There were no surprises out of today's FOMC announcement and that was met with disappointment. The hopeful bulls (and/or scared bears) created a strong 2-week rally on expectations for more Fed help. Not so fast was the message from the Fed.
Wednesday's Market Stats
The market had been rallying strong for the past two weeks, ever since some Fed heads started hinting that they might remain more accommodative and for a longer period of time than what had been feared. The strong September-October decline was blamed on worry about the Fed pulling liquidity out of the market. Once there were hints the Fed could remain more accommodative the bears panicked and started some vicious short covering while the bulls rejoiced at the good news (well, an expectation of good news) that QE4 is right around the corner.
The end result was the strongest 2-week rally that we've seen in the past three years. But is it a "real" rally or is it a short-covering rally? Knowing that the strongest rallies actually occur during bear markets we have to question the authenticity of this rally. Bear market rallies tend to be retraced just as quickly as it took for the rally once the reason for hope has been removed.
Bear market rallies are based on hope and the pattern for a bear market decline is often called the "slope of hope" as sharp rallies are followed by stronger declines. What we don't know yet is whether the 2-week rally we've had is just the first in what will become many hope-filled rallies in the next bear market. Or are we into another rally leg to a new high? The answer is not clear yet but with some indexes making new highs (TRAN) it remains a possibility that the bears need to respect.
Today's FOMC announcement was not supportive of the past 2-week rally. The hope for more was not met with assurances from the Fed and the first reaction to the announcement was a selloff in the stock market. Perhaps it was simply a typical "buy the rumor, sell the news" reaction as the market fully priced in what the Fed is going to do. Treasury yields spiked down (bonds were bought), suggesting the Fed will continue to support the bond market, but gold sold off while the dollar spiked up, which suggests less monetary stimulus from the Fed. So we've got mixed signals from the various markets and only with some additional time will we see how this shakes out.
It's hard to believe it's been two years since the Fed announced QE3 with their $85b/month purchases of Treasuries and mortgage debt. The taper program has been whittling the amount down and today they announced the expected completion of the program. Keep in mind though that they're not removing the money they've pumped into the system; they're stopping the purchase of more but they'll continue to roll over expiring debt by purchasing new debt, which may have been the reason Treasury yields spiked down this afternoon -- bond demand will still be there. Still, the removal of the added liquidity that the market has enjoyed for the past two years with this program is now stopping.
Also disappointing the stock market today was their statement, "The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month."
The use of the words "substantial improvement" in the labor market scares bulls. They want to see more evidence the Fed is nervous about the economy and therefore hint that more accommodation may be required. The Fed included the language "considerable time" when it comes to an anticipated change in their federal funds rate (which they refer to as "policy accommodation"), leaving themselves an open door in both directions for further changes. If they find labor employment and inflation change more than expected in the next several months they'll adjust their accommodative policy accordingly. This is of course nothing new but it means the market will be hanging on every word from the Fed heads over the next weeks/months.
The Fed talked about including a lot more data, such as what's happening in the global economy, to help them decide when it will be time to make a change to their policy accommodation. One bone the Fed did throw to the bulls (do bulls chew on bones?) was their statement that the Committee "currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run." The Fed is saying they no longer will use labor conditions or inflation targets to determine their policy accommodation decisions but will now look for much more data to help them decide. In the meantime, savers be damned, debt holders be loved. The message has been clear for a long time -- the Fed wants spenders, not savers.
The bottom line is that there were no surprises out of the FOMC announcement and that's actually what disappointed the bulls. They were really hoping for at least some hints of more accommodation, which is what the past 2-week rally was all about, and not getting it could cause some problems for the rally. Now it's time for some more direct intervention to prevent the bears from getting a toehold (wink).
The 2-week rally that we had obviously looks bullish. New highs appear to be right around the corner. But what makes it a dangerous time to join the bulls is how quickly the market rallied. As mentioned earlier, the sharpest rallies occur during bear markets and this rally was indeed a sharp one. John Hussman, President of the Hussman Investment Trust, has made a lot of noise lately about how dangerous this market is for investors. Based on his bearish opinion he is usually immediately discounted by bullish investors. My mere mention of his name here will likely have many of you immediately skimming the rest of this and looking for more evidence that supports your bullish perspective. It's natural to do that (it's what has made our country so divided as people look for only what supports their views).
