We all know President Trump likes to be boastful and plays a hard negotiation game. Doing both with North Korean's Kim Jong Un is a game fraught with danger and uncertainty, which of course the market dislikes. It's the excuse du jour for some profit taking and now the question is how much profit taking we'll see.
Today's Market Stats
Starting with Tuesday's comments by President Trump about treating North Korea to "fire and fury," which is similar to the "shock and awe" threats made before attacking Irag, the stock market has reacted negatively to the idea that we could get into a more significant pissing match. Threats of war with a lunatic at the helm (not Trump but Kim Jong Un, wink) is unsettling to the market, especially one with big profits to protect as we enter a typically weak period (August-September). It's that uncertainty factor that the market must now deal with.
Following Tuesday's sharp reversal, which created an outside down day for many indexes and key reversals, equity futures continued to sell off Tuesday night and into Wednesday morning. A gap down started the day but the dipsters are still out there and looking for good deals. While the bounce off this morning's low was weak, it nevertheless stopped a more significant selloff. SPX even managed to get back within a point of closing in the green (after being down -13 in the morning).
Obviously it would be bullish if the bounce off this morning's low get some follow-through buying on Thursday but at the moment it's looking more like a bounce correction. The bounce could get a little higher pop up Thursday morning but the bearish interpretation of the pattern off Tuesday's high suggests shorting the bounce will be the better trade. I'll show the setup on the charts below.
Most analysts recognized the Dow had become significantly overbought, especially after the rally from the small pullback into the July 24th low. That rally produced positive gains for 11 days and new all-time highs for 10 of those 11 days. Monday's positive close had been the 15th one out of the previous 20 days (starting from July 10th), which is another sign of overbought and using the indicator shown below, it pointed to potential exhaustion for the move.
The chart below is from a trading buddy (hat tip to Mark Ungewitter) that shows the Dow in the upper portion of the chart and the number of "up closes out of the past 20 days" at the bottom of the chart. The red dots placed on the Dow's line shows each time the Dow exceeded 14 up closes in the previous 20 days. This indicator doesn't flag every top but it does a decent job of it so Monday's achievement of 15 days was a warning sign and Tuesday's sharp intraday reversal was a sign that a top of some kind was likely in place.
DJIA up closes in previous 20 days, chart courtesy Charter-Trust-Company
Another sign of potential trouble for the market comes from Stan Harley at HarleyMarketLetter, who does very nice cyclical work. He recently shared the chart below, which shows a coincidence of the 93-day and 112-day cycles showing up around August 8th (+/- 4 days). Cycles point to potential turns in the market, not the direction of the turn. The trend into the turn tells you the direction of the turn, if it's to happen, and that means we should be on the lookout for a turn back down.
, chart courtesy harleymarketletter.com
Another reason to expect a possible top for the market, at least for a little longer than a day, comes from Tom McClellan and is shown with his chart below. It shows the difference between the bulls and bears according to the Investors Intelligence report. McClellan then plots that number and places a 50-dma band around it. As he notes on the chart, when the indicator pops out the top of the 1-standard deviation band and then drops back inside the band it tends to offer a good topping signal.
The reasoning behind this warning is that once investors start to become less bullish the market loses the buying power it needs to continue to push the indexes higher (the greater fool theory runs out of greater fools). Selling then begets more selling and the market experiences at least a larger pullback. That's where we are currently according to this chart, or at least that's the bearish potential.
When we combine the message from the three charts above it's hard to be a dipster here. I think it will probably be better to sell bounces for what is likely to be at least a larger pullback before heading higher. The more bearish interpretation of the larger rally pattern is that we have put in a significant high, one which could stand for years to come.
It is this bearish interpretation, which needs a lot more price action to verify/negate, that has me recommending investors play defense and protect profits. If the larger pullback, assuming one's coming, then looks like a correction instead of something more bearish, it would then offer a better buying opportunity than we have here. If you don't want to sell for tax reasons then at least hedge your positions with some shorts and/or puts. Think of it as insurance that hopefully you won't need (like car, house, life insurance).
