After the sideways chop that we've seen all year, including this week's whipsaws, about the only thing that can be said for the charts is they're a mess. And it's driving investors out of the market, something that should be of great concern.
Today's Market Stats
The trading range in tightening but the whipsaws have continued and there continues to be no sense of direction to this market. Traders who can catch the daily (hourly) swings have had some good trading opportunities. I suspect mostly HFTs, who have the ability to get in front of trades, have been the primary beneficiaries of this market. Investors are getting tired of it and leaving (pulling their money out) and that's leaving the market vulnerable from a low-liquidity perspective. What that means for the next week/month is the bigger question.
The market dropped hard this morning, following the global indexes, which were spooked by what's happening in China. It dropped -4% before a rally back up into the green and closed +1.2%. China policy makers have already said repeatedly that they will support the stock market and have money backing up their pledge. Today's trading in China is proof positive (so much for free markets). Even though China's support of the market will create this kind of bounce-back, in the long run its scaring investors out of the Chinese market, who are taking advantage of bounces to relieve themselves of their stock holdings. All parabolic rallies do not end well and while the government can try to delay the inevitable, it will be a losing battle and the government will merely add to the amount of money that makes it to money heaven.
Asian markets tanked and then European markets followed and that had us starting in the red this morning, which was then followed by strong selling into a midday low. The DOW was down about -230 points but then retraced all of its loss in the afternoon and made it +4 into the green following the FOMC minutes. That was followed by a reversal back down and the DOW gave up about 170 points into its afternoon low. Needless to say, today was a wild ride for traders trying to keep up and it's only a part of what we're seeing in the larger pattern, which suggests we might see stronger selling soon, possibly tomorrow and Friday.
Inflation data is a big part of the "data" that the Fed watches to help with their decisions about interest rates and for a long time they have said they want to see inflation around 2%, which helps pay down longer-term debt but causes loss of purchasing power (something the bankers don't care about). But this morning's data, in the CPI reports out before the bell, is not helping the Fed's cause. The rate of rise in inflation is dropping and both the CPI and core CPI rose only +0.1% in July instead of the +0.2% most economists expected.
For the past 12 months inflation is up only +0.2%, close to the dreaded "disinflation" that economists are worried about. Most of the disinflation is a result of a significant drop in commodities' prices, including energy. Excluding what's important to us, food and energy, the core index is up +1.8% for the past 12 months, which is in line with the average of +1.9% over the past 10 years. But while the longer-term average inflation rate is where the Fed wants it (near +2%), it's the short-term trend that isn't supporting the Fed's desire to raise rates.
One thing about the Fed that one needs to keep in mind, no matter how much jawboning they do for the market, and that is they will avoid embarrassment at all costs. And it would be very embarrassing for them to raise rates even a little bit if they're worried that the next quarter will require them to lower rates because the economy is slipping further into contraction territory. While they might be a little embarrassed about not being able to raise rates this September, or December, they have an easy out by saying the data didn't support the move, which is an out they've been carrying with them since first talking about raising rates (everything is "data dependent"). But to have to lower rates back down after trying to raise them would show their incompetence and they will avoid that embarrassment. The Fed will not raise rates this year or probably next either (and if they do I'll be surprised, wink).
The FOMC minutes did not present any new information and I'm not sure why there was such a volatile reaction following the release. It could be opex related as much as anything else. Squaring of opex positions before tomorrow generally creates some volatility if the market gets moving in one direction or the other.
The minutes show most Fed officials believe conditions are "approaching" what's needed for the Fed to start raising rates. Basically the Fed officials want to raise rates sooner rather than later and want to see if the August labor data will support an increase in September. The Fed is also looking for signs of an increase in inflation but this morning's numbers are not supporting them. While most economists believe the Fed will raise rates in September, it adds to my confidence in saying the Fed will not raise rates. Economists have an extremely poor record with their predictions.
The minutes also reflected the Fed's desire to continue rolling over expiring bonds and to keep reinvesting the proceeds, which keeps the Fed's balance sheet stable. This can be defined as QEL (QE light) and they want to continue that through the "early stages" of rate hikes, which tells me they'll be rolling over expiring bonds for years to come. Both the stock and bond markets liked this since the demand for bonds remains stable through Fed purchases and there's less fear about the Fed withdrawing more liquidity from the market.
