The market has been essentially on hold this week until this afternoon's FOMC announcement and reaction was positive. Now the bulls want to prevent the typical reversal the next day.
Today's Market Stats
Following last Friday's strong rally the market consolidated Monday and Tuesday and this morning while waiting to hear what the Fed intends to do this year. The initial reaction to this afternoon's announcement was positive for stocks and especially for precious metals and oil while the U.S. dollar tumbled. The Fed still intends to raise rates this year but Treasury yields chopped up and down and the 30-year finished flat while the 10-year finished 1% lower and the 5-year dropped more than 5%, which steepened the yield curve.
The Fed kept rates the same and said it would raise rates this year less than had originally thought (it's now down to two more instead of four). More importantly, Yellen did a good job walking the tight rope by not sounding too dovish or hawkish. While acknowledging the global economy has slowed more than expected, the Fed believes the slowdown has not negatively affected their expectations for the U.S. economy. Yellen also said inflation has not picked up and the lack of wage growth could continue to pressure inflation expectations. She did say she continues to believe inflation will gradually move back to 2% over time (no definition of "time"). In the meantime though, the Fed cut this year's forecast for core PCE (Personal Consumption Expenditures) from 1.6% to 1.2%.
A reduced expectation for rate hikes caused the U.S. dollar to sell off and that in turn helped spike precious metals and oil to the upside. Whether or not all of these moves will see follow through the rest of the week remains to be seen. Oftentimes the first reaction the Fed is reversed the next day.
If you've felt a little whipsawed by this market this year you can rest assured that your feelings are accurate. Last week Bloomberg had an article that showed how many 1% days we've seen for the S&P 500 this year and it's the highest number since 1938. This is usually not a good sign following a bull market since it's typically associated with topping action (as the bulls and bears battle it out for control). In 1938 the stock market was in a bounce correction off the November 1937 low (1937 was not a good year for the stock market) and the big back and forth swings into early March led to another strong decline (the Dow dropped about -27% into the end of the month before starting a bigger recovery for the rest of the year. The below chart is through March 8th and since then we've had two more days where the index has finished more than 1% from the previous day (this does not include intraday 1% moves). I haven't had time yet to look at volume on each of those 1% days but it would make for an interesting study.
1% days for S&P 500 in 2016
What this year's volatility means for the market obviously can't be known yet but I think it's a warning sign and part of a larger rolling top pattern that we've seen develop over the past three years, which can be seen on the longer-term SPX charts below.
S&P 500, SPX, Monthly chart
Here's something you can pass along to your non-trading family members and friends to help them enjoy bull markets and avoid bear markets. I'm sure many of you have seen, if not bought/tested, trading systems that give you little green and red arrows to show you when to buy and sell (no thinking involved, just do what the arrow tells you to do). So here's a simple trading system for investors who don't want to actively trade their accounts (and it won't cost you $5000 to purchase). Perhaps it's your IRA account or something your parents and/or friends would be interested in since it doesn't require sophisticated chart analysis or knowledge of indicators. The monthly chart below uses two monthly moving averages -- the 8 and 21 (I pick these because they're Fib numbers but 10 and 20 also work well).
When the 8-month MA crosses above the 21-month MA you go long the market and when the 8-MMA crosses below the 21-MMA you get out of the market (and/or get into some inverse funds). As you can see, this system allows you to capture the bulk of the longer-term bull market rallies and avoid the bulk of the bear market declines. We are on a new sell signal as of the cross in February. The 21-MMA is currently at 2027 (the 20-MMA is at 2032) and is currently being back-tested with the rally off the February low. Not shown on the chart is the Bollinger Band and after punching below the bottom of the lower BB in February it's back up to the midline of the band, which is often resistance to be shorted.
The other thing you can see from this monthly chart is how it rallied up to its long-term broken uptrend line from 1990-2002 in 2013 and pushed up along the line, breaking above it several times, into the 2015 high. The pullback from the line leaves a bearish kiss goodbye and the rounded top from 2013 is also a bearish rounding top pattern. The neckline near 1815 is a must-hold level for the bulls on any future pullback.
