For the 2nd day in a row China devalued their currency (after telling the world the 1st time was a only one-time devaluation) and it sent the global stock markets tumbling this morning. But the decline became too irresistible to value hunters and they drove the indexes back up near the flat line for the day. Both sides are now asking "what's next?"
Today's Market Stats
Developed countries continue to compete in the race to the bottom as they each devalue their own currency in an effort to fight the deflation monster and make their products cheaper for other countries to buy. It's the new way to fight a trade war (instead of tariffs as in previous trade wars). But as in all wars, it tends not to end well for anyone.
China has shocked the markets with not one but two significant devaluations in the past two days. After the first one, which hit our futures market Sunday night, China said it was a one-time reevaluation of their yuan and that there would be no more adjustments. Ha, if their mouth is moving they're lying (just like our politicians and Fed). After devaluing the yuan 2% on Sunday (their Monday), they did it again last night with another 1.6% devaluation. Those sound like small corrections but in the currency world they're huge moves. But not to worry, after two moves the Chinese tell us they're done. Ha, their mouths are still moving.
Many believe China did this out of spite for not being allowed into the IMF's world money called the Special Drawing Right (SDR). They had expected a decision by November to allow the yuan to be included in the basket of currencies but last week the decision was moved out nearly a year to the end of September 2016. Devaluing their yuan as they've done, with the surprise move, is tantamount to declaring they've joined the currency war (which the U.S. started with all the rate reductions and QE efforts).
But the problem for China was that they were leaving the yuan essentially pegged to the U.S. dollar, which has remained strong, and that's been hurting China's economy. While other countries have been devaluing their currencies (where's the outrage there?) to fight deflation and make their products more competitive in pricing in the export market, China has been losing market share and their own domestic demand is not enough to soak up the excess manufacturing capability that they have. They were willing to hold on until November to get accepted into the IMF's SDR but once the decision was pushed out a year the Chinese leadership realized they can't hold on for another year. Hence the devaluation now -- get it done, get the hate mail now and let it be forgotten in a year when the IMF reevaluates the yuan for inclusion. Actually, yuan devaluations are probably long from being finished.
China's economy is imploding and we see evidence of this even in commodity prices, which are now below where they were in 2009 at the bottom of that period of global contraction (and yet here we sit at the top in the stock market -- major disconnect anyone?). China feels it must devalue their currency to make it cheaper to sell their goods overseas. The fact that everyone is doing this and therefore no one is gaining an advantage seems to be lost on those making the decisions. But the race for the bottom continues as the currency wars heat up.
I have believed for a while that there's a snowball's chance in hell that the Fed would raise rates in September (or December for that matter) and now the chances are even less. The U.S. economy is headed for the slowest growth since 2012 and Yellen's forecast for unemployment to decline to 5% while the economy grows by +2.5% and inflation rises to 2% is as likely to happen as a pole flip in the earth's magnetic core.
China's devaluation is a direct admission their economy is in trouble. And if they're in trouble it's because the other countries are not buying their products. The global consumer has pulled back and obviously that means lower global growth. And if China continues to devalue the yuan it would keep the dollar stronger and as long as the dollar remains strong (above 93) the more difficult it is for the Fed to raise rates, which would only strengthen the dollar even more and make it more difficult for us to compete with prices with the rest of the world. We would experience even slower growth at a time when growth is already slowing. Do you see the corner into which the Fed has successfully painted itself? The Fed can't raise rates and instead of celebrating, as it is now, the stock market will realize it's because the global economies are not allowing rates to be raised and that means the stock markets are way overvalued.
These are interesting times indeed and as if figuring out what the stock market is up to was not hard enough on our own, we now have the global economies, currencies, bond markets, etc. to worry about. They're all factors that must be considered in our market analysis. They say everything that is known is already priced into the market and that's why we study charts. Surprise currency announcements and other events will always be a present danger and it's one reason why you don't go all in on a trade. Accept the fact that your position might get body slammed in an overnight move and be sure a big hit on your position is not going to wipe you out. At this time you should NOT be using any margin in your stock trades.
With that let's move to the stock charts, starting a "simple" look at DOW's uptrend, as shown on its weekly chart below. You can see how this morning's low was a small poke below the bottom of its up-channel for the rally from October 2011, which is currently near 17340. A weekly close at or above that level will be important. If the market rallies from here I see upside potential for the DOW to a new high in the 18500-18600 range by September (that would frustrate a few bears), where it would meet the midline of its up-channel and the trend line along the highs since last December.
