The Dow continued its journey to new all-time highs while the other indexes hang back (SPX) or sell off (techs and RUT). Not even the TRAN will follow the Dow and the Dow's lonely performance is reason for concern.

Today's Market Stats

The indexes got a little pop up with this morning's gap up but it was immediately sold into. The Dow was the only index to hold in the green on the quick pullback and then it proceeded higher while the other indexes dropped into the red. The tech indexes suffered higher relative losses again, thanks mostly to the selling in the FAANG stocks. We have a fractured market and that's generally not a healthy sign.

Many are saying this is the most hated bull market and based on the lack of participation by so many investors there's a good chance for a melt-up conclusion to the bull market, perhaps something similar to the late 1990s. I think it's a very different time than back then and comparing the two periods is like comparing night to day. If not for corporate buybacks and the outperformance by a few stocks (FAANG in particular) we'd have a very different kind of bull market.

There's an interesting "investment memo" from Howard Marks, the highly successful investor and founder of Oaktree Capital, that gives all of us some things to think about. The full memo to his investors can be found on Oaktree's site at Howard Marks memo and I've highlighted a few key comments and ideas he discussed, which can be summarized as "it's time to be cautious." As he said, "I think it's better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses."

Marks is happy to take some chips off the table at a time when returns are likely to be lower and likely negative. Stock values are high across the board and the S&P 500 is now trading 25 times trailing 12-month earnings, which is considerably higher than the long-term median of 15. At the same time we're seeing a record-low VIX indicating most investors believe the trend will continue without a worry. Stability breeds instability but very few are thinking about that.

The VIX hasn't been this low since Bill Clinton became president in 1993. Back then we had world peace, faster economic growth and a much small deficit, all reasons to be more hopeful for a continuing bull market than what we have today. Yardeni Research shows the percentage of investors who believe the market will fall is now at its lowest level since 1987.

Another quote from Howard Marks:

"Most people can't think of what might cause trouble anytime soon. But it's precisely when people can't see what it is that could make things turn down that risk is highest, since they tend not to price in risks they can't see. With the negative catalyst so elusive and the return on cash at punitive levels, people worry more about being underinvested or bearing too little risk (and thus earning too low a return in good markets) than they do about losing money."

Marks also touched on the explosion in ETFs as more money is moved from active investment funds into passive funds. Cap-weighted indexes have especially distorted the investment landscape because the large-cap stocks get most of the money when it flows into an ETF that includes those stocks. A higher percentage of money flows into the largest cap stocks, whether they deserve it or not, while the smaller companies (many of which are more deserving) get a smaller piece of the investment pie. It is this reason why the FAANG stocks have significantly outperformed the other stocks and why ETFs like the QQQ could be in significant trouble when the selling begins.

The climb in NDX (and QQQ) has been primarily driven by the five FAANG stocks and whichever direction they go so goes the index. Today all 5 FAANG stocks were down and so was NDX, QQQ and the Nasdaq. One can only guess how quickly things could turn bad for the tech indexes when the tech ETFs are sold since once again the large-cap stocks will bear the brunt of most of the selling. Ah, we reap what we sow.

One indicator of a lack of concern about the market/economy is the performance of the high-yield bond market (otherwise known as the junk bond market). In an era of uber-low interest rates many retirement investment funds, such as pension funds, have pursued higher yields in an effort to get at least close to the 8% many of their funds need in order to satisfy the future needs of retirees. The spread between high-yield funds and U.S. Treasuries is back down to where they've been at prior important tops in the market. HYG is a high-yield corporate bond fund and worth keeping an eye on, especially since it tends to trade with the stock market but provides early signs of topping.

HYG tends to form rising wedge patterns as it tops out and it's no different for the rally from last November. From an EW (Elliott Wave) perspective, the rally from November is now a 5-wave move inside a wedge and therefore should be topping literally any day now. The bearish divergence against the October 2016 high is another warning sign and when this breaks down it's likely to go fast. HYG will have confirmed a top is in place when it drops below its July 7th low at 87.45.

High Yield Corporate Bond Fund, Weekly chart

Volatility index, VIX, Daily chart

While HYG has been showing the same bullish complacency as the stock market, we're seeing the same thing in other countries' bonds (Argentina 100-year bonds at 8% anyone, or how about Italian bonds at 6.25%?). Thee VIX has of course garnered much attention with last week's intraday low below 9 after the July 21st close at 9.36. As I had pointed out last week, the quick spike below the bottom of its rising wedge last Wednesday has been followed by a quick spike back above 10 and is now on a buy signal.

Trading the VIX is not for the faint of heart and while the VIX could start to rally it doesn't mean the stock market will fall. But it does mean the worry factor will be on the rise and we could see that start to affect trader sentiment. This market needs more buyers to fill in behind the last buyers (the greater fool theory) and with a market that is priced high and to perfection, it can't tolerate worry.

