We've had a choppy pattern for this week's rally/bounce, which has the appearance of an attempt to hold the market up this week. But the larger price pattern supports new highs and it's still a good time to stick with the trend until the market tells us otherwise.

Today's Market Stats

The RUT has had a strong week but the others have not been able to put in the same performance. The energy and banking stocks have helped lift the small caps and there's probably been an effort to swing some money into these more volatile stocks this week to help improve the "performance" of funds as they get ready to close the books on September and the 3rd quarter. We'll have to see if there will be any unwinding of this effort next week. But even we get a decent pullback next week it's not looking like the market has seen its highs yet. Bears need to stay in their caves for at least a little longer.

This morning the market started with a gap down but that was just another dip-buying opportunity for all the dipsters out there. Between those who just looking for any dip to buy and those fund managers wanting to prevent any kind of selling this week, the bears have had nothing to do all month. The modest pullback (-3% for SPX) in August and the -1.4% pullback on September 5th are all the bears have had to play with. The rest of the time it's been better to simply stay long and add to positions with every pullback, as small as they have been. At some point that will stop working but ride it while you can.

As I'll get into with the charts, there is the possibility for a brief spike down early next week but it should be another good buying opportunity but perhaps only for one more leg up to complete the rally. Calling tops in this market has been an exercise in frustration (not that that will stop me, wink) and I'm not about to call one here. However, I'm seeing enough signs to tell me not to get complacent about the upside while not shorting it either. Building up a cash position is a good idea as we head into October. I believe this October, like previous ones in years ending in 7, will be a bull killer and not the bear killer that is October's reputation. There are no bears to kill here.

When trying to decipher the market, the king of all indicators is of course price. All else doesn't matter but it doesn't mean we shouldn't be looking for signs that prices are stretched. One indication of the strength of a market's move is market breadth, for which there are many components.

One market breadth indicator that has worked out well in the past, as far as indicating when the bulls should start to worry, is the cumulative advance-decline line. When it starts to show negative divergence with price (the a-d line makes a lower high while price makes a higher high) we should start to worry about the rally being on its last legs and to button up stops. At the moment there is no negative divergence and this has kept up the chatter about why bulls don't need to worry about this rally.

The cumulative a-d line for SPX has been shown before and shows a tight correlation with SPX over the past 5 years. As I noted on the chart, it's practically a 1:1 correlation and as correlations go, it doesn't get much better than this. But it's looking more like a coincident indicator and that's not terribly helpful. As I'll show further below, there are some things that tell us we might need to look elsewhere for clues now that some fundamental things have changed in the market.

Correlation between SPX Cumulative Advance-Decline line and SPX

Trading volume is one indicator of the strength behind a market move. We've often heard volume can be supportive of a move, up or down, and when volume is waning it means the move is losing its support. It's common for tops to be formed simply because most buyers are already in the pool and waiting for others to continue the buying so that prices keep heading higher.

Many look for a catalyst to start the selling but oftentimes it occurs simply because sellers start to overwhelm buyers (and it's the reason many market tops are rounding affairs, as opposed to v-bottoms). As I'll point out later on the SPX weekly chart, we're seeing bearish divergence at the new price highs since March and we're seeing a similar divergence in volume, which has been slowing since the rally off the February 2016 low began, as can be seen on the NYSE chart below.

In last week's market wrap I had shown a chart of corporate buybacks vs. SPX and pointed out the slowdown in buybacks since mid-2016 and this slowdown could be part of reason for the overall slowdown in volume. But whatever the reason, the declining volume is an indication the rally could run out of gas soon.

At the moment the slowing volume is just another indication that the rally is long in the tooth but not necessarily ending. However, the slowing volume in a rising wedge pattern is a reason to be cautious about the upside (rising wedges break down fast when they break).

