Both sides in the stock market are clearly battling it out for control and the result has been a large number of reversals and whippy price action. This is turning into a year of multiple >1% moves and that's very different from the past and the result has been a lot of frustration for traders.
Today's Market Stats
It used to be foreign exchange funds, depositories and foreign-related ETFs that experienced a lot of gaps from day to day but now it's common to see the morning move in the stock market start with a gap. Whether it's global trading and overseas markets' influence on overnight futures or all the algorithmic trading (HFTs), the net result has been big gap moves and many of those have been followed by a sideways market. Oftentimes if you weren't positioned for the gap there's been not much to trade. This morning started off with a big gap down and it was looking like we might go sideways again but then the buyers stepped in and drove the indexes back into the green. Will the rally hold into tomorrow morning? I'll be able to answer that question tomorrow morning.
Many of the algo trades are based on correlations, such as the between the S&P 500 and the US$/Yen currency pair. Lately we've seen a tight correlation between the S&P and oil and these correlations can create large moves in the market that are not necessarily related to anything that directly affects the stock market. But the program trading, which now accounts for about 80% of the market's trading volume, has a huge impact and these correlations must be considered (once they're identified), especially as the central bank policies start to have less of an impact on the market. I'll discuss these issues a little more with my discussion of currencies later.
So if you're feeling whipped by this market there's a reason for it -- you are. I have not personally verified this data but I read a market research report today from Phoenix Capital that talked about this year's price volatility. Apparently there were only 53 days between 1900 and 2000 that moved 1% or more. That's 53 days in 100 years. It's obviously been a bit more volatile than that since the bear market started in 2000 and now in 2016 the report said we had 22 such days through Monday. Add in yesterday's and today's moves and that makes 24 days out of 36 trading days this year that have seen moves of 1% or more. Just today we had a greater than 1% decline and then greater than 1% rally off the morning low. That means 67% of the days this year have seen a move equal to or greater than 1% and many times they've been reversal of prior moves or like today, reversals of intraday moves.
This is an amazing amount of price volatility while the VIX has stayed somewhat subdued (elevated in the 20s but not scary high) and to a large extent it shows how much this market is being moved by program trading. This likely means these large market moves are going to be more normal price behavior. The good news for active traders, if you can catch the reversals, is that this provides a very good trading environment to catch daily and intraday swings that are large enough to cover slippage in options plays. The bad news for traders, especially if you're not an active day trader, is that it's riskier holding positions overnight. A big gap move against you makes it much more difficult to exit a wrong-direction trade without taking a big haircut.
Part of the market's worry is earnings and whether or not the current P/E levels are warranted (no matter which way they're measured). Many traders are pleased that so many companies have met or exceeded analyst expectations, forgetting about the fact that earnings in general are in decline. Beating expectations is meaningless for bulls if earnings are in decline, which they are. Revenue growth has slowed, if not reversed, and that makes lofty P/Es difficult to justify. According to FactSet Earnings Insight, about 70% of the companies have beaten expectations, which keeps the bulls excited about buying the dip, but it's revenue earnings that can't be manipulated (as much) like earnings per share, especially with all the buy-back programs in existence (a pure waste of money for a company, except to reward management and shareholders).
In contrast to the 70% beat on expectations, about 76% of companies that have reported earnings have missed on revenue expectations. Of 85 companies that provided 1st quarter guidance only 17 said they foresee positive growth, leaving 68 saying they expected negative growth. The combined earnings growth for Q4 shows a 3.7% decline and if this figure holds true for the remainder of the reporting companies it will give us the 3rd consecutive quarter of decline in year-over-year earnings. This will be the first time this has happened since 2009. This is not something companies can massage away through their accounting gimmicks and it should be of great concern by the market. But hope is a wonderful thing, as long as it's not used as an investment strategy.
