Following a tight trading range for almost three weeks it looked like a bearish breakdown with Tuesday's selloff. But today's recovery has the potential to turn the breakdown into a head-fake break and a rally to new highs. However, the bears still have a foothold here and have the potential to drive the market lower Thursday/Friday.
Today's Market Stats
If you're feeling a little whipped by this market, welcome to the club. Tuesday's selloff had it looking like the 3-week trading range was an ending pattern rather than a bullish consolidation pattern. But the selloff on Tuesday has the potential to be the conclusion to the consolidation pattern and today's rally was the start to the next rally to new highs.
Today's economic reports had little effect on the market since they were market neutral. The ADP employment report for July came in about the same as June (179K vs. 176K, revised up from 172K) and the ISM Service for July was 55.5, only a point below the 56.5 for June and in line with expectations for 55.8. The economic reports continue to show weakness with generally weak and weakening numbers. If anything, other than the worry over declining economic numbers and corporate earnings, neither of which support the high valuations of the current stocks prices, today's neutral reports keep the Fed on hold about additional rate increases.
I've long held my opinion that the Fed will not be able to raise rates. They really should not have raised the rate earlier this year but they're feeling trapped in front of the slowing economy and they desperately want some wiggle room. With what's happening in Europe and in the U.S. it's almost impossible to raise rates without having a negative impact on sentiment and in turn the market. The consumer is already in contraction mode.
What concerns the Fed more than anything else at this point is the idea that Wall Street is starting to ignore the Fed and calling them impotent. When the Fed says things are honky-dory and not to worry, the market is starting to see them like other politicians -- they have to say the economy is doing great because they have no available tools to combat the next recession. If consumers start to understand how much things have actually slowed down and they start to worry more they'll simply pull back even further.
If the mighty consumer starts to pull back it will leave the economy even weaker. Companies will sell less, start to lay off workers, reduce their borrowing, invest in less capital equipment and more importantly for market support, they'll reduce stock buybacks, which is arguably one of the largest supporters (if not the largest) of the stock market. With where the Fed is currently situated, they have very little to stop an economic slide and the recession is likely to turn into a longer and more severe recession (depression?).
Wall Street is a current participant with the Fed in the attempt to keep consumers in the dark by telling them everything is fine and that there's nothing to worry about. Wall Street needs investors to stay bullish, especially since smart money needs dumb money to take stock off their hands. Has the 3-week consolidation been a distribution of stock to retail traders? One could easily make that argument in front of the seasonally weak period of the year (August-September).
The current inflation-adjusted P/E ratio for the S&P 500 suggests a fair historical price between 1200 and 1470, which would be a 32%-44% decline from current levels.
All of this is of course not useful for market timers but it does provide a strong reason for caution about any additional upside movement. Keep your stops tight on long positions and think about the fact that it would be better to get stopped out early and then reenter on a recovery rather than get caught in a sudden decline hoping for a big bounce to exit. Very rarely is the market kind to retail traders.
S&P 500, SPX, Weekly chart
For the past three weeks SPX has been stalled underneath a price projection at 2177.67 (it popped above it Monday morning but was immediately rejected from that level). Yesterday it broke down from the 2-1/2 weeks with a tight trading range but today bounced back up into the same range (about 2157-2177) with the close at 2163. That leaves a question mark as to what will happen next and on a weekly basis I see the potential for a rally to at least 2223, which is the 127% extension of the previous decline (May 2015 - February 2016). The bulls stay in control as long as SPX stays above its May 2015 high near 2135, a break of which would signal the top is likely in place, even if it will be for just a larger pullback before heading back up.
S&P 500, SPX, Daily chart
Yesterday's decline for SPX broke below its 20-dma but managed an afternoon bounce to get back above it, now near 2159. Today's rally has it closing above its 20-dma and back inside its recent trading range, which keeps the door open for bulls to launch another rally, one that could take it up to at least 2191 (projection shown on the 60-min chart further below). The bears need to see this bounce finish with a lower high followed by a break below yesterday's low at 2147.58, which would tell us the 2135 support level should be tested next. A break below that level would be a stronger indicator that the top is in at least for now.