For the past week or more we've had a fractured market, especially between the Dow and all others. The tech indexes and the RUT have been struggling more to hold onto this month's gains and SPX is showing weakness. A fractured market is typically a warning sign that the trend (up in this case) is coming to an end. The money running into the Dow could be a defensive move, especially out of the higher-beta stocks like the techs and small caps. SPX could be our "tweener" as it splits the difference between the bluest of the blue chips and the riskier stocks. I'll start tonight's review of the indexes with the SPX

S&P 500, SPX, Weekly chart

The parallel up-channel for the rally from 2010-2011 is shown in bold green (lighter green for the top of the channel). The dashed green line is the mid-line of the up-channel and it has been acting as resistance since the recovery off the January 2016 low. This is typical price behavior for the 5th wave of a channel and it's been a matter of trying to figure out where the 5th wave will likely finish since it will be the completion of the rally from 2009.

For the past several months I've been thinking SPX could make it up to the 2475-2516 area for a final high. There were many times it was looking vulnerable to a breakdown before that target zone but here we now are at the lower end of the zone (last Thursday's high was 2484). The bulls would love to see a breakout above 2516 (where the 5th wave of the rally from 2009 would equal the 1st wave) since it would negate the bearish divergence and suggest a blow-off top (melt-up) is in progress.

The 5th wave of the rally from January 2016 is the leg up from March and it's showing bearish divergence against the March 1st high, which helps confirm the wave count. The pieces are in place to call a top at any time but there's no evidence yet that a top is in place. A drop below the June 29th low near 2505 would be the first warning sign for the bulls to pay attention to. In the meantime the bears need to stay aware of the uptrend still intact and higher potential.

S&P 500, SPX, Daily chart

Zooming in the leg up from March I'm showing the potential for a rally at least to about 2507, where the move up from May 18th would achieve two equal legs up, but I'm not feeling confident about that potential. Last Thursday's sharp decline has been followed by a choppy bounce correction and that suggests lower prices dead ahead. That expectation can only be negated with a rally to a new high above 2484. A drop below last Thursday's low near 2460 would keep SPX on a sell signal.

Key Levels for SPX:
- bullish above 2484
- bearish below 2440

S&P 500, SPX, 60-min chart

It's possible last Thursday's sharp spike down was the completion of a pullback correction off the July 20th high and we'll see SPX chop its way higher to the 2500 area in the next week or two. But if we're in the beginning of a more significant pullback/decline we should see stronger selling kick in tomorrow. Perhaps new-month money will push SPX a little higher, especially if the Dow manages to continue climbing, but I see more downside risk than upside potential from here.

Dow Industrials, INDU, Daily chart

The Dow has clearly been the outperformer for the past week and it's hard to tell if that's bullish or simply a sign that money is rotating out of the riskier stocks and into the relative safety of the bluest of the blue chips. Funds that need to stay invested will find it much safer to be in more liquid stocks when the time comes to sell.

The Dow rang the bell today at 21888, where the 5th wave of the rally from April equals the 1st wave. It also hit the trend line along the highs from April 26 - June 19, which fits as the top of a rising wedge for the rally from April. The late-day selling brought the Dow back down to the trend line and left a shooting star at resistance. A red candle on Tuesday would leave a sell signal following the little throw-over above the top of the wedge, which would only be negated with a rally to a new all-time high. Keep in mind that wedges tend to be retraced much faster than the time it took to build them. If the bulls can hold on here we could see the Dow make it up to at least 22025 where it would run into the top of a small parallel up-channel for the leg up from June 29th. Tuesday should provide the answer as to which direction the Dow (and likely the rest of the market) will likely head this week and next.

Key Levels for DOW:
- bullish above 21,900
- bearish below 21,496

Nasdaq-100, NDX, Daily chart

NDX looks like SPX -- the sharp decline last Thursday has been followed by a choppy bounce correction and that keeps things looking more bearish than bullish. This morning's gap up was followed by immediate selling and the morning low was then followed by a sideways consolidation. Again, more bearish than bullish and it's looking like we should expect a continuation lower, in which case the selling should become stronger. The question for Tuesday, as with the others, is whether or not new-month money coming into the market will hold things up for at least a day.

Key Levels for NDX:
- bullish above 6025
- bearish below 5780

Russell-2000, RUT, Weekly chart

Forgetting about the daily squiggles, even those squiggles have resulted in the RUT being down 4 days in a row, the big picture of the RUT is what should be scaring bulls into submission. The big megaphone topping pattern and the rising wedge from March into the top of the pattern looks like a very dangerous time to be long at least this index. If it can bust a move to the upside, with a sustained break above 1452 I'd give up my bearish opinion.

But if the RUT breaks its uptrend line from February-November 2016, currently near 1417, and then its July 6th low near 1399 we'd have a confirmed high in place. A breakdown would likely be followed by strong selling in this index, along with the techs, and it would likely catch more than a few complacent bulls asleep at the sell button.

Key Weekly Levels for RUT:
- bullish above 1452
- bearish below 1398

Transportation Index, TRAN, Daily chart

The TRAN has been consolidating since last Thursday when it landed on its uptrend line from June 2016 - May 2017. The consolidation is what was expected if we have a bearish turn down from the July 14th high. A more significant sell signal would come from a break of the 200-dma, now near 9111 since that would also be a confirmed break of the uptrend line as well. Note the bounce off the 200-dma on May 18th. The TRAN needs to get back above price-level S/R near 9490 in order to turn the pattern back to bullish.