NYSE and its trading volume

There's another problem with the current market, which could be related to the declining volume seen above. The chart below compares the equal weighted SPX index with the "normal" cap-weighted SPX index that we normally watch. Currently there's a large divergence between the two, which is larger than anything seen in the past decade. This tells us the rally has been on the backs of the large caps while the smaller stocks are participating less.

This is more evidence of the shift to passive investing (buying ETFs like SPY) vs. active investing and the consequence is that when the selling starts in the ETFs there is going to be a much larger decline in the indexes than might otherwise have occurred. The ETFs will simply go begging for buyers and selling the ETFs will mean selling all the stocks in those ETFs, regardless of the quality of some individual stocks. It's the reverse of what's happening now with a lack of price discovery. All stocks in the ETF, regardless of whether or not they're worth buying, get bought together. When the selling starts we'll see the baby getting thrown out with the bath water.

S&P 500 Equal-Weighted index vs. S&P 500 Cap-Weighted index

Getting back to the cumulative advance-decline line (the 2nd chart above), it is probably not as useful a breadth indicator that it once was. Many are calling for the market to continue rallying and that we shouldn't worry about a top because the a-d line is so strong. As Bill Fleckenstein mentioned recently, we are in a different kind of trading environment, which he described with the following formula and statement: "QE + ETFs + algos = new era, until it isn't. Then chaos."

Backing up Fleckenstein's formula, Doug Kass, a big name in hedge fund management, recently said "Be alert, consider the contrary and think about sitting out some of the market's dances, perhaps before your legs are chopped off." His concern about the market comes from the fact that he thinks too many are looking at the market the same way, or as he calls it, "group stink." As he says, "Group stink is a powerful force in the markets, especially when the machines and algorithms and the ever-constant inflows into popular passive funds and ETFs dominate the investment backdrop."

In Kass's opinion there is too much group stink right now and there's a near-universal view that stocks will just keep heading higher from here and that any dip is just another opportunity to buy more. We all know what happens in group stink situations where everyone runs over to one side of the boat.

Don't be caught with the crowd too long

OK, warnings out of the way, I [group] stink we'll see higher prices in the coming week(s) but I also believe this market is dangerously close to a major high. I say dangerous because part of the group stink is that we should all sit tight and not let a market decline shake us out of our positions. But by the time these same people recognize there's a problem you will have already lost at least 20% of your portfolio value and you're not going to get it back for a long time. Why live through a large decline when you can get into cash and be a buyer at lower prices? Hence the reason to raise cash levels. IMHO, the upside potential is dwarfed by downside risk.

S&P 500, SPX, Weekly chart

SPX, like the NYSE shown above (with the volume discussion), is wedging up tighter into the tip of its rising wedge for the rally from January 2016. At the same time it's showing bearish divergence on the momo oscillators since March, which fits well with the 5th wave of the rally. Yesterday's high near 2512 is only 4 points away from the 2516 projection for the 5th wave (the rally from January 2016), where it would equal the 1st wave of the rally.

If the rally can make it a little higher than 2516 it would run into the top of its rising wedge and the midline of the up-channel for the rally from 2010-2011, both near 2550 in another two weeks. It takes a drop below the August 21st low near 2417 to tell us a top is in place but an early warning would be a drop below the uptrend line from February 2016, currently near 2473.

S&P 500, SPX, Daily chart

If SPX stair-steps higher in the coming week, as depicted in bold green on the daily chart, we could see the rally finish near 2525, which is where it would run into the trend line along the highs from March-May. The shorter-term pattern, which is shown more clearly on the 30-min chart further below, suggests we could see a sharp pullback into early next week and then the resumption of the rally. Only a sharp break below the uptrend line from February-November 2016 (the bottom of the rising wedge on the weekly chart) would convince me that we've seen the top. So the bears need to see SPX below 2480 before turning aggressive.