S&P 500, SPX, Weekly chart
In addition to SPX testing its 20-MMA at 2032 it's also testing its 50-week MA at the same level so from a moving average perspective it's important for the bulls to close the week above 2032 (an intraweek break is not as important). Today's post-FOMC rally hit a high at 2032 (20-MMA) and closed at 2027 (21-MMA). I'm sure those two numbers were pure coincidence today (wink). The week needs to close above 2032 otherwise the bearish setup is for the bounce off the February to lead to a stronger decline than we've seen so far this year.
S&P 500, SPX, Daily chart
Last Friday's rally stopped marginally above its downtrend line from December, currently near its 200-dma at 2018. Monday and Tuesday it consolidated near the downtrend line and now today's rally is a clear break above the line and that's bullish. The next line of resistance is the 78.6% retracement of its December-February decline, at 2041. This has been a very common retracement level for years and it's been very common for it to hold as resistance (or support in a decline). SPX would go positive for the year above 2044. For this reason I think it would be confirmed bullish above 2042-2044 but at the moment it's looking like we could be a lot closer to the end of the rally instead of in the middle of a higher move. What kind of pullback that follows will provide more clues about whether or not we should expect higher but the bearish risk here is for the start of a very strong decline.
Key Levels for SPX:
- bullish above 2042
- bearish below 1969
S&P 500, SPX, 60-min chart
There's a trend line along the highs since February 1st, currently near 2032 (the same 2032 as the 20-month MA and 50-week MA), which stopped the rally on Monday and again today. As can be seen on the 60-min chart below, the bearish divergence at the new highs this month suggest the bulls are running out of energy and considering the trend lines and important moving averages I don't think now is a good time to be betting on the long side. With the potential of a reversal of this afternoon's post-FOMC rally I think the better trade is the short side with a tight stop. It essentially needs to work right away Thursday morning and then assuming we'll start at least a larger pullback we'll then get some clues about whether to expect just a pullback or instead something more bearish.
Dow Industrials, INDU, Daily chart
Like SPX, the Dow made it above its downtrend line from December, currently near 17299, and nearly up to its 78.6% retracement of its December-February decline, at 17388 (with today's high at 17379). If today's rally does not hold it will leave a head-fake break of the downtrend line so bulls need to hold the line on a pullback. If the bulls can keep things going here, the next upside target would be the downtrend line from May-November 2015, near 17670. Not shown on the daily chart below, two equal legs up from February, for an a-b-c bounce correction, is at 17327, which was achieved today.
Key Levels for DOW:
- bullish above 17,390
- bearish below 16,820
Nasdaq-100, NDX, Daily chart
NDX rallied up just shy of resistance today at its 62% retracement of its December-February decline, at 4420, and its 200-dma at 4421. It would obviously be more bullish above 4421, especially if it can close above it for the week. But it's a risky place to bet long with it up against strong resistance.
Key Levels for NDX:
- bullish above 4420
- bearish below 4220
Russell-2000, RUT, Daily chart
Since running into its broken H&S neckline on March 7th the RUT has been struggling to make it higher with the other indexes. It's possible we're seeing a little sideways consolidation following the March 7th high, which will be followed by another rally, but the daily oscillators have crossed back down and as long as it stays below price-level S/R at 1080 it will stay bearish. It would turn much more bearish with a drop below price-level S/R at 1040 but it would be more bullish above 1105.
Key Levels for RUT:
- bullish above 1105
- bearish below 1040
KBW Bank index, BKX, Weekly chart
The weekly chart of the BKX shows the importance of the 66-67 area since it's now strong resistance until proven otherwise. This level was strong support in 2014-2015 until it broke in January and its March 4th high at 66.07 was a back-test of this resistance zone. Bouncing back up to this price-level S/R is a good setup to play a reversal back down following the bearish kiss goodbye against resistance. It would turn more bullish above 67.