There are legitimate concerns about the declining level of liquidity in today's market. There are people who study this and have been warning for a while that liquidity is drying up, especially after the Fed stopped its QE4 program (now holding with QEL). The reason for concern is that liquidity is what provides an orderly market -- it makes it easier to match sellers and buyers. But when liquidity vanishes, especially during a selling event, sellers can find themselves without buyers. The computers then go looking for prices and if you're in a market order to sell (as many stops are), you could find yourself selling at a drastically lower price than you thought likely.
Part of the problem causing liquidity to dry up is that investors are leaving the market. The current bull market is often described as the most-hated bull market anyone has seen. There are several reasons for that and without investor participation we've seen the indexes holding up on the backs of fewer and fewer stocks. That's been worrisome for some time. And this lack of participation is showing up in sentiment numbers. Tom McClellan posted the below chart to a small trading group that I'm with and asked the following question: "Does this really feel as bad as the Ebola Panic, when we were all about to die of hemorrhagic fever?"
Investors Intelligence Sentiment vs. SPX, July 2012 - August 2015, chart courtesy Tom McClellan
As you can see in the above chart, the Bullish minus Bearish sentiment is now back down near where it was at the market low in October 2014 (when the Ebola scare was as much to blame as other factors) and yet the market has held near its high as it trades sideways vs. the spike down as we had last October. The sentiment reading is now significantly below the lower band that McClellan uses to judge extreme moves and the current decline in sentiment looks ripe for a reversal (with a stock market rally) from a contrarian perspective. If most everyone is out and the market runs out of sellers we could then get a strong rally as everyone rushes back in (including the buying from short sellers).
The other interpretation of the above chart is that it's just more evidence for how much this market is hated by investors. I've talked with a number of people who are sick of being in the stock market. They're complaining that the only ones making money are their financial advisors. They're tired of losing money as the market goes nowhere, especially since there's still a lot of residual fear about another market crash (especially among baby boomers who can't afford another 50% loss). Many money managers are feeling the same and this in turn is reducing the liquidity in the market.
The Fed is not injecting new money (only rolling over expiring bonds) and investors are pulling out, all of which has significantly reduced the market's liquidity. And market liquidity is like oil to an engine -- without out it things begin to seize up. The real risk is that any selling could get carried away to the downside as liquidity simply disappears (which we've seen before in flash crashes). Sometimes very bearish sentiment means bad things for the market, not good things in a contrarian sense.
Exacerbating the liquidity problem is what we see happening in the emerging markets. There has been a surge in outflows, which is hurting the economies of these smaller countries. Like small businesses helping get an economy growing, it's the small emerging markets that help get global economies (and markets) growing. The opposite appears to be happening. China's yuan devaluation seems to have accelerated this trend. In the past year nearly $1T has left these markets and for small markets that's a lot of liquidity that has vanished.
As funds leave the emerging markets it puts downward pressure on the local currency, making the U.S. dollar stronger, which dampens demand for imports, which drives down demand for commodities and further negatively affects those countries dependent on commodity sales. It creates a downward spiral and at the moment no one is quite sure where this will end, all of which makes it even harder for the Fed to raise interest rates. Previous stock market crashes have followed a currency collapse in a small country and we're probably not far from that happening again. The cracks in the dam are widening...
As mentioned in the title of tonight's report, the charts are a mess and have been all year. It's getting quite frustrating trying to figure out what the market is up to and about the only thing that has been accurate in any prediction is that you should expect reversals of reversals. Lack of follow through has been the hallmark of this market and when that breaks is anyone's guess. But that's what I do (guess) and I'll provide my best guess on what the current pattern tells me.
Starting with the SPX weekly chart, it still supports the idea for another rally up to the top of a shallow rising wedge to complete the final 5th wave off the October 2014 low. That would take SPX up to about 2150-2160 by mid-September but the rally needs to get started now otherwise the rounding top pattern will begin to look like the more important pattern. A drop below 2040 would be a significant break and it would likely begin the stampede for the one and only narrow exit door. Have I mentioned the lack of liquidity in this market (wink)?