Key Levels for SPX:
- bullish above 2178
- bearish below 2108
S&P 500, SPX, 60-min chart
The tight trading range since July 14th can easily be seen on the 60-min chart below. It was looking like either a shallow up-channel or ascending triangle/wedge and depending on how the pattern was interpreted changed whether it was bullish or bearish. Yesterday's breakdown made it look more bearish than bullish but that has been somewhat negated with the recovery back above the uptrend line from July 15th, currently near 2161.50. It might have been just a manipulated rally in the final 15 minutes to create some short covering. If true we'll see an immediate reversal back down Thursday morning, which would leave a head-fake break back into the trading range. But the bullish interpretation of the consolidation pattern calls the decline into yesterday's low as the completion to the correction and now we'll get another leg up. For the rally from June 27th, and as noted on the chart, the projection at 2191 is where the 3rd through 5th waves would equal the 1st wave, which is a common projection for when the 1st wave extends. The other projection at 2210 is where the 5th wave would equal 62% of the 3rd wave, which is another common projection when the 3rd wave is shorter than the 1st (as is true in this case). And then above 2210 is the 2223 extension shown on the weekly chart, giving us a few levels to watch for if the bulls stay in control.
Dow Industrials, INDU, Daily chart
The Dow has been the weaker index since July 20th but the pattern of its pullback was looking like a bullish descending wedge until yesterday's breakdown. At the same time it broke below its descending wedge it also dropped below its May 2015 high at 18351. Thanks to the last minute shove higher into the close it managed to get back above 18351 by 4 points. For all intents and purposes, today's bounce brought the Dow back up for a possible back-test of S/R at 18351 and a selloff on Thursday would leave a bearish kiss goodbye. So obviously the bulls need to thwart the bears from allowing that to happen. The bullish interpretation of the choppy pullback from July 20th is that it's now ready for another rally leg and for now I'm showing the potential to rally up to about 19000 to again back-test its broken uptrend line from February-May, which was last back-tested with the rally up to the July 2oth high.
Key Levels for DOW:
- stay bullish above 18,350
- bearish below 18,000
Nasdaq Composite index, COMPQ, Daily chart
On Monday the Nasdaq rallied above its December 2015 high at 5176.77 (with a high at 5199) and even managed to close above it with a closing price at 5184. But it couldn't hold above that resistance level and dropped back below its March 2000 high, at 5132.52, on Tuesday before closing slightly above it. Today's rally has it now in between the two resistance levels, leaving us guessing which direction it will go from here.
Key Levels for NDX:
- bullish above 5177
- bearish below 5075
Nasdaq Composite index, COMPQ, 60-min chart
Last week I showed the 60-min chart of the Nasdaq to point out a pattern with a slightly narrowing up-channel that suggested we'd see the December 2015 high tested. As you can see, following the test it broken down and fell out of the up-channel/wedge. Today's bounce has it back up near the bottom of the channel, currently near 5168, and could be doing just a back-test and then drop away from there. That's what the bears want to see. The bulls want to see a head-fake break of support followed by a nice short-covering rally back up to new highs. I'm leaning bearish here because of what looks like a small impulsive move down from Monday that's been now followed by a 3-wave bounce correction. This suggests at least another leg down and the only way it can be negated is with a rally above Monday's high at 5199.
Russell-2000, RUT, Daily chart
As with the other indexes, the RUT dropped down to its 20-dma yesterday, at 1200.91, which was also a break below price-level S/R at 1205. Today's bounce has it back above 1205 and might have left a head-fake break of support that will now be followed by another rally leg. But as with the tech indexes, the decline from Monday into Tuesday's low looks like an impulsive 5-wave move down and that suggest the current bounce will be followed by at least one more leg down. The larger bearish pattern supports the idea that we'll get a much more bearish move from here, one that will take the indexes below the June lows. It's too early to tell which side is now in control but the short-term pattern is bearish until negated with a rally above Monday's high at 1224.46.
Key Levels for RUT:
- bullish above 1225
- bearish below 1198
10-year Yield, TNX, Weekly chart
Bonds sold off today, correcting a portion of Tuesday's rally (opposite of the stock market), and that had TNX bouncing back up to its downtrend line from May 31 - July 21, near 1.56%. We could see a continuation lower from here, especially if the stock market sells off and money rotates into the relative safety of Treasuries. But if bonds continue to sell off we could see TNX rally to 1.75% where the bounce off the July 6th low would achieve two equal legs up. Before that level is its downtrend line from November 2015 - May 2016, currently near 1.72%
KBW Bank index, BKX, Daily chart
On Tuesday BKX dropped down to price-level S/R near 66.50 (with a low at 66.56) and its 20-dma at 66.65 (66.90 today). From there it bounced back up today, with a relatively large rally (+1.5%) compared to the broader averages, and banged into its broken 200-dma at 67.82, with a high at 67.90 and a close at 67.89. Its downtrend line from June 2 - July 27 is now near 68.14 so watch that level if tested. A break of its downtrend line would suggest a rally up to at least its longer-term downtrend line from July-December 2015, near 69.80, whereas a break below 66.50 would likely lead to at least a larger pullback if not something more bearish.
