All of the indexes have been struggling the past week+ with some chopping their way slowly higher while others chop sideways or down. The market has been looking tired and while some indexes did not enjoy IBM's rally today it helped the Dow break through some tough resistance. Now all the bulls need is some follow through.
Today's Market Stats
Following last night's earnings report IBM blasted higher in the after-hours session. There was no give-back this morning and the shorts couldn't cover fast enough. The rally continued into this afternoon and only gave back a little at the end of the day. It was up +10% (+14.69) before closing +8.9% (+12.99). That gave the Dow a big boost and launched it up and over some strong resistance and now all the bulls need to do is hold today's gains, or at least not let it backtrack too much before continuing higher. The other indexes however, were more reserved and still suggest caution about the upside.
Other than the Dow, we had the same kind of start to the day that we've been seeing repeatedly -- start with a gap up, immediately sell into and then work the indexes back up into the afternoon and then sell into it again, which has it looking like a distribution pattern playing out. This can continue for as long as big money wants to distribute inventory and retail traders want to buy. The net result has been a lot of choppy price action with some indexes, like SPX, slowly working their way higher in a small rising wedge (the Dow broke out of its rising wedge pattern today and needs to hold above it).
The RUT has been a little different from the others with a choppy pullback over the past 2 weeks but the pattern looks like a potential bull flag consolidation pattern. The net result of all this choppy price action is that we traders need to wait for confirmation of the direction it's going to break out. The Dow could be our leading index and if the others follow in the next day or two we could be looking at the start of the next rally leg. But the risk of a downturn is high and it's reasonable to remain cautious about the upside.
There was no reaction to this morning's pre-market economic reports, which included housing starts and building permits, both of which declined slightly in September. As we move into fall and then winter it's typical to see a slowdown in building and sales so a little slowdown is to be expected, although the slowdown in September was a little more than had been expected and housing starts are now at a 1-year low.
This afternoon's Fed's Beige report basically said the economy is blah (my term, not theirs). The pace of growth for the economy is "split between modest and moderate," whatever that's supposed to mean. I guess it simply means it's not robust, hence blah. The Fed is confused as to why a stable economy and a tight labor market (in their view) hasn't led to more inflation. They still expect higher inflation but can't find any evidence of it yet.
Unfortunately the Fed's economic models don't reflect the fact that our economy is not nearly as strong as they think it is. There has been a fundamental change with all the money thrown at it but a significant lack of use of that money (except for asset appreciation like houses and stock prices).
The Fed believes the recent hurricanes put a damper on economic growth but that it's temporary and they're likely to continue with their plan to raise rates again in December. Essentially there was nothing in the Beige book that wasn't already known. The market sold off slightly following the report but nothing significant.
With the anniversary of the October 19, 1987 Black Monday, which had followed a steep decline the previous days, there's been a lot of talk about the vulnerability of the current market vs. back then. It could be just talk around the 30-year anniversary but there are some smart market observers, who were in the market back then, who are issuing warnings that today is looking eerily similar to what the market was like then. As I'll show further below, even though the Dow was very bullish today, there are reasons to be cautious about the upside.
A strong reason to be cautious, both in the long term and the short term, is that the market is stretched to the upside. Current market valuations suggest the return over the next 10 years is likely to be dismal. Therefore it doesn't make a lot of sense to commit large sums of money to a stock market that is over-valued and likely to correct.
The short-term problem for the market is that we have a very different market than we've had in the past and yet some similarities. Part of the problem today is the amount of computer (algo) trading combined with passive investing (ETFs instead of stock picking). The flash crash in 2015 still hasn't been figured out as to why or how it happened. And today we're even more vulnerable as the move into ETFs will lead to a situation where there will be no buyers when the selling begins. There is a significant air pocket below us that's been created by having virtually no backing and filling during the rally. It's been a steady rise with virtually no pullback. That sets us up for a nasty correction when it comes and it's very likely to catch most off guard.
As for the current picture, the charts don't emphatically point in one direction or the other and we're waiting for a break from the past two weeks so that we can get a sense of the next move, which could be big. Whether or not that started with the Dow today remains a big question mark. We'll have a better sense of that by the end of the week or next week at the latest (we need to get through opex and its control of the market).
I'll lead off tonight's chart review with the SPX weekly chart.
S&P 500, SPX, Weekly chart
For the past 3 weeks SPX has been nuzzling up against its trend line along the highs since April 2016 (ignoring the slight poke above it in February 2017) and the midline of its up-channel from 2010-2011, both of which are currently crossing near 2564 (today's high). SPX would start to look more bullish above 2565 although there are some shorter-term reasons that support a rally to the 2580 area and therefore it would be more bullish above 2585. From a weekly perspective the first sign of trouble for the bulls would be a break below the uptrend line from February-November 2016, currently near 2500, and a top would be confirmed in place if SPX drops below its August 21st low at 2417.