Hussman has studies past stock market peaks and believes we're repeating the pattern of past peaks, including the recent 2-week rally. He was out beating the drum about the dangers of this market back in September when he identified it as a time of increased risk from a "severely overvalued, overbought, overbullish syndrome of conditions ... that is then followed by a clear deterioration in market internals." Those were in fact the conditions at the September high. Hussman recently pointed out what typically follows the first breakdown into an oversold short-term low. He refers to the subsequent rallies as "fast, furious, prone-to-failure" advances and believes that's what we just experienced. Off the September highs we had breaks of longer-term uptrend lines and the 50- and 200-dma's that were then followed by a "fast and furious" advance. The only question that remains now is whether it's going to be "prone to failure."
Quoting from Hussman's latest market observations, he notes the following:
My impression is that we are observing a similar dynamic at present. Though we remain open to the potential for market internals to improve convincingly enough to at least defer our immediate concerns about market risk, we should also be mindful of the sequence common to the 1929, 1972, 1987, 2000, and 2007 episodes:
1) an extreme syndrome of overvalued, overbought, overbullish conditions (rich valuations, lopsided bullish sentiment, uncorrected and overextended short-term action);
2) a subtle breakdown in market internals across a broad range of stocks, industries, and security types;
3) an initial 'air pocket' type selloff to an oversold short-term low;
4) a 'fast, furious, prone-to-failure' short squeeze to clear the oversold condition;
5) a continued pairing of rich valuations and dispersion in market internals, resulting in a continuation to a crash or a prolonged bear market decline."
Bullet #5 is of course important here. We don't know if this 2-week rally will result in a further selloff but if it does then the pattern suggest the selloff will be more severe than the preceding rally. In that case bullish positions for the November opex cycle will be at risk. But if we've got at least one more new high left in this market then we need to identify some upside targets to watch for.
I'll start off tonight's chart review with a weekly chart of the DOW to point out some levels of interest. Using the log price scale, you can see the perfect test back on October 15th of the trend line along the highs from 1971-1972-1987. Not seen on the chart, this line was support at the 2002 and 2003 lows but then was broken in 2008. It was then resistance to the rally into the May 2011 high but then recovered in March 2013. It's been tested multiple times since then and continues to act as support. The market obviously thinks this trend line is important so it's an important line for the bulls to defend. A drop below the October 15th low, at 15855, would be a strong sell signal.
Dow Industrials, INDU, Weekly chart
The uptrend line from October 2011 - November 2012 was broken at the beginning of October and is currently nearing 17100 so if there's at least a little more upside on Thursday keep an eye on that level for potential resistance. If the DOW joins the TRAN to new highs we could see a rally up to at least the trend line along the highs from last December-July-September, currently near 17490. The continuation of the bearish divergences doesn't prevent a new high but it makes it a risky bet from here.
The daily chart of the DOW, below, is using the arithmetic price scale, which shifts the positions of the longer-term trend lines. The uptrend line from October 2011 - November 2012, referenced on the weekly chart above, drops down to near the October low, as shown on the daily chart below. The broken November 2012 - February 2014, which is not shown on the weekly chart, was tested today, which sets up a potential bearish kiss goodbye from here if Thursday sees more selling. The bearish wave count calls the 2-week rally just a bear-market rally that will be followed by strong selling. The bullish wave count calls for just a pullback, shown in green, before heading higher into November-December. It could press higher before pulling back but if it simply continues to power higher without a pullback it's going to make it even more vulnerable to a sharp selloff.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,100
- bearish below 16,500
I've been trying to figure out the wave pattern of the rally off the October 15th low as a way to help determine whether it's likely just bear-market rally or something more bullish. Unfortunately the pattern leaves the door open for both possibilities. I can't even get a higher-odds probability to peak its head out. The 30-min chart below shows a couple of idea and when the wave count doesn't help enough I resort to trend lines/channels and in this case a rising wedge, which is bearish. Today's pullback broke the bottom of the wedge, near 16985, just before the FOMC announcement. The uptrend line will be near 17035 at tomorrow's open and a bounce up to the line for a back-test followed by a kiss goodbye would be a sell signal.
