The major indexes have been stuck in consolidation patterns since November and appear to be stuck. But it's looking like we should soon break out and the only remaining question is the direction of the break. We could get an answer before the end of the week.
Wednesday's Market Stats
Equity futures chopped sideways last night and into this morning and the cash market continued the choppy sideways consolidation today. SPX had a relatively quiet day, trading in a 15-point range until the market got hit with strong selling in the final 25 minutes of the trading day and that opened up the trading range to 18 points. The DOW was the stronger index all day, thanks to Visa's (V) +2% gain and Disney's (DIS) monster gap up and +7.6% gain. It had a 180-point trading range today.
Funny how a 180-point trading range today felt like a slow day. It was mild by comparison to the last several weeks and we're seeing a contraction in the price swings in the large consolidation patterns that we've been in since November. The trading range is tightening and the patterns are at the point where we should soon break out/down and see a strong move. Finger to the wind says we'll see an upside breakout but there are a few more pieces to put in place before that becomes a safer trading bet.
This morning's economic reports of interest were the ADP Employment and ISM Services reports. Because of recent declines in the unemployment numbers there was an expectation for an upside surprise in the ADP report. Unfortunately they were wrong and the report showed fewer jobs were filled. The number for January was +213K vs. expectations for +230K and down significantly from December's +253K, which was revised higher from the originally reported +241K. The report barely caused a ripple in the pre-market futures.
After the open we received the ISM Services report and there was a slight tick up in January vs. December, 56.7 vs. 56.5. The market tends to pay less attention to this report, vs. the ISM manufacturing report (yesterday), which saw a decline in January from December (it dropped from 55.1 to 53.5, which continues the slew of economic reports showing a slowing of our economy). One component of the ISM Services report shows pricing pressure (deflation) continues -- the prices-paid component dropped to 45.5 in January, down from 49.8 in December, which was down from November's 55. The other warning from the report is that most of the gain in production came from chewing through the backlog of orders and unless new orders can pump the backlog back up we're looking at continued slowing in the months to come.
At 10:30 AM we then received the oil inventory report, which showed a further buildup of 6.3M barrels added last week. This wasn't as high as the nearly 8.9M barrels added in the previous week but it's still a large addition to an already saturated market. Oil prices reacted predictably on the news and spiked down and continued to sell off the rest of the day. By this afternoon's low oil had given back almost 62% of the rally off last Thursday's low before closing at 48.53 (-8.5%), slightly above its 47.95 low. Yesterday afternoon's high was 54.24.
The indexes were looking like they were going to close at/near their highs for the session as we rounded the corner into the closing bell. But then some ECB news hit the wire and the market spiked back down, taking all the indexes into the red, including the DOW which had been green all day. A slight bounce back up into the close managed to keep the DOW in the green but the others were unable to do the same. The news from the ECB was that they are rejecting Greek bonds as collateral for their QE program.
I found the market's reaction to the ECB news a little strange considering the ECB had previously announced that Greece would be excluded from the QE program (the only country to be excluded). Then Mario Draghi and Greece's new finance minister, Yanis Varoufakis, had met earlier today and Varoufakis claiming the ECB would do "whatever it takes" to support all EU members, including Greece. But Germany would have none of it and after a meeting between EU central bank chiefs the ECB announced they would not accept Greek bonds as collateral for more loans.
Oops, somebody got their wires crossed or else the first meeting with Varoufakis was an attempt to play nice and Germany put the kibosh on the plan. Cancelling its acceptance of Greek bonds as collateral for loans shifts the burden to Athens' central bank to finance its lenders and the Greek banking system is already teetering on the edge of bankruptcy. This effectively isolates Greece and it's obvious the EU is trying to force Greece into making a new deal for support. This follows the recent Greek election that installed an anti-austerity party and the fear by EU members is that the Syriza party will simply not pay their debt, although they've been backing off on their hardline position recently.
Greece has been close to Russia and all of this could drive them further into Russia's waiting hands. Without Greece's vote the EU cannot institute new sanctions against Russia so there's a lot of political football going on behind the scenes. It's not just a banking issue and between currency wars, the Greek debt issue (first of many countries in the EU that will be dealing with the debt problems), and Russia there are many pieces to the chess game and Putin happens to be a master at geopolitical chess. All of this could really start to spook the market so it pays to keep your ears on the railroad track and listen for the coming train.
In the meantime, while all this plays out on the grand geopolitical stage, which is quite fascinating, we have a stock market that could still rally in the face of all these worries. A slowing economy? It means the Fed will stay accommodative so let's rally! Trouble in other countries and currencies, which could tip more than one bank/country into default and start the dominoes falling in the international banking system? Nah, the collective central banks have our backs. They know what's going on (cough) and will be able to head off all problems before we even hear about them. After all, they've been right on top of all the problems in the past (cough, gag).