The RUT has done a good job warning us that the market was likely much closer to a top than most wanted to believe, having topped out July 25th. The shape of the pattern for its decline suggests we should get a stronger decline and I'll therefore kick off tonight's chart review with a top-down look at the RUT to highlight some downside targets to watch for (and where the bulls would likely be back in control).
Russell-2000, RUT, Weekly chart
Since early December 2016 we've been watching the RUT trade up against its trend line along the highs from 2007-2014-2015 but not be able to punch up through it. After repeated attempts every month since February and a small pop above the line on July 25th (for a stop run), the RUT reversed and has now given up about -4% from its high. That doesn't sound like much but when compared to the other indexes, it's a monster decline (wink).
The RUT is currently testing price-level support near 1396 and looks ready for at least a small bounce but I'm not seeing enough in the shorter-term charts to suggest anything more than just a relatively small bounce correction before heading lower. I think better support will be down near 1296 by the end of the month.
Russell-2000, RUT, Daily chart
The RUT's daily chart depicts a bearish pattern for its decline this month but obviously it's just a guess until we see more price action. I'm showing an expectation for a sharp 5-wave decline and for that pattern we're in just the start of the 3rd wave down. This pattern suggests a strong decline back down to the May 18th low at 1351 before the next decent consolidation/bounce and then lower into the end of the month. The first sign of trouble for the bears would be a rally back above Tuesday's high at 1426, which is price-level S/R.
Key Levels for RUT:
- bullish above 1426
- bearish below 1402
Russell-2000, RUT, 60-min chart
The best wave count for the RUT's decline is a 1st wave down into the August 3rd low (it could be wave-a instead of a 1st wave) and then a 2nd wave (or wave-b) bounce correction into Tuesday's high. That puts us into the strongest part of a move -- the 3rd or c-wave and following an expected bounce correction on Thursday we should see the selling accelerate into the meat of the 3rd wave down. Anything less than very strong selling in the coming days would be a clue that something less bearish, and potentially bullish, is playing out.
S&P 500, SPX, Daily chart
SPX has been in a choppy sideways trading range since July 20th. The high-to-low of that range is about 2491 to 2460 and today's low at 2462 remains inside that range. Today's bounce got SPX back above its 20-dma, currently near 2473, which held yesterday's decline as well. Bulls obviously want to see SPX remain above this intermediate moving average since a break of it would have fund managers thinking about profit protection.
It's possible this morning's low completed a consolidation pattern off the July 20th low and an impulsive rally back up would tell us new highs are coming. At the moment we have a 3-wave bounce correction off this morning's low, shown more clearly further below on the 60-min chart, so we should find out quickly Thursday morning whether or not the bulls are going to grab the reins back.
Key Levels for SPX:
- bullish above 2491
- bearish below 2448
S&P 500, SPX, 60-min chart
It's all short-term stuff but the leg down from Tuesday's high is an impulsive 5-wave decline. That's either the completion of a sideways consolidation that it's been in since July 20th or it's the 1st wave of what will become a larger decline. What follows will tell us which it is.
The bounce off this morning's low is a 3-wave move at the moment and two equal legs up points to 2476.05, which is practically on top of the 50% retracement of the decline from Tuesday, at 2476.47. A little pop up Thursday morning would achieve this level and it would also result in a back-test of the short-term uptrend line from July 27th.
For these reasons it's going to be tough resistance near 2476 and worthy of a shorting opportunity. By the same token it would be more bullish above 2477, especially if it stays above 2477 and the bounce turns into an impulsive rally. That would be the signal for the bears to go back into their caves and wait until they're called for supper.
Dow Industrials, INDU, Daily chart
Other than the key reversal on Tuesday, which created a shooting star for the Dow, it doesn't look particularly bearish. The Dow hasn't even made it back down to the broken trend line along the highs from April-June, currently near 21980. Watch for a possible back-test of the trend line and a bullish kiss goodbye to follow. Below 21980, especially if it stays below that level, would look more bearish. It takes a drop below 21770 to prove a significant top is likely in place.