There's clearly a battle going on in the stock market as both sides argue their points and the price volatility is reflective of that. Let's see if there's any clarity from the charts
Review of the charts
S&P 500, SPX, and Value Line Geometric index, VALUG, Weekly chart
The weekly chart below shows the parallel up-channel for the 2009-2015 bull market rally, the bottom of which held as support last August-September but broke in January. The best SPX has been able to do so far is back-test the bottom of the channel and anytime I see this it's always a good setup to trade resistance. It might recover back into the up-channel but this kind of bearish setup works more often than not and since this is a game of probabilities, the higher-probability setup here is for the back-test to fail and SPX to continue lower. I've shown before the comparison with the Value Line Geometric index (VALUG in green) and how it's testing its May 2011 high. For SPX to do the same it will need to drop to 1370 (a 28% decline from the current level). There is no guarantee it will get down there but that's the current risk.
S&P 500, SPX, Daily chart
SPX broke its 20-dma at the morning low but the recovery and close above it, especially with a bullish hammer candlestick, looks like it could lead to another leg up for its rally off the February low. If that happens we could see a rally up to its 200-dma, currently at 2028 and coming down slowly. With the big whippy moves we've been seeing in the market it's very difficult to determine whether one day's move will see any follow through and it's no different here. Today's rally could be reversed and lead to at least a larger pullback before heading back up. Take nothing for granted in this market!
Key Levels for SPX:
- bullish above 1957
- bearish below 1810
S&P 500, SPX, 60-min chart
As of the end of today's trading it clearly looked bullish following the strong rally off this morning's low. But it also looked very bearish this morning so that left me thinking tomorrow's first move is a coin toss. On the 60-min chart below I show an expectation for another pullback before setting up a stronger rally to give us a 3-wave move up from February 11th. But in reality this is a read and react market right now, especially since we're in a corrective pattern. They're difficult to trade because there's often little follow through and that's been especially true in this market.
Dow Industrials, INDU, Daily chart
The Dow has the same pattern as SPX and you can see the strong bounce off its intraday test of the recovered 20-dma near 16231. If it can rally above its 50-dma, near 16590 on Thursday, which stopped the rally on Monday, it would be more bullish. In that case we could see a rally up to its 200-dma in the first week of March, currently at 17231. But there is a wave count that calls for another leg down for at least a test of the January-February lows and therefore today's strong recovery could be reversed just as quickly as this morning's decline was reversed.
Key Levels for DOW:
- bullish above 16,700
- bearish below 15,300
Nasdaq-100, NDX, Daily chart
NDX also recovered from an intraday break back below its 20-dma but almost left a bullish engulfing candlestick (if it had been able to close above yesterday's high). But it's still struggling with its two broken uptrend lines from March 2009 - August 2015 and June 2010 - November 2012, now near 4186 and 4222, resp., closing in the middle at 4200. Above Monday's high at 4235 would obviously be more bullish but then it would soon have to contend with its 50-dma, coming down but currently near 4296.
Key Levels for NDX:
- bullish above 4325
- bearish below 3900
Russell-2000, RUT, Daily chart
One thought about what might play out in the weeks ahead is shown on the RUT's chart below. It's just an idea but for a 4th wave sideways correction in the decline from its June high it would fit well. The reason I mention the sideways triangle is that it would be filled with whippy price action with lots of reversals. It could still head a little higher first, such as back up to its broken uptrend line from March 2009 - October 2011, now near 1043, and maybe even its 50-dma near 1050, but in a corrective pattern it's best to stay cautious rather than aggressive in either direction.
Key Levels for RUT:
- bullish above 1040
- bearish below 940
10-year Yield, TNX, Weekly chart
The Treasury market is not supporting the current bounce attempt by the stock market. Typically yields follow fairly closely with the stock market, which reflects the money rotating back and forth between stocks and bonds. As the stock market rallies, money comes out of bonds and that raises yields and vice versa. The bounce in the stock market off the February 11th low led to SPX making a new high on Monday above its February 1st high and today was a successful pullback to its recovered 20-dma, which held as support. By contrast, TNX made a much lower low in February vs. its January 20th low and it has not been able to even make it back up to its broken 20-dman, near 1.81%, which has acted as resistance twice since February 11th. In addition to that MA its' been struggling with its broken uptrend line from June 2012 - February 2015, near 1.76% (today's close was 1.745(%). As long as there is an underlying bid in bonds (holding yields down), there should be caution about stocks on the long side, especially if bonds are going to consolidate for several weeks (notice the similarity between the idea for a sideways triangle in the 4th wave position as mentioned for the RUT above).