Home sales have been mixed but showing some signs of slowing. Today's housing data was mixed with slightly better housing starts than were expected but permits were lower. The chart of both starts and permits shows the steep decline from the peak in 2005 to the 2009 low followed by the slower climb back up and level off this year. Interestingly, the decline is impulsive (5-wave move down) and that's been followed by a correction to the decline that has not yet retraced 50%. An impulsive decline followed by a correction to the decline strongly suggests another leg down will follow.
DJ U.S. Home Construction index, DJUSHB, Weekly chart
Banks have been doing what got them into trouble in the last housing bubble -- lending to unqualified buyers (little to no money down, large mortgages, fog-a-mirror qualification standards, etc.). It's even worse for automobile loans and college student loans, making total risky loans much higher than in 2007, but sticking with the home market, the higher risk-taking by the banks is an indication there's again an effort to find buyers, any buyers, to move inventory and that's a warning sign. The weekly chart of the home builders index below shows the bounce off the February low has the index back up to its broken uptrend line from October 2011 - October 2014, which it broke below in January, and at the same time it's back-testing price-level S/R at 553 (starting from the May 2013 high) with last Friday's high at 550. Not shown on the weekly chart, the 62% retracement of the December-February decline is at 555. Until proven otherwise, this is a good setup for the bears.
Transportation Index, TRAN, Daily chart
The transportation index has made a strong bounce off the January low, up nearly +21% off that low. It was bullish when the TRAN made it back above its August low at 7464 and it has remained inside a narrow up-channel for its rally. It's looking like the index could make it up to its 200-dma, at 7842, if not its downtrend line from March-November 2015, currently near 7940. Importantly, the higher number is also where it would retrace 78.6% of the leg down from November 2015, above which would indicate a greater likelihood that it will make it above its November high. The short-term risk here is that this week's highs are showing bearish divergence against the March 4th high on the oscillators. The bulls need to keep price inside the up-channel whereas the bears need to see a break below the March 10th low at 7426 to confirm the leg up from January finished.
U.S. Dollar contract, DX, Weekly chart
The US$ tanked on the FOMC announcement due to traders believing fewer (if any) rate cuts will weaken the dollar. It's still holding inside an up-channel for its climb off its August 2015 low, the bottom of which was tested this afternoon, near 95.70. A further drop would likely have it dropping down to the bottom of the down-channel that it's been in since its December 2015 high, the bottom of which is near 94. There's not much to tell us which way it will go from here and longer term I think we'll see the dollar remain rudderless for most of 2016.
Gold continuous contract, GC, Weekly chart
The metals and oil spiked higher on the FOMC announcement, which was helped by the dollar's decline. Gold's overnight high last Thursday, at 1287.80, achieved a test of its 38% retracement of its 2001-2011 rally, at 1285.49, and that was followed by a pullback this week. The rally into last week's high was also a small break above the top of a parallel down-channel for the decline since August 2013, which is near 1260, and this week's decline below 1260 left a failed breakout attempt. But this afternoon's rally took it back up to the top of the down-channel and unless it turns right back down from here there is potential for a push higher to test the January 2015 high near 1308. The bearish pattern calls the 3-wave move up from July 2015 low as complete, which suggests another leg down to the bottom of its down-channel, which will be near price-level support near 1000 (S/R from 2008-2009). The bullish interpretation of the pattern is that the rally from the December 2015 low is the 1st wave of what will become a much stronger rally following a pullback correction. We can't know which pattern will play out but at a minimum it's looking like gold is ready for at least a larger pullback, either from here or after another minor new high.
Oil continuous contract, CL, Daily chart
Oil rallied +6.1% today and most of that was before the FOMC announcement. At its March 11th high, at 39.02, oil reached its downtrend line from June-October 2015 (to the tick) and this week it dropped back below price-level S/R at 38, which left it on a sell signal. Today's rally got it back above 38 but it again stalled at its downtrend line, now near 38.70. A rally above 39 could see a rally to 40, where the c-wave of an a-b-c bounce off the January 20th low would be 162% of the a-wave. Oil would turn more bullish above 40. The larger wave pattern would look best with another decline into May/June, potentially down to about 23 before putting in a longer-term bottom. If that happens it would likely turn most traders very bearish on oil at exactly the wrong time but we'll have time to evaluate it if it happens.