S&P 500, SPX, Weekly chart
Choppy mess. Need I say more about the daily chart? There's a sideways triangle that has formed after the July 20 high and July 27 low, the bottom of which was tested with today's low. A trade above Tuesday's high near 2104 would be bullish while a trade below the July 27 low near 2063 would be bearish. Mind the chop in between. The good news for bulls so far is that the 200-dma continues to hold as support on a daily closing basis. But how many times can it be tested before it runs of buyers at support?
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 2104
- bearish below 2063
I continue to look for impulsive (5-wave) moves to help indicate market direction but we're seeing repeated 3-wave moves and that fits with the sideways triangle noted above. I've noted on the daily chart above and 60-min chart below the key levels to let us know when a break is confirmed but keep in mind that it could result in just a larger 3-wave move before reversing again. Trades need to be managed closely and look for base hits instead of home runs.
S&P 500, SPX, 60-min chart
Using the arithmetic price scale shows the DOW trying to hold its uptrend line from October 2011, near 17375, but closed slightly below it today. It's possible there's a slightly larger bullish descending wedge pattern for the decline from May and we could see a relatively small break below its December 2014 low before it sets up for a larger rally. It could of course simply rally from here. But the bearish wave count is a series of 1st and 2nd waves to the downside (with the series of lower highs for the bounces) and that supports the idea that we're about to see a disconnect to the downside. While I don't like to predict these kinds of moves (since they're rare), it's important to understand the downside risk here. Don't let the market move much against a long position that you might have.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,630
- bearish below 17,340
Following the high for NDX on July 20th, it had a 3-wave pullback with two equal legs down at 4446.76, which was achieved last Wednesday with its low at 4436. It was a good setup for bulls to get long and it was starting to look good for a rally that could take it to new highs. But after only a 3-wave bounce into Monday's high at the 20-dma it has dropped back down, leaving the upside in question (and the downside). It closed back below its 50-dma today, at 4519, which is bearish but this one could go either way. In other words, there is no good setup to recommend. It's bearish below 4415 and bullish above 4635. Mind the chop in between.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4635
- bearish below 4415
Since Monday's high, when the RUT stopped dead at its downtrend line from July 16th and was not able to jump above it on Tuesday, this is the one that has had me feeling more bearish about the market. The blue chips, until today, had me feeling the bulls had some good potential but the NDX and especially the RUT had me feeling like the bears are not done yet. Last Wednesday's low fit well as the completion of a bullish descending wedge (with the potential that it's instead a leading diagonal 1st wave down from the June 23rd high) but the 3-wave bounce into Monday's high followed by the downturn says we're still stuck inside the descending wedge. We could see a rally from here, in what will become a larger corrective move to the upside in the final rally, but a drop back down to the bottom of the wedge, near 1175 by next Monday, seems to be a higher-odds play. If the bottom of the wedge is reached we'll then get some clues as to whether or not we should get a higher bounce correction. A break below the bottom of the wedge would be very bearish and it would support the uber-bearish wave count on the DOW's chart (crash leg lower). Strict discipline required here on your trades.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1245
- bearish below 1175
Bonds have been just as choppy as the stock market in the past week and they're not providing much help in figuring out what the stock market is doing. Looking at TLT, Monday finished with a doji sitting on its 200-dma and still inside its rising wedge from early July. Tuesday it broke down and closed below the bottom of the wedge, which had it looking like we'd see some follow through to the downside today. While there was a selloff this morning it was immediately reversed after the open and TLT had a relatively strong rally. Today's candle is a bullish engulfing candlestick (lower open followed by a higher high and close above yesterday's high), which has it now looking like a 3-wave pullback from last Wednesday might have completed this morning and now we'll see a continuation of the rally (decline in yields). But today's rally took TLT back up to its broken uptrend line from July 13th and could be nothing more than a back-test, to be followed by a bearish kiss goodbye tomorrow. It did close marginally back above its 200-dma at 124.60. Confirmation for the bears would be a selloff tomorrow but at the moment it could go either way. Gun to my head, I'd say TLT is going higher and that would put additional pressure on stocks.
20+ Year Treasury ETF, TLT, Daily chart
Looking to the banks for clues, the BKX looks just as confused as the others. From the high on July 23rd it had a 3-wave pullback with two equal legs down at 75.89, achieved with the spike down last Wednesday to 75.90 (OK, missed by a penny). This is a very common pattern among different indexes, which is what had me feeling confident about a rally this week and into September. This week's price action has negated those bullish thoughts. A rally could still happen but it's certainly looking less likely. After its 3-wave pullback into last Wednesday's low the BKX then bounced back above its broken uptrend line from January and used that trend line for support this morning and again this afternoon when it pulled back into the close. That all looks bullish but it's been struggling to get through its 20- and 50-dma's, both now near 78.30, since last Friday. A close above 78.30 would be bullish and even more so above its August 10th high at 79.54, but a close below 75.89 would be bearish.