KBW Bank index, BKX, Weekly chart
Another expectation for a larger correction/consolidation pattern is shown on the BKX weekly chart below. It could consolidate on top of its uptrend line from March 2009 - October 2011, currently near 58, for another month or two before heading lower (assuming we're in a bear market and not still in a bull market). The banks have been weaker than the broader market, which is reflecting concerns about the debt bomb that's out there. The collapse of the energy sector has spilled over into most other sectors and the explosion of debt in the past several years, thanks to the Fed's easy-money policies, is coming due. The financial system is at significant risk, especially considering all the 3rd party derivatives exposure, and it won't be just the banks that take it on the chin. Keep a close eye on the banks (follow the money).
Transportation Index, TRAN, Daily chart
The choppy climb up from its January 20th low has looked both bullish and bearish. There was a strong bullish divergence with its higher low on February 11th compared to the Dow. But the choppy climb has it looking more like a bear flag pattern than something more bullish. The rally into Monday's high, at 7463, was an intraday break above price-level resistance near 7453 (its August 2015 low) but it closed below 7453, as well as its 50% retracement of the leg down from November 20th. MACD and RSI are both rolling over from overbought, but without bearish divergence, so it could go either way from here but it's looking risky for longs. The Trannies have been a very good canary for the broader market.
The US$ has been in a sideways trading range since March 2015 and one reason is likely because the relative strength of the U.S. economy draws money into this country. The Fed also helped strengthen the dollar with its talk for the past year about raising rates. But opposing those factors that strengthen the dollar are worries that the Fed will have to some things to devalue the dollar in order to make international companies' products more competitive (in the race for the bottom in devaluing currencies around the world). But are the central banks really in control of any of this? Many more analysts are now beginning to question that thesis.
Germany's central bank chief, Jens Weidmann, is now openly questioning the ECB's decision to go nuclear with their own NIRP. Weidmann is a member of the ECB's governing council and he said QE was "no longer necessary." Most members of the ECB appear to be behind doing more of "whatever it takes" but fractures in unified support are beginning to show up and a disagreement with powerhouse Germany is not to be taken lightly. France is lining up behind Germany to pull support for Mario Draghi so it's not just the countries' open borders that are beginning to crumble in the EU.
Nikkei 225 index, $NIKK, Weekly chart
Bank of Japan's Kuroda has been the central bank head since 2013 and he has been aggressively pushing QE, NIRP, ZIRP and anything else he can do to pump up the Nikkei (including outright purchases of stocks) and depressing the value of the Yen as a way of pumping up inflation and the stock market. It worked for a while as can be seen on the chart below. But since the middle of last year the NIKK has tumble hard while the Yen has been on the rise. The last few weeks have shown the currency and stock markets are losing faith in Kuroda's ability to do anything. After he announced NIRP last month the stock market rallied one day. That's it, one day.
The stock market continued its decline and the Yen continued to rise, in effect calling Kuroda's bluff as he promises to do "whatever" it takes (the statement by all central bankers now, who very likely feel trapped but don't know what else to try). As John Mauldin stated, "Japan is a bug in search of a windshield." And keep in mind that a rising Yen will cause a rush to exit stocks as algorithms hit the sell button (there's been a strong inverse correlation between the Yen and SPX and many trading algorithms trade based on this relationship, just as they are trading the oil correlation at the moment).