I am of course being facetious and all of the things mentioned above, and more, are in fact a big worry. While I want to play the possibility of an upside breakout, I'm very concerned about a significant downside surprise, starting with a lock-limit down morning. Wear protection when playing in this market! Let's start with a review of SPX.
SPX has remained inside a sideways triangle consolidation pattern since December and tested the top of it yesterday and today. Monday's low was a slight break below the bottom of the triangle pattern (the uptrend line from December 16 - January 16) and the recovery back inside the triangle put it on a buy signal. It continues to look like a bullish continuation pattern and a pullback from the current high could finally lead to a breakout to the upside. That's the bullish interpretation, whereas the bearish interpretation is that it's not a triangle pattern but instead it's simply building a bearish topping pattern (something we've seen at previous important highs. Short term it's looking like we should get a pullback from resistance but the bulls want to see only a partial retracement of this week's rally and then a strong break of resistance.
S&P 500, SPX, Weekly chart
I've been playing around with a couple of different wave counts (the squiggles in the stretch between the November 2012 low and the September 2014 high can be counted a few different ways) and a bullish wave count calls this triangle pattern, since the December 5th high, a 4th wave that should lead to the final 5th wave, as depicted in green on the charts. Sideways triangles typically lead to the final move of the trend (up in this case) and that's why 4th waves are typically triangles. Upside potential is to 2150 and possibly 2200. In either case if you're in bearish positions you'll want to stop out above 2065.
The daily chart below shows the whippy price action inside the triangle and the green wave count is an a-b-c-d-e that started from the December 5th high and December 16th low. The rally from Monday looks like a completed 5-wave move and should therefore lead to at least a pullback. If the bullish wave count is correct we'll see just a pullback and then a stronger rally. If the bearish wave count is correct, this week's rally completes another 2nd wave bounce correction, which sets us up for a strong 3rd of a 3rd wave down. In other words, get ready for a big move that will finally break out of this triangle consolidation.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2065
- bearish below 1980
Getting in closer with the 60-min chart below, all of the choppy moves leaves too many possible wave counts and that's why we need to see what happens from here to help identify the larger pattern. If this week's rally completes an a-b-c bounce off last Thursday's low (as an expanded flat correction with the lower low on Monday) we should see the market start to drop hard in an impulsive move. That would be the first clue for the bears. But if we get a corrective pullback from this morning's high it's going to look more bullish. Once the pullback correction finishes in that case, get ready to rock and roll to the upside.
S&P 500, SPX, 60-min chart
The DOW was the stronger index today, thanks to Visa's (V) strong day following its earnings report. Its price (266) has an outsized influence on the index and it rallied +2.5% today. Off its December 26th high the DOW was looking a lot like SPX with a sideways triangle pattern but it had a larger break below the bottom of the triangle pattern into Monday's low. Instead of triangle pattern it's looking more like the choppy pullback formed a bull flag pattern and today's rally had it testing the top of it this morning and then breaking it this afternoon before a strong selloff shortly before the close.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,840
- bearish below 17,037
From here I see two higher-probability moves for the DOW and like SPX we're likely to see a strong move either way before the end of this week. The bearish wave count suggests we could see a little higher to complete a large a-b-c bounce off the January 6th low, which will be followed by a strong 3rd wave down (shown in red). The bullish wave count calls for a pullback to retrace a portion of this week's rally and then off to the races to the upside. Perversely, a continuation of the rally from here for another day or two would actually be more bearish, whereas a pullback from here would keep the bullish potential alive, depending on what kind of pullback we get (impulsive vs. corrective).
NDX remains firmly inside its descending triangle pattern off its November 28th high. It would turn bullish above its January 23rd high, near 4293, and bearish below the bottom of the triangle, near 4090. Lots of chop and danger for traders in between.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4300
- bearish below 4090
The RUT briefly broke below the bottom of a potentials sideways triangle on Monday but then quickly recovered, which also put it on a buy signal. Yesterday and today it ran into the top of the triangle, which is the downtrend line from December 31 - January 28, but as with the others it's looking like it's ready for at least a pullback before continuing higher. The bulls would be in trouble below Monday's low and its 200-dma, both near 1153.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1204
- bearish below 1150
Bonds are looking like they're ready for a pullback (bounce in yields). And selling in bonds could help the stock market rally so it's going to be important to watch how they do from here. Last week TLT (20+ year Treasury bond ETF) had rallied up to its trend line along the highs from December 2008 - July 2012 and popped above its trend line along the highs for its rally from December 2013. This week's selloff has it back below the shorter-term trend line so it could be ready for a larger pullback from resistance. There was bearish divergence at last week's high on the daily chart (not on the weekly chart below) so we could see at least a retest of the high but at this point I think the upside for bonds is the riskier bet.
