candlestick (gap up, new high, lower close than yesterday) could be signaling the start of the next decline, which could get really ugly for the bulls if the bearish wave count is correct. But with the higher volatility we can't yet know whether or not today's pullback is bearish or just a correction to a new rally leg that will take us to new highs in November. As shown with the Bradley turn model, it supports a continuation of the rally following a pullback correction. It's a tough spot for traders and quick trades are a must until the bigger pattern clears up since there's significant risk if you hold a position and the market moves against you. Trade 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