S&P 500, SPX, Daily chart
The daily chart shows a little more clearly the price action at the trend along the highs since April 2016 and the slight loss of momentum since the October 5th high. There's upside potential to a price projection at 2579, which is where it would achieve two equal legs up from April (I'm looking at the possibility for just an A-B-C move up from April for the 5th wave of the rally from January 2016 since the rally has created a large rising wedge pattern). Slightly higher is a trend line along the highs for the rally from August, which will be near 2585 by next Monday.
Key Levels for SPX:
- More bullish above 2585
- bearish below 2541
S&P 500, SPX, 60-min chart
The 60-min chart doesn't show the trend line along the highs from April 2016 but essentially it's the top of the little rising wedge pattern that has developed since the October 5th high. That little wedge will be negated if today's rally continues into the end of the week, in which case I'll be looking for 2579-2587. In addition to the 2579 price projection on the daily chart (for two equal legs up from April), there is the same price projection for the 5th wave of the rally from August (where it would equal the 1st wave). That makes 2579 a price level of interest if reached.
SPX is currently trying to get through the price projection at 2564.73, which is where the 5th wave would equal 62% of the 1st wave in the rally from August, which is a common relationship when a move has gone too far too fast (without any appreciable correction). Therefore there is the potential the rally could complete at any time, especially considering the fact that it is pressed up against resistance at its trend line along the highs from April 2016 (daily chart).
International Business Machines, IBM, Weekly chart
Before looking at the Dow, which was driven primarily by IBM today (the other 29 stocks effectively cancelled each other out), I think it's a good idea to check out IBM's chart to see what it's currently dealing with. The risk is a one-and-done kind of move today. IBM broke above its downtrend line from 2013-2014, near 159, and closed today on its broken 50-week MA at 159.58 with today's close at 159.53. It had popped above this level and came within a point of hitting its broken 200-week MA at 162 before pulling back into the close.
With today's high at 161.23 it was able to achieve a 50% retracement of its February-August decline, at 160.96, and back-test its broken uptrend line from February 2016. In other words, it's facing a lot of resistance here and it's possible there will be no follow through to today's rally. That of course remains to be seen and if IBM is able to rally above price-level resistance at 165 and above the 62% retracement of its decline, near 166, it could be off to the upside for this stock.
Dow Industrials, INDU, Daily chart
With IBM's push, the Dow broke above the top of its parallel up-channel from April, near 23060. It also busted out the top of a rising wedge pattern for its rally from August, the top of which is near today's open at 23087. This all looks bullish if the Dow can now hold above this morning's open on any pullback.
The pattern for the rally from April, the way I'm counting it, is a double a-b-c (double zigzag) and the 2nd a-b-c is the move up from June 29th. The c-wave of this move would be 162% of the a-wave at 23189, about 16 points above today's high. A trend line along the highs from June-August (light grey line) was reached today and the combination of this and the 23189 projection has me wondering if today has nearly completed its rally rather than starting a stronger leg up. Again, we'll know better in the next few days but stay bullish above 23087 and bearish below it, especially below 22820.
Key Levels for DOW:
- bullish above 22,000
- bearish below 22,000
Another reason to be cautious about today's rally for the Dow, even though price action looks bullish, not all is well underneath the surface of the water (cue the soundtrack from Jaws). The battle between "smart" money (commercial traders) and "dumb" money (retail traders, which includes most fund managers) is almost always won by smart money. They truly play the long game of buying low and selling high. Even Warren Buffet now has one of his largest cash positions ever held. The same is true for many large "smart" fund managers -- they've been slowly building their cash position while retail traders get giddy about buying new daily highs.
Measuring what the smart money is doing can be seen from the COT (Commitment of Traders) report and right now the COT report shows the widest spread between commercials (black line at the bottom of the chart below, which shows a very large net-short position) and non-commercials (blue line, showing a very large net-long position) since before 2003 (as far back as I can find a chart). In addition to the wide spread, each side holds the largest position since before 2003. In other words each side is betting BIG and it's a huge spread. The warning from this chart, which goes back to 2009, is that the coming correction is going to hurt a lot of the retail traders betting on the long side. The only question is when the correction will come.
Dow e-mini futures vs. COT report
Nasdaq-100, NDX, Daily chart
The techs were hurt today by the FAANG stocks, which mostly finished in the red (only a minor gain for GOOGL). NDX continues to struggle with its broken uptrend line from June-November 2016, which it's been battling since October 5th. A little higher is its trend line along the highs from November 2014, currently near 6165, so there's a little more upside potential (and more bullish above 6180) but the pattern is at the point where it can't tolerate much of a drop without turning on the selling. I think the first sign of trouble would be a drop below 6100 but it will take an impulsive decline, instead of a choppy pullback, to tell us a high is likely in place.
Key Levels for NDX:
- bullish above 6180
- bearish below 6010
Russell-2000, RUT, Daily chart
While the other indexes have been chugging higher (hard to call them rallies) the RUT has been consolidating off its October 4th high and has nearly made it down/over to its uptrend line from August 18 - September 8, currently just below 1495. This is also where a trend line along the lows of the consolidation intersects the uptrend line Thursday morning. As long as the RUT stays above 1495 it's in a bullish consolidation pattern and breakout to the upside should coincide with a bullish breakout by the other indexes as well.