20+ Year Treasury ETF, TLT, Weekly chart
The banks don't give me a clear sense of direction yet but at the moment I see a higher-odds scenario that calls for another leg down following the current rally off last Thursday's low. That throws a monkey wrench into the idea for a stock market rally so it's going to be important to watch what the banks do. BKX had a 3-wave move down from December 29th to the January 16th low, which leaves us with a corrective pullback (labeled wave-a on its chart below). From that low it would have an a-b-c bounce with two equal legs up at 40.21. That's labeled wave-b and it could lead to another decline in wave-c, potentially finding support at the trend line along the lows from May-October 2014, currently near 64.15. A rally above 70.21 would be more bullish but then the bulls will have to contend with the 200-dma, at 70.68 and its 50-dma, which will soon cross the broken uptrend line from March 2009 - October 2011, near 71.25. I do not feel bullish about the banks and this is the one keeping me cautious about feeling bullish about the major indexes (following a pullback).
KBW Bank index, BKX, Daily chart
Following the U.S. Dollars high on January 26th it has had a 3-wave pullback (more easily seen on the daily chart vs. the weekly chart below). The 3-wave pullback had a projection for two equal legs down, for an a-b-c correction, at 93.36. Yesterday's low missed the projection by 2 cents at 93.38 and got a strong bounce off that low. The low was also a test of the top of its parallel up-channel from 2008-2011, which can be seen (if you squint hard) on the chart. So far this all fits with the idea that the dollar's rally has not finished yet and it could make it up to the Fib projections at 97.35 before it will be ready for a larger multi-month consolidation. It makes me wonder if oil will drop a little lower before finding its bottom.
U.S. Dollar contract, DX, Weekly chart
Gold's bounce off the November low looks corrective and it's one of the things that keeps me bearish gold, along with the larger wave count that suggests we've got lower prices before the downside pattern is complete. But shorter term the pullback from the January 22nd high also looks corrective and suggests we could see gold push a little higher before starting back down. A higher bounce could take it up to its downtrend line from August 2013, currently near 1330, which would also be a back-test of its broken uptrend line from 2001-2005. Above 1330 would therefore be more bullish.
Gold continuous contract, GC, Daily chart
As mentioned earlier, oil inventory rose another 6.3 million barrels last week, to 413.1 million. Storage, including the big terminal in Cushing, OK, is filled and overflowing (which is one reason why so many large oil ships are holding so much, as well as waiting for higher prices). The total inventory is the highest on record going back to 1982. This is of course the result of the new oil-drilling efforts (primarily shale oil) and as can be seen in the chart below, the production of oil is now back to the highs seen in 1973 and 1986. Flip the chart upside down and it's not hard to figure out why oil prices have collapsed.
Oil production, 1973-January 2015, chart courtesy businessinsider.com
The skyrocketing increase in oil production is of course unsustainable, especially with the number of drilling rigs in decline. Once the production from currently installed rigs begins to decline we'll see this chart reverse, potentially from near current levels. This is probably what has the price of oil basing/rallying in the past 3 weeks. After hitting my downside projection at 43.63-44.42, with a final low so far on January 29th at 43.58, I've been looking for oil to consolidate in what could be a multi-month choppy consolidation as traders try to figure out the supply vs. demand equation. With a slowing economy and slowing production (eventually) we could see prices remain relatively steady with a slight rise over the next several months (similar to what oil did following the low in November 2013).
Oil continuous contract, CL, Daily chart
Tomorrow morning should be relatively quiet as far as economic reports go. I think the market will be more interested in more news out of Europe and what's happening with Greece and its debt problem. A war of words on top of the currency wars that are going on could start to escalate and make more than a few people nervous. Europe has the Bear to its east licking its chops as it watches carefully for its next "opportunity" (Ukraine).
Economic reports and Summary
The major indexes have me feeling a little bullish here. A pullback to retrace some portion of this week's rally could lead to another stronger rally leg and eventually drive the indexes to new highs this month. SPX could rally to 2150 or higher and the DOW could make it up to the 18700 area. Just think, only 1300 points above 18700 (another +7%) could have the DOW ringing the bell at 20K. Bring out the party hats!
OK, yes, I'm more than a bit skeptical about seeing DOW 20K and I'm not even sold on the idea yet that we'll see a rally to new highs. The banks have been weak and it's looking like they could get weaker. A stock market rally to new highs without the banks on board would be more justification to look to short the rally. It would at least mean traders must exercise caution since it's best to follow the money. With all the currency wars going on right now and all the sovereign debts issues that could plague emerging markets, we're not that far away from a real nasty news event and another flash crash is right around the corner. Trade the long side very carefully if we get a good setup with a pullback on Thursday/Friday.
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