Key Levels for DOW:
- bullish above 22,200
- bearish below 21,770
Nasdaq-100, NDX, Daily chart
The pattern for NDX looks similar to SPX with the sideways consolidation following the spike down on July 27th. This looks like a bearish continuation pattern but that's of course no guarantee. The expectation is for at least another leg down to match the size of the July 27th decline but that expectation would be at least questionable if it rallies above Tuesday's high near 5973.
Key Levels for NDX:
- bullish above 5973
- bearish below 5800
Transportation Index, TRAN, Daily chart
The TRAN was another index providing fair warning to bulls about the health of the stock market rally. Following its high on July 14th it dropped sharply to its uptrend line from June 2016 - May 2017, currently at today's low near 9180 (arithmetic price scale). If the bounce off this support line continues to say below price-level S/R near 9310 it will stay bearish.
Another drop lower would give us an impulsive 5-wave decline from the July 14th high. That would then suggest an important double (triple?) top was made following the December 2016 high. But back above 9310 would start to have things looking a tad more bullish, at least for a larger bounce pattern.
U.S. Dollar contract, DX, Daily chart
Last week the US$ dipped slightly below price-level support near 93 and found support at the bottom of a narrow down-channel for price since May. It has bounced back up to its broken 20-dma, currently near 93.70, tagging it yesterday and today but has been unable to climb back above it.
At the moment it's tough to tell whether the dollar will get a bigger bounce but keep an eye on the bottom of the wider down-channel from January, the bottom of which was broken on July 18th and is currently near 94.10. Since the bottom of a broken down-channel like this should act as resistance if back-tested it will be important to see how the dollar behaves there (if tested). I see the potential for a sideways consolidation over to the bottom of the broken down-channel and the top of the narrow down-channel, near 93.80, in about two weeks before heading lower to stronger support near 90.
Gold continuous contract, GC, Daily chart
Gold is threatening to final break free of its downtrend line from September 2011 - July 2016, currently near 1280. At the same time it's recovering back above its broken uptrend line from December-May, now also near 1280. A continuation of its rally above 1281 would be bullish whereas another failure from this level could ignite stronger selling. The next few days should answer the question for both sides of the argument.
Oil continuous contract, CL, Daily chart
Oil's consolidation following the high on August 1st looks like a bullish continuation pattern, which suggests we'll get another leg up for its rally from June. Based on a couple of price projections from its wave pattern and the downtrend line from May 2015 - January 2017 I think we'll see a rally to about 52.50 (depicted in bold green). From there we'd have to wait to see whether price consolidates or starts an impulsive move back down
Thursday morning's economic reports include PPI and unemployment claims. The PPI data is expected to show some inflation growth from June to July, which would keep the Fed on track to raise rates in September but if there's no increase in inflation there could be another pause by the Fed. How the market would react to such a thought is anyone's guess.
The reversal off Tuesday's high has the makings of something more bearish but it's obviously we don't have much price action to help verify that. As was obvious following this morning's gap down, the dipsters are still active (never let a good little pullback go ignored). But we'll have a better idea after Thursday when we'll get to see whether or not the bounce off this morning's low turns into something more bullish or just a correction to the decline.
If today's bounce is to be just a correction, which is the way I'm leaning, we should not see much higher for the bounce before it turns back down into stronger selling. The bearish pattern calls for a sharp decline into next week, which means we'll have a good risk:reward setup for a short trade Thursday morning (if the bounce rolls over, which for SPX should be from about 2476).
If today's bounce develops some legs and keeps going for most of Thursday we'd then have a bullish signal that new highs are probably coming. Trading Thursday's direction should provide a good trade for the next several days at least. But in the land of chop, trade carefully and with discipline.
Good luck and I'll be back with you next Wednesday.
Keene H. Little, CMT