Tomorrow's economic reports include unemployment numbers and more importantly the Philly Fed, which is expected to come in at a "less bad" -1.4, an improvement from -2.8 in February. If it comes in below zero it will be the seventh month in a row.
Additional thoughts and conclusion
One of the problems facing the market is where the buying is coming from. Bloomberg published an article last week that highlighted the fact that corporations are doing most of the buying (share buybacks). The divergence between the buying by individuals and funds vs. corporations is historically large, especially in the past two months, and it highlights the importance of corporate buybacks, without which the stock market would very likely be much much lower today.
S&P 500 companies are expected to buy about $165B of their stock in the current quarter whereas there has been a net selling in ETFs and mutual funds of about $40B since January (making it one of the largest quarterly withdrawals ever). The problem is that corporations have borrowed massively (almost $10T since 2008), some of which was used to buy back shares of their own stock (not a productive use of the money).
With corporate earnings in a steady decline they now have two problems -- they can't continue to borrow at the rate they've been borrowing, which means less money for buybacks, and reduced earnings are going to make it more difficult to pay back their loans. Corporations could turn from buyers to sellers of stock in order to free up some needed capital. Not only would they stop supporting the stock market with their buybacks but they'd become net sellers, which could exacerbate the selling by others.
The amount of share buybacks has amounted to about $2T since 2009, which is obviously a lot of support for the stock market. Much of this was made possible with very low borrowing rates, thanks to the Fed's distortions of rates. And the buybacks have only distorted the picture of health for businesses -- they show improved earnings per share even when earnings are in decline. This will all come to an end since it can't be sustained and the impact on the stock market can only be guessed but I don't think it's hard to see it's not going to be good for the bulls.
More corporations have been resorting to "adjusted" earnings instead of using GAAP (Generally Accepted Accounting Practices) to help them report stronger earnings. This was done extensively in the lead up to the 2000 dot.com bubble. Last year 20 or the 30 DJIA companies used adjusted earnings, which were 31% better than GAAP results last year vs. a 12% difference in 2014 so you can see what's happening and the distortions in "real" earnings. Adjusted earnings are used to hide weaknesses in their business and all of this is going to come to a head, probably sooner rather than later.
There's a lot of talk about the relative strength of the U.S. market as a reason why we'll continue to attract money to both the bond and stock markets. While I definitely agree with that belief, what many market participants fail to recognize is the tight linkage in the global financial system and how weak it is. There is a massive global debt burden and a collapse in the bond market of one company, bank or sovereign entity could quickly spread through the system.
Contagion risk is very real and it doesn't take a big company/bank to create the problem. There are derivatives of derivatives and the same counter-party risks we saw in 2007 except larger by order of magnitude. The problems we had back then were not solved and instead were only made worse over the years. The coming correction could also be worse by a large factor. Be careful with your assumptions that everything is fine just because that's what you read in the financial press and hear from central bankers and government officials. It might be harsh to say it but if their mouths are moving, they're lying. And the more they deny something the more you can believe the opposite.
As for the market right here, the bounce off the February low has turned most participants bullish, as I had said it would when the bounce got started. The bearish wave count calls it a 2nd wave correction and I call these the sucker waves for a reason. The 3rd wave (down in this case) is called the recognition wave because it's when the majority of traders recognize they got sucker punched. Don't be one of them.
There is a possible bullish wave count that suggests the rally will continue to new all-time highs and I'm watching the pattern for that possibility. If we see a larger pullback that remains choppy and consolidating then I'll look higher. But at the moment, until I see that kind of bullish pattern, there is risk for the bounce off the February low to turn back down into a very strong decline (stronger than we saw last August and January). It is for this reason that I think it's very important to play defense until we see evidence the bulls have more buying up their sleeve after a pullback.
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