Dow Industrials, INDU, Weekly chart
One thing that many are talking about is the death cross for the DOW, which is when the 50-dma crosses down through the 200-dma, which it did yesterday. One thing to take note about these though -- instead of being bearish they tend to mark turning points and instead should be called a bullish cross. By the time the index has dropped enough to get the cross it's usually oversold and ready for a reversal back up. Obviously the two MA's will be potential resistance if and when reached but for now there are enough pieces in place to suggest yesterday's death cross will in fact mark the bottom of the DOW's pullback this morning.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,630
- bearish below 17,200
There are a couple of points I'd like to make about the DOW's daily chart. First, it's using the arithmetic price scale, as is the weekly chart shown above, and that lowers the uptrend line from October 2011. Using the log price scale that uptrend line is near 17790 (near the 50-dma) and I'll be watching it for resistance again if tested (it held as resistance on a weekly closing basis on July 31st). With the arithmetic price scale it's holding as support. The second important point is the descending wedge pattern for the decline from July 20th, which at the moment looks like it completed with this morning's spike below the bottom of the wedge on news (a typical way for wedges to complete). The pattern for the pullback from May looks corrective, with an A-B-C pullback with two equal legs down at 17252, which was achieved (easily) today. With today's low at 17125 it also looks like a satisfactory test of its December 2014 low at 17067 and these are part of the reason I'm feeling bullish against this morning's low. But another drop below 17200 would have me turning more bearish.
I've mentioned before a rounding top pattern that appears to be developing as the choppy price action since last November/December has that choppy topping pattern look to it. But it doesn't preclude another stab higher and on the SPX weekly chart below that's what I'm projecting. The uptrend line from February-July fits as the bottom of a shallow rising wedge pattern for the 5th wave in the rally from October 2011 (to complete wave-C of an A-B-C bounce off the 2009 low). Currently near 2060, it was tested today and held on a closing basis (intraday stop runs are common in this market). More importantly, for the bulls, SPX has not yet dropped below price-level support near 2040, a break of which would be much more bearish.
S&P 500, SPX, Weekly chart
The bold blue lines on the daily chart below are the boundaries of the shallow rising wedge mentioned above, the top of which will be near 2150 next week. Two equal legs up from July 7th, for an a-b-c move to complete the 5th wave of the rising wedge, points to 2140.86, shown on the chart. The top of the wedge will be near 2152 by the end of the month and a little throw-over above the top, equal to today's 8-point throw-under, points to almost 2160 in early September. That gives us a 2140-2160 upside target zone, which will be narrowed if and when the rally makes it up there. We're still in the chop zone, which I define to be between 2045 and 2115 so be careful about continued choppy whipsaw price action until either one of those levels breaks.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2115
- bearish below 2045
Today's rally off this morning's low looks like a 5-wave move, which means we should look for a pullback Thursday morning. Maybe the pullback will be a scary one in order to suck the shorts back in so that they'll provide more short-covering fuel for a rally into opex. But the 5-wave move up suggests the pullback should be bought for at least another leg up for either another a-b-c move back up or something more bullish. Based on the choppy decline I'll be looking at a pullback as a buying opportunity for a higher rally into next week. If wrong, that's what stops are for.
S&P 500, SPX, 60-min chart
NDX also has a corrective (3-wave) move down from its high on July 20th. Each of the two legs down is also a 3-wave move and that has it looking like a double zigzag pullback correction. That's just EW terminology for the kind of pullback it looks like and it means we should be looking for a reversal of it and the start of a new rally leg. Two equal legs down for the zigzag pattern points to 4446.76, which was achieved with this morning's low near 4436 and the strong reversal supports the higher-probability move belongs to the bulls. An upside projection, at 4786, is based on two equal legs up from the July 7th low and that projection cross the trend line along the highs from November 2014 - April 2015 around mid-September. That gives us a price and time to watch for the next rally (if we get it), which if achieved would then set up a shorting opportunity for what should be a monster move back down into next year. Who knows, maybe the Fed will announce a large rate increase in spite of everything that points to no increase. More likely there will be no increase and a final high could be made on "good" news.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4635
- bearish below 4400
Similar to the DOW, the RUT looks like it completed a bullish descending wedge today. The decline from June 23rd has formed the wedge with the requisite 5-wave move and that in turn should be the completion of an A-B-C correction off the April high. The Fibs fit the EW pattern, known as an expanded flat correction where the b-wave (the May-June rally) was 127% of the a-wave (the April-May pullback), which was missed by only a point. Then the c-wave (the June-August decline) is a 5-wave move that typically achieves 162% of the a-wave, which is near 1187 and missed by a little more than 2 points. Until and unless the RUT drops below 1186 this is a bullish pattern, supporting what I'm seeing in the other indexes.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1245
- bearish below 1186
Treasuries may have given us an important turn signal today. With Treasury prices often counter to stock prices (money rotates into the relative safety of Treasuries during risk-off times) we might have seen at least a short-term top in Treasury prices today. The 20+ Treasury Bond ETF (TLT) daily chart below shows a key outside down day today (it gapped up, made a new high and then closed below yesterday's low). It also tried to climb above its 200-dma, at 124.48, as well as the top of a rising wedge pattern off it June 26th low, and left a throw-over above both before collapsing back down. A decline in TLT would be supportive for a stock market rally. A good trade on TLT is short against today's high at 125.71 (only a suggestion for educational purposes, wink).