Relative Strength of TRAN vs INDU, Daily chart

It's instructive to look at the relative strength (RS) of the TRAN vs. the Dow since so many look to their relationship to help determine the health of a bull market and to warn of possible trouble. The TRAN outperformed the Dow into December 2016 but has been underperforming the Dow since then. The "rally" in the TRAN's RS from May into early July was a 50% retracement (to the 1/10th of a penny) of the December-May decline and that's been followed by a strong decline since the peak on July 10th.

Note the 5-wave decline from December into May and the 3-wave bounce correction, both of which point to continuation lower in the RS of the TRAN. The July decline is likely only the beginning of the TRAN's further weakening in its RS compared to the Dow. The significance of this is that the TRAN is forecasting further weakness in the economy, something that hasn't been reflected yet in the broader averages. I think this is an important message from the market that most traders are not paying attention to.

One thing to keep in mind about this RS relationship is that it tends to reverse following stock market peaks. It's usually not because the TRAN starts rallying but instead because the Dow falls faster. In others words the weakness in the TRAN foretells what's coming and then when the Dow starts to fall it falls harder than the TRAN (as it "catches up" with the TRAN).

U.S. Dollar contract, DX, Daily chart

The US$ has now made it down to the bottom of a down-channel for the portion of its decline from May. This follows the breakdown below the bottom of the down-channel for the initial portion of the decline from its January peak. With today's close below price-level support near 93 it could certainly break below the bottom of the steeper down-channel, in which case it will head for possible support at the trend line along the lows from February 2015, currently near 90.35.

If the waterfall appearance of the dollar's decline from January continues with a break below 90 it could turn into a very nasty and scary selloff in the dollar, one which would likely shock the world (and hurt the buying power of all those emerging countries that tie their currencies to the U.S. dollar).

Could a crash in the dollar be the thing that breaks the back of the stock market rally? It's too early to speculate about that, especially since we could see the dollar get a bounce off support here. What kind of bounce follows, if it bounces, would tell us more about whether or not to expect lower prices for the dollar.

Gold continuous contract, GC, Daily chart

The dollar has declined nearly -11% since January and while gold's path has been more erratic, it's up nearly +11%. Whether or not the dollar finds support near 93, lower near 90, or not until much further below, will help determine whether or not gold can make a bullish breakout from here. Today gold broke back above its broken uptrend line from December-May, currently near 1270, so bulls want to see that level hold on any pullback.

The stronger line of resistance is the downtrend line from September 2011 - July 2016, now near 1282. Gold is now overbought so it might not make it through this time but obviously it would be bullish above 1282, especially if it holds the downtrend line as support on a back-test.

Oil continuous contract, CL, Daily chart

Last Friday oil jumped above both its downtrend line from April-May and its broken 200-dma, both at 49.40. Today it added to those gains and popped above its broken uptrend line from April-November 2016 but pulled back slightly to close on the line near 50.20. If it pulls back and holds support at its broken downtrend line from April it will stay bullish. Otherwise a back-test of its broken uptrend line followed by a drop back below its 200-dma and the downtrend line would leave a failed breakout attempt.

Economic reports

It's going to be a busy week for economic reports, which will be capped off with the NFP report on Friday. The ADP employment report has not been providing a very good view of what to expect from the NFP report but at the moment they're both close with 190K-200K estimates. Tuesday morning we'll get personal income and spending, PCE Prices (a Fed-favored inflation gauge), Construction Spending and ISM but none of them are expected to show much of a change from May. We'll then get the auto and truck sales reports tomorrow afternoon. Auto sales are starting to drag as buyers deal with maxed out credit cards and higher default rates on existing auto loans, which is causing banks to tighten lending standards a little more.


We have a few indexes suggesting the rally from November has completed, which means the rally from 2009 could be finished. It's obviously too early to make a call for either one but the wave count for the rally suggests now is not a time to be aggressively chasing this market higher, or even aggressively buying pullbacks. If the top is in, even for the Dow, the next big move will be at least a multi-month pullback correction before possibly heading higher. The more bearish potential is that the bull market that started in 2009 is now complete.

There are a lot of reasons to believe the current bull market has much further to run, especially since there appears to be a lot of money coming into our market. Liquidity is the driver and right now we seem to have plenty of it. But complacency is running high while volatility is at an historical low and that's not a good combination. As I quoted Howard Marks at the beginning of this report, "'s precisely when people can't see what it is that could make things turn down that risk is highest...".

There is no fear and the number of investors who fear a stock market decline is at its lowest level since 1987. We have reasons to be worried to the point of being careful. Employing some downside protection (puts, short hedges, inverse funds) might limit your upside potential but it's the downside risk that you should now be protecting against.

Good luck and I'll be back with you a week from Wednesday.

Keene H. Little, CMT