Dow Industrials, INDU, 30-min chart
If the DOW pushes up to at least a minor new high tomorrow, it could test the broken uptrend line from November 2012, near 17102 tomorrow morning. It would be another potential setup for the start of at least a larger pullback so watch for a setup to play the short side if it breaks down from the 16985-17100 area. But if the DOW makes it much above 17100 and stays above then we'd have a bullish move, especially if it pops out the top of the rising wedge pattern, near 17200 by the end of the day tomorrow.
Yesterday SPX closed slightly above its broken uptrend line from November 2012 - February 2014, currently near 1980. But it's struggling with price-level S/R near 1985 and today's candle is a long-legged doji at resistance. This candlestick is usually a sign that the market has lost its way and that typically means it's lost its momentum. Commonly seen at/near tops, a red candle on Thursday would create a sell signal. We can't know yet whether any selling from here would be just a pullback before pressing higher later in November or if we'll start a more significant decline. The bearish potential suggests the short side would be the better trade and then monitor it for signs of being just a corrective pullback vs. a more impulsive (bearish) decline.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1985
- bearish below 1890
The 60-min chart below shows the oscillation around the broken uptrend line from November 2012, which created the long-legged doji on the daily chart. SPX is also struggling near the 78.6% retracement of its September-October decline, at 1976.76, which is one of this market's favorite retracement levels (for a deep retracement, which often gets both sides leaning in the wrong direction). Because of the trend line and 78.6% retracement, any further rally would be bullish, although the 2010-2020 area would likely be tough resistance, especially with an overbought market.
S&P 500, SPX, 60-min chart
Like SPX, NDX finished with long-legged doji, which was inside yesterday's candle. An inside day and a doji are often interpreted as indecision days, or days of rest, so that's clearly what we could have here. But the setup the short-term pattern shows loss of momentum at the current high and at least a pullback before heading higher (the bullish case) should be expected. The bearish case says the sharp rally off the October 15th low will be completely retraced and quickly. It's not a good place to be pressing bullish bets, especially if it drops back below price-level S/R near 4050. It remains bullish above that level but again, not it's not a place where I'd be adding bullish positions.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4050
- bearish below 3870
The RUT is the index that I've been using for the past few weeks to point out the likelihood for at least a high bounce following the September-October decline. But I thought it would rally some, pull back into the end of October and then rally some more into early- to mid-November. It instead decided it didn't need a pullback and simply rallied up to potential resistance at its downtrend line from July-September and its broken uptrend line from October 2011 - November 2012. The two trend lines cross near 1156 on Thursday so it would be more bullish above that level (on a closing basis since we know intraday breaks of S/R are common). At the moment the RUT is also struggling with its 200-dma, near 1146 (where it closed today), and the 62% retracement of its July-October decline, at 1147.43. It's a good place for at least a rest and we'll find out soon if the bulls feel they need a rest or not.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1157
- bearish below 1104
Off the October 15th lows, the TRAN had one of the strongest rallies of all the indexes. It's beckoning the other indexes to follow since at the moment we've got bearish non-confirmation of its high but not for the DOW. The TRAN not only retraced its September-October decline but did so in about half the time. It looks like one of those "too much, too fast" kind of moves and frankly looks like a short-covering rally typically seen during bear markets (as discussed earlier with John Hussman's quotes). At this morning's high, at 8793, it came close to its trend line along the highs from 2010-2011-2014, about 40 points higher. The question for bulls is whether or not they think the TRAN will have better luck this time getting through the trend line, especially with volume tapering off as the rally has progressed and now overbought.
