The rally from October was supposedly due to an expected win by Republicans in both Houses, which is supposed to be good for the stock market. But statistics show the bulls may have misplaced faith in this.
Wednesday's Market Stats
The Republicans will take over the Senate and they increased their control in the House, which was anticipated, and it's part of the reason why the market has rallied strongly in the past three weeks. The rally was also helped by Japan's surprise QE2IB (QE to Infinity and Beyond) program but now that the bulls have what they wanted we have to wonder what else will drive the market higher. Following this morning's gap up there was no follow through. And one problem with the idea that a Republican-controlled Senate and Congress is that statistics show it's actually not helpful to the market, especially right after the midterm elections.
Statistics show that over time the stock market has not done well under a Republican-controlled Congress but the market does supposedly likes the idea of gridlock. This of course begs the question: what the heck have we had for years now? But a Democratic president and Republican Congress will likely be even more gridlocked and that's what the market likes (stay out my business is the general feeling). But in the short term there's evidence (scant though it may be) that the weeks following this kind of an election are not favorable for the market, which suggests at least a larger pullback before heading higher into next year.
There's also a good chance we'll see a sell-the-news reaction soon after these elections. The market could push higher for another day or two (or not) but the rally priced in this win and with an extremely overbought and overbullish market it's ripe for at least a larger pullback. As I'll cover in the charts, the price pattern for the rally is looking close to complete, which is another reason I'm now looking for at least a correction to the rally before heading higher. There is a more bearish possibility that says the rally from October 15th, once completed, will also complete the 5-1/2 year bull market.
The market was more interested in the election results than any economic indicators this morning so the ADP Employment and ISM Services reports were generally ignored. The ADP report showed 230K jobs added, which was generally in line with expectations and an improvement over September's 225K (revised up from 213K). The ISM Services number was 57.1, a little less than the 58 that was expected and less than the 58.6 we had in September.
Because of the election results the futures had rallied strong in the overnight session and we started the day with a big gap up. It quickly turned into a gap n crap start and the techs quickly closed this morning's gap while it took until this afternoon's decline for the RUT to do the same thing. The blue chips held up better, indicating some defensiveness in today's market. Now the question is whether the bulls can add any more to the rally or if it's all baked into the cake and now we'll see profit taking.
I think it will be important to watch the DOW carefully here since it has pushed up to important trendline resistance and how it does here will tell us more about how well the bulls can be expected to do, even if it's just for a higher move only into next week. Starting off with the weekly chart of the DOW, you can see how the straight-up rally from October 15th has now slammed back into the trend line along the highs from May 2011 - May 2013. This trend line has stopped rallies since December 2013 (with minor pokes above the trend line. Interestingly, a trend line along those minor pokes is only marginally higher and it was tagged with today's high at 17485. From a purely trendline analysis perspective this is the perfect spot for a bear attack.
Dow Industrials, INDU, Weekly chart
The daily chart below is a closer view of the trend lines in play at the moment. You can see the trend line along the highs from December 2013 - July 2014 is where the September rally stopped. Will it have better luck this time? Tomorrow the trend line sits near 17500 so that's the level the bulls need to break through in order to open the gate to higher levels (such as 18K). Maybe they'll jump over resistance with a gap up after running the futures higher tonight (the usual method this market deals with resistance). Above 17500 the bears should stay away but with a rally that's gone too far too fast I would not want to chase it higher from here since any break of resistance could be just a stop run that gets reversed quickly.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,500
- bearish below 17,150
There's another trend line in play for the DOW right here -- using the log price scale (the weekly and daily charts above are using the arithmetic price scales) shows the uptrend line from November 2012 - February 2014, which is approaching 17540. So maybe a quick run up in the morning, nab some stops, ring the bell at the trend line and then reverse back down. Obviously I can only guess how much further this rally could run but for the sake of the bulls it should at least pull back soon. A rally that has gone too far too fast into a flameout would not be a good thing for investors, especially if they're chasing it higher and find no chairs when the music stops. But if the buyers can keep the market headed higher for the rest of the week I see upside potential first to the 17750 area and then 18K.