If the RUT drops below 1490 it would leave a failed bullish pattern in its wake and failed patterns tend to fail hard. Considering the vulnerability of this market (air pocket below us, commercial traders massively short, passive investing, computer trading, highly overvalued, shall I continue?), take any failure to rally seriously.
Key Levels for RUT:
- bullish above 1515
- bearish below 1490
30-year Yield, TYX, Weekly chart
There's been a lot of noise in the daily charts of the Treasury yields and little sense of direction. The weekly charts aren't providing much clarity either. But last week I discussed the 30-year yield and the fact that its bounce failed at its broken and crossing 50- and 200-week MAs. I thought it needed to hold above price-level S/R at 2.85 but it failed to do that with a drop back below it last Friday. If it stays below 2.85 I think it will be bearish and today's rally brought it back up to that level. While it will have to deal with potentially stronger resistance at its downtrend line from 2011-2013 if it rallies from here, I would say it's bullish above 2.85 (bearish for bond prices) and bearish below.
U.S. Dollar contract, DX, Daily chart
The US$ pulled back to support last week at its recovered 20- and 50-dma's, as well as the bottom of a previous down-channel from January, and bounce off support has it looking like we could see its rally continue. It's currently struggling with price-level resistance near 93.30 and a new downtrend line from April through the October 6th high, which was tested with today's high at 93.65 before pulling back to close at 93.23. If both of these resistance points can be cleared it would then be bullish.
If the dollar makes a new high above the October 6th high at 94.10 it would give us an impulsive move up from the September 8th low and that would signal a bottom is in place. A subsequent pullback from a new high would then be a buying opportunity for the dollar. But without a new high above 94.10 the dollar would turn short-term bearish if it drops back below the October 13th low at 92.59. There is still the potential for a drop down to the $90 area before setting up the next longer-term rally.
Gold continuous contract, GC, Daily chart
On October 5-6 gold successfully back-tested its broken downtrend line from 2011-2016, near 1266 at the time, and it was looking like it was off to the races when it got back above its 20- and 50-dmas last Friday. But gold has dropped back down below those MAs, now near 1289 and 1302, resp., as well as price-level S/R at 1300. As long as gold holds above its October 6th low near 1263 it stays potentially bullish. But a drop below 1262 would confirm the likelihood that gold is heading lower (potentially below last December's low at 1124).
Oil continuous contract, CL, Weekly chart
The bounce pattern for oil's rally from June has the potential to make it up to the $56 area and still be just a correction to its longer-term decline. There's also price-level S/R near 58.50, shown on the weekly chart below, that could be an upside target. But currently oil is fighting resistance at a downtrend line from May 2015, currently near 52 (today's high was 52.33). A longer-term uptrend line from 1998-2008 is currently near 53 so there's plenty of resistance for oil bulls to fight through.
As noted on the chart, it's possible to consider the downtrend line from May as the neckline of an inverse H&S bottoming pattern, which means a break above the trend line could be very bullish (the price objective for the pattern would be the height of the head, so about 84-85. But I think the larger oil pattern is bearish and the sideways consolidation over the past 3 years will be followed by another leg down. I think oil is in a longer-term decline, especially if demand continues to shrink while new sources/methods continue to increase supply.
Thursday's economic reports include the unemployment data and Philly Fed index and Leading Indicators, the latter being more or less an after-the-fact kind of report. The Philly Fed index is expected to show a little slowing from September but the market is likely to ignore it. On Friday we'll get some existing home sales data for September, which is expected to be down slightly from August, as were today's reports on new homes.
The stock market is clearly bullish and it doesn't make sense to fight it. In other words, no reaching in to grab rising knives. Ride it for as long as it holds but I think the rally has reached the point where it could top out at any time. More importantly, I think there's considerable downside risk since a decline could rapidly pick up speed and scare more and more traders into selling.
Computer trading could will likely exacerbate the problem by selling ETFs hard and not finding buyers on the other side. Between that and the air pocket below us (due to no significant corrections along the way in the rally) we could see a flash crash that puts the one in August 2015 (down -10% in 3 days) to shame. Waking up to a big gap down is the kind of downside risk I see.
Believing there is significant downside risk, it's tempting to get into some speculative short positions but that's equally dangerous in a market that could still have a long way to go into a blow-off top. However, getting into some short positions as a hedge to protect your long positions makes a lot of sense right now. Hopefully you won't need the insurance but you'll be glad to have it if we suddenly experience a 1000-point down day for the Dow. Do I believe we could see that kind of move? Absolutely.
It'll be interesting to see how the next week plays out since the indexes are either poised to turn back down from ending patterns to the upside (such as the SPX rising wedge pattern) or ready to break out to the upside from consolidation patterns (such as the RUT's choppy sideways/down flag pattern). The Dow has broken through some important resistance levels and could be our bullish indicator.
Right now, with the differences between the indexes, we need to let price lead the way from here. Stay cautiously long until we see some impulsive moves to the downside. Just stay aware of the potential for a significant decline that happens very quickly and catches most bulls back on their heels, unsure how to react and likely to get hurt badly before realizing the market is not coming back.
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