KBW Bank index, BKX, Daily chart
The U.S. dollar's choppy pattern since its high in March leaves many different corrective patterns available and figuring out which kind it will be in advance is very difficult. I've been showing an idea for a sideways consolidation through the rest of this year based on the larger pattern before it and where I think it is in the large wave count. As long as it stays trapped between 93-100 there's not much to do with the dollar but wait to see which way it's going to eventually break, which I believe will be to the upside next year.
U.S. Dollar contract, DX, Weekly chart
Gold is looking like it could rally up to price-level resistance near 1141, which was a shelf of support since last November until breaking in mid-July. It would be at least short-term bullish above that level but remains bearish below it.
Gold continuous contract, GC, Weekly chart
Silver has already made it back up to its previous shelf of support since last November, near 15.25. An uptrend line from November 2014 (ignoring the spike down on December 1st) was tagged with last week's high at 15.58 but it then dropped back down below 15.25 for the weekly close and continues to struggle near this 15.25 resistance level. The bullish divergence on the chart continues to caution bears not to be aggressive on the short side but as long as support-turned-resistance holds price below 16 I would not look to get long silver.
Silver continuous contract, SI, Weekly chart
Oil has declined for eight straight weeks and has made mincemeat out of anyone who has tried to catch falling knives in this commodity (every week I read more trade recommendations to get long oil and the oil stocks because they're so low). I too have been expecting a bounce back up but the relentless decline has it looking like it could head lower still. I continue to show the potential for a large sideways triangle for a consolidation into next year but if it continues to head lower, especially down to its January 2009 low, it could put in a bottom sooner rather than later. Where that bottom could be (many other commodities have already broken below their respective 2009 lows) is anyone's guess but I do think it's risky trying to short it here.
Oil continuous contract, CL, Weekly chart
Thursday will finish up the week for economic reports and it will include the usual unemployment data and more importantly for the market, the Philly Fed index, which the market will be watching carefully to see if yesterday's Empire index is starting a pattern or instead was an outlier. Leading indicators is expected to show further slowing while Existing Home Sales is expected to be relatively flat from June.
Economic reports and Summary
The rally off last Wednesday's lows had the potential to turn into something more bullish, as in new highs into September, but that is no longer looking like a high-probability move. We could still get a higher bounce/rally but with the corrective 3-wave structure it would likely be a very sloppy choppy rally or it will be just a higher bounce before turning back down. The short-term pattern now better supports the idea that we'll see a continuation of the selling.
It's possible the selling could become quite intense over the next couple of weeks if the bearish wave counts are correct. With the problem of liquidity drying up in the markets (globally and especially in emerging markets) and all the currency devaluations happening (the race for the bottom), things could turn ugly in a hurry for markets. That's always a dicey prediction because market crashes are rare. Probably the best thing to say is that I see an elevated risk for a market crash at this point and that requires tight stop management on long positions.
Investors (those who don't want to trade in and out) should also establish a stop level, a break of which would convince you that the downside risk is greater than the upside potential. We're there now in my opinion but trend following says you should use your judgment for when the trend has broken and then honor your stops and get out. The risk is that stops could get triggered on a large gap down and either not be executed (if it was a stop-limit order) or be executed at a price much lower than your stop. Getting into a trade is much easier than getting out (it's the fear/greed factor) and the best time to make the decision about getting out is when you don't have to -- there's a reason why many money managers sell into rallies instead of panicking out in a decline.
We continue to be in a sideways choppy trading zone, which has been full of whipsaws as we get reversals of reversals and then another reversal for good measure. That could continue for months but I think what we're seeing is a topping pattern (rolling top), which typically sees a lot of chop like this. Following such a long bull market it's not hard to recognize a topping pattern could easily take a year. It's painful for traders and investors and it will be nice when we get a break out of this maddening trading range and start to make some money in swing and position trades again. In the meantime, stay safe and carefully manage your trading account.
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