U.S. Dollar contract, DX, Weekly chart
Moving on to our Fed, they are in the process of preparing us for a few things:
1. Negative interest rates
2. A ban on cash (talk of removing the $100 bill, and 500 Euro bill from circulation)
3. More QE
The first two are tightly linked -- going to negative interest rates will only encourage people to withdraw their money and park it outside the banking system, even under their mattress. That would have a significant negative impact on banks' earnings as well as their capital base. One way to stop withdrawals is to go all digital and get rid of cash and that way the government/banks have a lock on your money and can institute tighter monetary controls at any time (ready for bail-ins?). France already bans any transactions over 1000 Euros with cash. Spain is looking into doing the same with 2500 as the limit and Germany is considering 5000. Basically NIRP can't work without a cash ban in place and we're being prepared for this by the likes of Larry Summers, et.al., as they use the excuse of criminal activity being supported by access to big bills (see Summer's article at Going After Big Money).
Gold continuous contract, GC, Weekly chart
With all of this information floating around about cash bans, NIRP, failing currencies and the potential for stoking inflation, it's no wonder gold has been rallying strong. I might not be convinced gold's breakout is real but I certainly can't argue with its recent strength. Gold is one of the best insurance programs to protect against a global currency crisis and failed central bank policies. Gold has broken out of a descending wedge that it's been in since 2013 and that has just about everyone I read turning super bullish on the shiny metal. At the moment I think it's a knee-jerk reaction, which will be followed by another leg down but I have to admit I'm not feeling comfortable with my bearish view on gold. I see the potential for another leg up to test its January 2015 high near 1308 but at the moment it's struggling to get above the top of a parallel down-channel for the decline since 2013. If gold can get above its February 11th high near 1264 there's one other resistance level to watch, near 1285, which is the 38% retracement of its 2001-2011 rally.
Oil continuous contract, CL, Daily chart
Along with the stock market, oil has been trading in a sideways range since its January 20th low and it could continue to do that for several more weeks before heading lower, even if it's to be just a minor new low or a test of the January-February lows. If it drops down to the bottom of a descending wedge pattern for the leg down from June 2015, we could see oil get closer to $20 before making a longer-term bottom. But if it rallies a little further then keep an eye on a downtrend line from June-October 2015, near 36.75, where a 3-wave bounce pattern off the January 20th low could finish and be followed by another leg down.
Other than New Home sales this morning there wasn't much in the way of economic reports to influence the market. Thursday morning will be a little busier with unemployment claims data, Durable Goods and house pricing data. Friday will be more related to what the Fed says they're watching -- GDP, personal income/spending and core PCE prices
The large number of large price swings is making it very difficult to figure out which way this market wants to go. Since the January lows we've seen some very strong moves and today's strong reversal off the morning gap down has it looking like it wants to break out to the upside. At the moment we remain inside a wide trading range between the January-February lows and the February 1st highs. Finger to the wind, it looks like we'll see the indexes make it higher but that could happen after another leg down to give us a larger pullback from Monday's highs.
Keep in mind that if we get a continuation of the rally that it will turn many, if not most, traders very bullish, especially with talk about the double bottom in January-February. But the larger risk is to the downside, especially with the confusion about what the central banks will or will not do and whether any of it really matters anyway. What should really matter is the fact that corporate earnings are in decline and that makes it more difficult to justify a renewed rally. A higher bounce maybe but not to new highs. There's not enough evidence to support new market highs from here, either from the economy or the charts.
One chart that I found from Arch Crawford, shown below, is very informative because it's hard to massage the numbers. It shows the decline in earnings by people and the tax revenue derived from it. They're both in decline and the 4-week average has dropped hard in the past month. An economy dependent on the mighty consumer is not looking so good and we're seeing the effects in the retail sector and the likes of Walmart. It's just another piece of the puzzle to help answer the question as to whether or not we're entering a recession and if so, it's not a time to be invested in the stock market. Trade it instead and keep the bulk of your money in cash equivalents (not money markets but instead in Treasuries). If you're not comfortable trading the short side (shorting stocks, buying puts, buying inverse ETFs), now is a great time to start learning and just start off small.
Good luck with your trading and keep it short-term oriented. 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