Dow Industrials, INDU, 60-min chart
SPX also has a few trend lines that are in play here but a bit higher than what we have for the DOW. Using the log price scale we have the uptrend line from November 2012 - February 2014 near 2042 on Thursday. Crossing the same level is the trend line along the highs from July-September. Slightly higher is the trend line along the highs from April 2010 - May 2011, currently near 2049. That gives us a trendline resistance zone at 2042-2049, about another 20-25 points above today's high. That would have the DOW up around the 17750 area that I mentioned above.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2055
- bearish below 1985
Above 2050 would have SPX looking bullish with the break above its trend lines but I have 2055 as the key level to the upside based on a price projection for its wave pattern, shown on the 60-min chart below. The 1st wave of the move up from October 15th extended and when that happens it's typical for the 3rd through 5th waves to achieve equality with the 1st wave, which is the 2055 projection. That opens up the upside target zone to roughly 2042-2055. An early warning for the bulls would be a break of the uptrend line from October 15th, which SPX has been walking up since testing it with Tuesday morning's low. Currently near 2017 it means the bulls need to keep at this and not let price break below this afternoon's low near 2016.
S&P 500, SPX, 60-min chart
NDX has been oscillating around the 4150 level since gapping up to it last Friday. The bulls will see the sideways choppy consolidation as a bullish continuation pattern while the bears see topping action. As for additional upside potential, there's a trend line along the highs from April 2010 - April 2012, currently near 4202. Century-level resistance at 4200 is also potential resistance. A little higher is the 127% extension of the September-October decline, a common reversal Fib. So watch that area for a possible top if reached. NDX would close last Friday's gap near 4100 and a drop below that level would be a good indication the top is in for now and we'll have to evaluate the pullback/decline for evidence for what will follow (the same as for the DOW and SPX).
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4200
- bearish below 4100
Continue to keep a close eye on how the semiconductors are doing. The SOX has rallied strongly with the rest of the market, which supports the bullish move. But it's now having trouble with its broken uptrend line from November 2012 and is close to its September 19th high near 659 (about 10 points higher). I think it's going to form a double top (triple top if you include the double top in July and September) and the bearish divergence, as can be seen on the RSI on the weekly chart below) is calling out to the bulls "Danger Will Robertson, Danger!" This is looking like a short play just waiting to get triggered (with a decline below 640).
Semiconductor index, SOX, Weekly chart
After gapping up last Friday, like NDX, the RUT has stalled and hasn't been able to find enough buyers to push it higher. The underperformance by the techs and small caps is indicative of defensiveness following the strong rally off the October low. The RUT made it up to its broken uptrend line form March 2009 - October 2011 (green trend line on its chart below) and its 78.6% retracement of its July-October decline, at 1176. The RUT would turn at least short-term bullish above 1180 and it could make it back up to its March and July highs near 1213 (triple top?). But if it drops back down from here and closes last Friday's gap near 1155 I think it would be signaling the top is in place and we'll have to watch to see what kind of pullback/decline develops next. If we're getting ready to start the next bear market decline it will likely be the RUT out in front again.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1180
- bearish below 1155
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A week ago I had mentioned the TRAN's strong rally up close to its trend line along the highs from 2010-2011-2014, near 8833 at the time. With yesterday's rally it finally rang the bell at the trend line, now near 8870. With the overbought conditions I think it would be a risky bet on a breakthrough (for anything more than a minor poke above the line. The higher-odds scenario suggests at least a pullback before heading higher and the longer-term chart suggests we could now start back down to the bottom of the expanding triangle that has formed since July. One idea is that we'll see the right side of a diamond top form in the coming months, something I'll track until the idea is negated.
Transportation Index, TRAN, Daily chart
As I had mentioned last week, the U.S. dollar's rally pattern from May would look best with one more marginal new high to complete a 5-wave move up, which it has now done. If it gets above 88 it would look like something more bullish than a 5th wave to complete the leg up from May but at the moment, especially with bearish divergence against the September high, it looks like the dollar's rally could complete at any time now. The short-term pattern suggests it make it closer to the 88 area but it shouldn't push much higher than that. Dollar bulls need to pull stops up tight here. We should get at least a larger pullback to correct the rally from May and possibly something more bearish if the dollar is going to head back down to the bottom of a large sideways triangle since 2008-2009, which mean back down to the $75 area next year. But I continue to believe we'll get a larger rally in the dollar in the coming years, one that will take the dollar up to 110 if not 120. The dollar still smells "less bad" than the other fiat currencies.