Transportation Index, TRAN, Daily chart
The TRAN also fell to support at its 200-dma yesterday, at 7666, with a low at 7622, and bounced today back up to its broken 50-dma at 7716, with a high at 7719 and a close at 7711. That leaves us guessing for now which one is going to hold as support or resistance. The pullback from July 14th looks like a 3-wave correction to the rally and that supports the idea that we're going to see another rally leg kick off (but not a guarantee it will happen). Above 7860 would be a bullish heads up and above 8000 would confirm the bulls are taking it higher. The bearish pattern suggests another leg down, perhaps to the 7500 area, followed by a larger bounce and then strongly lower into September.
U.S. Dollar contract, DX, Weekly chart
The US$ pulled back sharply last week from its downtrend line from December 2015 - January 2016, currently near 97, but so far there's no evidence that it will break down from here. I expect to see continued choppy and whippy price action for the dollar all year and I continue to expect a move up to the top of its trading range near 100 before pulling back again into the end of the year (to then set up the next rally leg).
Gold continuous contract, GC, Weekly chart
Following gold's pullback from July 6 into the low on July 21 it has bounced back up to challenge the July 6th high at 1377.50 (Tuesday's high was 1374.20 and today's was 1373.40). I still like the upside projection at 1417.50 (for two equal legs up from December 2015 and a test of its downtrend line from September 2011 -October 2012) to complete its bounce correction before heading back down. Whether we'll get just a larger pullback or something more bearish will have to be figured out once the pullback/decline gets underway but at least for the short term I don't see much more upside potential for gold than that 1417.50 projection.
Oil continuous contract, CL, Weekly chart
On Monday oil lost support at its 200-dma, currently at 40.62, and today's rally took it back above it with a high at 41.20 and close at 41.17. On the daily chart there are no bullish divergences, suggesting a bounce off this morning's low at 39.19 will be followed by at least a retest of the low, if not lower. The weekly chart shows a break of support at its 50-dma, at 41.46 and the bearish wave count suggests a return to at least the February low at 26.05 and potentially lower. A slowing global economy would be the primary reason for lower prices. But so far the uptrend line on RSI shows the possibility for the pullback from the June 9th high at 51.67 to be just a correction within what will become a larger bounce/rally, especially if MACD turns back up from the zero line. I think that's a lower-probability scenario but one that still needs to be respected.
Thursday's economic reports include unemployment claims data, Challenger Job Cuts and Factory Orders. There are no significant changes expected but Factory Orders for June are expected to decline further from May's -1.0%. Friday will be the big day with the NFP report, which is expected to be down more than 100K from the 287K reported in July (which was up big from June's 37K). With today's ADP report showing very little change from June maybe the market will get a happy surprise with a better-than-expected number on Friday. Of course that would have the market worrying about the Fed getting back on the rate-increase wagon.
For the past three weeks we've been waiting for a tight trading range to break and yesterday it broke down. But today's rally puts several indexes right back up inside the trading range. It's possible yesterday's "breakdown" will turn into a head-fake break and now some buy programs could kick in some short covering that will take the indexes to new highs. There are some short-term patterns for yesterday's decline and today's bounce that suggest the bounce is just a correction to what will become at least a larger pullback and maybe something more bearish.
At this point I'm thinking the higher-odds scenario calls for another leg down for the pullback/decline off Monday's high, which won't be negated until we see a high above the Monday highs. That means the current bounce should be viewed as a shorting opportunity and then if we get another leg down it should be watched carefully for where it would achieve two equal legs down from Monday since that could conclude an a-b-c pullback. If the 2nd leg down (again, assuming we'll get it) exceeds the projection for two equal legs down I would then start thinking more bearishly.
So it's a little early to get too bearish, especially since we don't have confirmation yet that a top is in place. Hopefully the indexes won't stay stuck in the 3-week trading range -- gag me with a spoon if that's what follows. Stay long above Monday's highs but look to play the short side for another leg down and let price lead the way and keep your bias out of what "should" happen from here.
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