20+ Year Treasury ETF, TLT, Daily chart
The initial negative reaction in the banks was a sign that a Fed rate hike has been pushed out by China's actions and that wouldn't help banks' profitability. This morning's decline broke below the uptrend line from January for BKX but it recovered it by the end of the day, near 77 (although intraday it looks like a bounce back up to the trend line for what could be a back-test to be followed by a bearish kiss goodbye). From its high on July 23rd there is so far just an a-b-c pullback with two equal legs down at 75.89 (missed by a penny with today's low at 75.90) and now it takes a rally above Monday's high at 79.54 to confirm new highs are likely coming.
KBW Bank index, BKX, Daily chart
The U.S. dollar tumbled a dollar lower today and briefly broke below its 50-dma, at 96.37, and closed pennies below it. It's also back-testing a previous broken downtrend line from April 13 - July 7, just as it did with a previously broken downtrend line from April 13 - May 27. The pullback from last Friday could be the start of another trip back down near the May low as part of a larger sideways consolidation that I've been showing on the weekly chart. A drop below today's low at 95.94 would likely mean lower prices for the dollar but keep in mind all the choppy price action in the dollar and that means potential whipsaw, subject to overseas news and what the Fed has to say. At the moment the message from the dollar is that the Fed will not be raising rates in September.
U.S. Dollar contract, DX, Daily chart
The relatively strong bounce in gold the past week has many calling for a stronger rally and a good time to buy gold. Every time I see so many newsletters calling for a strong rally in gold I keep thinking about all the previous times there were similar calls, only to see new lows follow. I don't think it will be any different this time, although I do see the potential for a higher bounce so for a trade it might work. But first I'd want to see gold get above a previous trend line along the lows from June-July, which was broken on July 17th and it led to a strong decline. At the moment gold is back up for a test of the line, near 1126, and it could be followed with a bearish kiss goodbye. A decline from here would target 1050 before another multi-month consolidation in a stair-step pattern lower into the end of the year. But the first sign of bullishness would be a climb back above price-level S/R near 1142 and its 50-dma which is coming down to the same level. Notice on the daily chart below that MACD has made it back up to the zero line and a cross back down from here would create a MACD sell signal, just as it did following the June 18th high.
Gold continuous contract, GC, Daily chart
While gold is back-testing a trend line along the lows from June-July, silver is back-testing a broken uptrend line from November 2014 - March 2015 (it ignores a brief spike down in December 2014), near 15.60. It's bullish above that level but remains bearish below it and another leg down would likely be a test of the July 24th low at 14.33 before a multi-month consolidation in its stair-step decline.
Silver continuous contract, SI, Daily chart
Oil has made it back down to previous lows in January and March and it currently showing a significant bullish divergence. I'm sticking with the big sideways consolidation into the end of the year until proven otherwise. That calls for a rally back up to the 58.50 area in October before dropping back down again.
Oil continuous contract, CL, Weekly chart
Not that anyone is paying much attention to domestic economic reports right now but tomorrow's will include the unemployment claims data, retail sales, which are expected to show further slowing in this sector as the mighty consumer pulls in their spending horns, and export and import prices. If we see further signs of deflation it will be another point for the Fed to evaluate in their rate-increase analysis (since they're so data dependent, as they say at each meeting). The PPI numbers on Friday are also expected to show a slowing in inflation, otherwise referred to as disinflation (that 'D' word is allowed but not Deflation).
Economic reports and Summary
In this yo-yo market that we've been in since last December, when SPX first climbed above today's closing price at 2086, means we really don't have a clue as to what direction this market will finally trade when it breaks out of the trading range. That means traders need to be cautious and assume the reversals of reversals will continue. But I think the market might have tipped its hand this week and I'm seeing more bullish signs than bearish.
I don't know what could drive a rally to new highs but I definitely see the potential from here. That could drastically change by this time next week and all I can do is go with what the market is telling me at the time. I use a combination of EW patterns, trend lines, Fib projections, oscillator divergences, market psychology, astrological signs (have I missed anything) and at the moment most of the tools I use tell me to look to buy pullbacks. August is typically a bearish month but I have a feeling to many are going to be caught leaning the wrong way if they keep trying to sell rallies.
Again, that could change in a heartbeat, which it has often done in this choppy market, but until I see some bearish price patterns emerge from this mess I'll be leaning with the bulls into a September high. From there we would then have a shorting opportunity of a lifetime (better than in 2008) but I'll get ready for that opportunity if and when it presents itself. Trade carefully in this whippy market.
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