Key Levels for SPX:
- bullish above 2516
- bearish below 2480

S&P 500, SPX, 30-min chart

Because the pattern for this week's bounce off Monday's low is so choppy it's either an ending pattern to the upside or part of what will become a larger 3-wave pullback from September 20th. A sharp pullback that stays above the uptrend line from February-November 2016 would be a buying opportunity since it should lead to another (and final) high in October. Regardless of how this rally finishes (stair-step higher like that shown on the daily chart above or a sharp decline and then back up), it's looking like we could be setting up once again for an October surprise in the year ending in 7.

Dow Industrials, INDU, Daily chart

Since Monday, when the Dow dropped back below its uptrend line from November 2016 - May 2017, it has been banging its head on the trend line with its bounce attempts but it hasn't been able to climb back above the line, which will be near 22420 on Friday. Like SPX, I show the potential for the Dow to stair-step higher into next week to complete its rally. But because of the choppy bounce pattern this week we could instead get a sharp pullback into Monday/Tuesday and then another rally leg. In either case it's looking like we should expect higher prices before a top looks more likely.

Key Levels for DOW:
- stay bullish above 22,179
- bearish below 22,038

Nasdaq-100, NDX, Daily chart

The techs have been weaker than the other indexes, largely thanks to the FAANG stocks. These few stocks led the tech indexes higher when they were rallying but now they've been a drag as they lose their momentum to the upside. As an example, last week I showed the H&S topping pattern for AMZN. Its neckline is near 938.60 and it was tested on Monday and Tuesday. It predictably bounced off that neckline support but any further decline below Tuesday's low at 931.75 would suggest the H&S pattern will play out (which points down to 785 for an objective).

AAPL's weekly chart showed the start of a break of its uptrend line from November 2016 (the bottom of its up-channel), currently near 159, and it indeed broke with last week's close at 151.89. It could bounce back up for a back-test of the bottom of the up-channel but at the moment it's looking like it could simply continue lower from here. This is not a stock I'd be looking to buy until it reaches its 50-week MA, currently near 138. That should be good for a bounce but with the longer-term pattern looking like a major top is in place I think there will be better places to invest. AAPL is done (imho).

FB is bouncing back up to its broken 50-dma, which it broke on Monday, currently near 169.55 (today's high was 169.07) and we'll have to see if it can recover. Otherwise a back-test followed by a bearish kiss goodbye would suggest the top for FB is in place.

Last week NFLX tested its July high and Monday's strong decline leaves a double top with bearish divergence. GOOGL looks like it could press higher. So 4 out of 5 of the FAANG stocks look like they're in trouble (not confirmed yet but looking like a failure waiting to happen). The tech indexes are strongly dependent on these 5 stocks so they bear watching closely.

As for NDX, it looks like it could be in the final leg of a shallow rising wedge. The choppy pattern and the Fib projections for the legs of the wedge fit and the expectation from this pattern is that NDX will finish near 6025 next week. If the bulls can rally NDX above 6050 it would point higher to the trend line along the highs from November 2014, near 6150 in the 2nd week of October. In this case I would expect to see a strong recovery in the FAANG stocks. With the choppy price structure it's hard to tell what kind of larger pattern is playing out but what I've depicted on the NDX chart (a little more upside and then a selloff) is my best guess at the moment. I reserve the right to change my mind when the market tells me to. ;-)

Key Levels for NDX:
- bullish above 6050
- bearish below 5839

Russell-2000, RUT, Daily chart

The RUT has had a strong rally from its August 18th low and it got a strong pop once it cleared resistance at its trend line along the highs from 2007-2015. Today it added marginally to the rally but short term it's looking ready for a pullback. At this point I'm looking only for a pullback before heading higher again. I show strong upside potential to about 1525 by October opex 9the 20th). That is of course just speculation at the moment but I think it's important to see the upside potential so that you know what kind of risk:reward you have when evaluating a trade. Only after a pullback (assuming we'll get one, unless they've been outlawed) will we start to get some upside targets for the final leg (5th wave) of the rally.