U.S. Dollar contract, DX, Weekly chart
The metals have been hammered the past two weeks and gold dropped $118 from a high near 1255 on October 21st to today's low near 1137. In so doing it gave up price-level support near 1180, a level that has supported gold since 2010. It could be heading for the next price-level support line near 1000. It's not likely to be a straight move down to there and with gold now significantly oversold on its daily chart we could see a bounce start at any time. But as depicted on the weekly chart below, I see the potential for gold to hit 1090 before it gets a bigger bounce/consolidation into early 2015. At that level it would retrace 50% of its 2001-2011 rally and it would likely be a good setup for an oversold bounce. Then another leg down towards the 1000 support line in 2015, potentially lower towards the 62% retracement of its 2001-2011 rally, near 893.
Gold continuous contract, GC, Weekly chart
Silver has dropped down to an older broken downtrend line from November 2012 - August 2013, currently near 15.15 (this morning's low was 15.12). This downtrend line was broken in February, acted as support during the pullback into April and is now being tested again. Stronger support should be a price-level S/R near 14.65 and being as oversold as it is on the daily chart we could see a stronger bounce start at any time. As with gold, I think silver will work its way lower into at least early 2015 but we could first see a bounce back up to price-level S/R at 18.60 before dropping again into early next year. The downside target I'm projecting on its weekly chart below is 12.25 by the end of April 2015 where it would find trendline support and potentially put in its final low for its 2011-2015 bear market.
Silver continuous contract, SI, Weekly chart
Along with most commodities, oil has dropped sharply since June and especially since its little consolidation in September. I've had a downside projection for the leg down from June at 74.60, which is where the 2nd leg of the decline from August 2013 would achieve 162% of the 1st leg down. That's also near the prior low at 74.95 in October 2011 so there's reason to expect support in the %75 area and we're now close enough to suggest oil bears need to be very careful -- it's time to draw stops tight. If the 3-wave move down from August 2013 is the completion of another leg inside its larger sideways triangle following the May 2011 high then we'll see the start of another choppy rally to the top of the triangle, currently near 110. But as labeled in red, if the decline from August 2013 is going to turn into a 5-wave move down we'll get just a choppy bounce correction over the next few months for the 4th wave before heading lower in the 5th wave, potentially down to the $70 area by mid-2015.
Oil continuous contract, CL, Weekly chart
Thursday has no market-moving economic reports but Friday will be important as we get the NFP numbers. Before the open tomorrow, at 7:45 AM ET, we'll get to hear what the ECB rate decision will be. While it's not expected, they could surprise the market with some kind of QE announcement. After all, it's important to keep up with the Jones's (Japan in this case).
Economic reports and Summary
On the charts I have us in the 5th waves for each of the indexes for the rally from October's low. The final 5th wave is commonly put in on a news-related spike, which we got with this morning's gap up. So was that it? Is the top in place? It's too early to tell and with some upside potential shown for the different indexes I'm certainly not ready yet to declare a top in place. But it's probably very close, as in hours or days away. Be careful about chasing this rally any higher from here. Whether a high will be THE high or just another in what will become a much larger rally can't be known yet. That will become clearer only after evaluating the pattern of the next pullback/decline. In the meantime the short-term outlook says be prepared for at least a larger pullback.
Depending on your trading/investing horizon, now is a good time to pull stops up tight on long positions if you'd rather not give up all of the gains since October 15th since that's the level, if broken, would indicate the longer-term uptrend has been broken. In other words, longer-term investors can wait for that break before abandoning ship. But if you don't want to give back that much then pull your stops up tight and use the key levels I've given on the charts to trigger your exit. For short traders, use the key levels to indicate when it's safe to get back in the water and trade with the bears (how's that for a mixed metaphor?). If you're following the markets during the day, use the uptrend lines from October 15th, a break of which would be a good signal we hit the bend at the end of the trend.
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