Transportation Index, TRAN, Daily chart
It's been a while since I've reviewed the chart of home builders and I thought now's a good time since it looks poised to start the next leg down. A 3-wave bounce off the August 7th low fits well as an expanded flat a-b-c correction (good Fib wave relationships) and the rally up to the top of its down-channel from February looks complete. This is a good setup for a short play on the group (ITB or XHB) and I'd use a stop just above 506 on the DJUSHB index.
DJ U.S. Home Construction index, DJUSHB, Daily chart
The rally into last February's high completed an a-b-c bounce correction to its 2006-2009 decline and retraced a little more than 62%. Notice the rounding top pattern on the monthly chart of the home builders near the 62% retracement level (31.80):
DJ U.S. Home Construction index, DJUSHB, Monthly chart
Traders in the U.S. dollar looked as though they were surprised by the FOMC announcement today. The dollar spiked up, which fits with the larger pattern calling for one more minor new high to complete the 5th wave in the move up from last May. It should be only a minor new high, perhaps near 87, before starting a larger pullback. As depicted on its weekly chart below, the bullish wave count calls for a pullback into early 2015 before starting a stronger rally that will easily break above 87 and head up toward 110, if not 120, into 2016. But if it's going to stay trapped inside a larger sideways triangle that it's been in since 2008-2009 we will see the dollar work its way back down toward 75 later in 2015/2016.
U.S. Dollar contract, DX, Weekly chart
Gold should not have much more to its current pullback before heading higher. I do see the potential for a test of its October 6th low, near 1183, but it would likely be accompanied by bullish divergence and be a good setup to play the long side on gold. For the rest of this year I'm expecting gold to rally, probably coinciding with a larger pullback for the dollar, before starting a stronger decline that will likely take gold below 1000. I continue to look for an end-of-year rally (not straight up) to about 1325 before turning bearish again.
Gold continuous contract, GC, Daily chart
Oversold and showing some daily bullish divergence at its recent low, oil looks ready for a larger bounce/consolidation before heading lower early next year. Oil would look a little more bullish back above its broken uptrend line from 2011-2012, currently near 85.45, but for the moment I think we'll see a multi-month consolidation before it heads lower, eventually making it down to the $70 area in early 2015. If it works its way up to its broken uptrend line from 2011-2012 by next March we'll see it reach maybe 87 before heading down toward 70. That would then set up a large bounce correction in 2015 so I don't think we'll see oil hang around the $70 level for very long, assuming it will eventually make it down to there. For now I see oil holding the low 80's for the rest of this year.
Oil continuous contract, CL, Weekly chart
There will be no market-moving economic reports in the morning so the market will be on its own to face however market participants are going to react to today's FOMC news.
Economic reports and Summary
The combination of a rally that has been, in John Hussman's words, "fast, furious, prone-to-failure" and with indexes up against resistance with short-term bearish divergence, it's not a good time to be pressing bullish bets. We could get another rally leg on Thursday, especially if the pullback this afternoon was designed to suck in some shorts that will be used for short-covering fuel, but I'd be more interested in looking at a new high, with more bearish divergences, as a shorting opportunity. It might be good for just a trade for a larger pullback but it has the potential to turn into a strong decline, reversing the 2-week rally. Either way I'd continue to exercise caution on Thursday since we've seen plenty of times where the market is "helped" the day after a disappointing reaction to the FOMC announcement. We can't have the market acting disappointed since that might scare Mom and Pop investors.
The big question remains -- are we going to get new highs for the indexes out of this rally? The TRAN says yes, since it's already there. But the bounce pattern is far from clear and it's just as easy to argue it's only been a fast and furious bout of short covering, which leaves the market vulnerable to a downside disconnect without the shorts in place. It's usually why bear market rallies are followed by even stronger selling; bulls panic out of their long positions, having thought new highs were assured, while bears chase the move lower, afraid of missing the decline they were sure was coming but got chased away.
If we do get new highs out of this rally there's a turn window around the middle of November, perhaps right after the midterm elections. Because the rally has been so fast I think it's dangerous to chase it to the upside from here. But a new high with bearish divergences would have me looking to short it. As always, timing is everything so 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