Key Levels for RUT:
- bullish above 1458, cautious below 1452
- bearish below 1414

10-year Yield, TNX, Weekly chart

With what looks like a bull flag pattern for the pullback from December, TNX could soon break out if it makes it a little higher. Today's high at 2.34 was a test of the top of the down-channel and if it breaks above July 2016 high near 2.4 it would be a bullish move. There's still the downtrend line from 1988-2007 it would have to deal with later, near 2.47, but breaking out of the bull flag pattern would likely be an indication we'll get another leg up at least equal to the July-December 2016 rally, which points to 3.32%. Otherwise a turn back down from here and a drop below the September 7th low near 2.03 would likely lead to a strong decline.

U.S. Dollar contract, DX, Daily chart

The US$ has broken out of its down-channel from May and is now back above its 20- and 50-dma's. It's looking like smooth sailing to higher prices, maybe. The dollar is currently back-testing both price-level S/R, near 93.30, and the bottom of its previous down-channel from January (from which it broke down in July), currently near 93.15. It's possible that's all we'll see for this bounce and now down to the $90 area before setting up a stronger rally. But if the dollar rallies a little further and breaks above 94 it would strengthen the dollar bull's case that it's ready now for a stronger rally.

Gold continuous contract, GC, Daily chart

Gold lost price-level support this week at 1300, as well as dropping back below its 50-dma, currently climbing up toward the 1300 level. Gold bulls would look to be in better shape back above 1300 and especially if it can get back above Tuesday's bounce high at 1317. Otherwise it's looking like gold should head lower and the next downside target would be a test of its broken downtrend line from 2011-2016, near 1267.

Oil continuous contract, CL, Daily chart

Oil tried to climb above its downtrend line from 2015-2017 and its broken uptrend line from 2016, both of which crossed on Wednesday near 51.90. If that was the top, which is the setup here (but not confirmed), we'll see oil head back down and drop below its June low at 42.05. The first thing oil bears need to do is get oil back below the September 6th high at 49.42 to leave a confirmed 3-wave bounce up from the August 31st low. If the oil bulls prevail here we should see at least a test of the January-February highs near 55.

Economic reports

This morning's reports were not market movers, especially since there were no surprises. The 3rd estimate for GDP came in at the expected 3%. Friday morning's reports include personal income and spending, with a slight drop expected for both. We'll also get PCE prices, watched closely by the Fed, and they're expected to show a little higher inflation than we've been seeing. Chicago PMI and Michigan Sentiment after the open should not be market movers.


There are enough differences between the price patterns of the major indexes to keep us guessing who's in charge. Clearly the RUT is in charge to the upside since its August 18th low but it's a volatile index and who knows how long this will last. There was a lot of wringing of hands and gnashing of teeth when the RUT was in its strong decline into the August low. Now everyone has turned bullish with the small caps rallying hard. If oil turns back down and takes the oil stocks with it we could see a rapid reversal in the RUT. But right now the RUT is our leader to the upside.

The techs have been hurt recently by the selling in the FAANG stocks and as discussed above, 4 out of the 5 FAANG stocks look vulnerable to stronger selling. A strong RUT and weak tech indexes leaves us guessing which way the wind will blow next. In the middle we have the blue chips and the choppy move up this week does not look bullish. If they continue to chop their way higher it will be a sign of an ending pattern to the upside. But a top does not look to be in place yet and if we get a sharp pullback into early next week I think it will lead to another, and likely final, leg up to a new high. The same can be said for the RUT.

As it looks now, which is obviously subject to change as the price pattern dictates, we should see the market make final highs in October. I think we're looking at a strong possibility for this October to be a bull killer, opposite to its normal bear-killer status. Octobers in years ending in 7, for whatever reason, have been times for bulls to lay in their stops and get out of the way of a coming decline. Otherwise there will be much more pain than most are thinking likely right now. Don't be a complacent bull. And if you're a bear I think you'll need to stay in your cave a little longer until the coast is clear.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT