The stock market has been showing signs of uneven performance between the major indexes but today experienced a big split between the tech indexes and the others. The FAANG stocks sold off hard, which tanked NDX in particular, and the question is whether it's more end-of-month related or something more serious. In any case, today's bifurcated market is not a sign of health.
Today's Market Stats
On Tuesday we had a strong rally in the stock market but interestingly, the VIX also had a positive day. The strong rally should have tanked the VIX but we saw just the opposite. Today we saw a strong decline in the tech indexes while SPX finished flat and the Dow and the RUT finished positive and the VIX finished up +6.7%.
The bifurcation in the market as well as a VIX rally is a warning sign and while it doesn't mean the rest of the market is going to follow the techs lower it does mean it's time to be cautious. Another sign of a bifurcated market is when we have a split between the banks and semiconductor stocks, which is always a reason for both sides to exercise caution. The SOX finished the day down -4.4% while BKX finished the day up strong with a +2.7% rise. Major disagreement and they need to get back in synch to help us figure out where the broader market is headed next.
The bulls continue to show more strength than the bears and while the bears might have valid arguments about why the market should not be rallying they are not being listened to at the moment. But unless it was just a one-day event, the techs call into question the idea that there will be new highs -- they got hammered today, thanks mostly to the selloff in the FAANG and semiconductor stocks. If this was just an end-of-month rotation we'll see the tech indexes recover.
This morning's economic reports had very little effect on the market, which is more interested in what Congress is doing (tax reform bill) than what the economy is doing. The GDP 2nd estimate for Q3 showed a slight improvement from 3.0% to 3.3%. Pending home sales in October jumped higher by 3.5%, which was much stronger than the expected 0.6% and a big improvement from -0.4% in September (revised lower from the originally reported 0.0%).
Goldman Sachs came out with a statement this week about how expensive today's market valuations are. The report acknowledged the fact that equities, bonds and credit haven't been this extended since the "Roaring '20s and the Golden '50's." The bull market into the 1920's was a result of an industrial revolution in the U.S. and the 1950s was a period of very strong growth as the U.S. found itself a leader in a world recovering from WWII.
The current bull market is more a result of easy-money policies and lots of cash simply looking for higher-yielding assets. Which do you think is the stronger foundation for a rally? Today's extremely high valuations have been more a result of financial engineering than in the past, which makes it a dangerous time for our current all-time high valuations. Throw in the passive investing in ETFs and the retail crowd finally chasing this market higher, along with extremely high valuations and you have a house of cards ready for the first ill wind to blow (is that a butterfly I see flapping its wings in Africa?).
Compounding the problem with the high valuations is the fact that they're actually scarier than what's being reported. Actual corporate earnings are not as good as what's being reported since so many companies have gone back to non-GAAP (Generally Accepted Accounting Principles) earnings statements. For those who traded the market in the late 1990s, this was a common occurrence back then as well. The Enrons and Worldcoms of the day had significant financial troubles that were being masked by faked earnings reports.
Of the 30 Dow companies nearly half (14) reported "adjusted" earnings for Q3 instead of GAAP earnings. Each quarter they figure out what expenses to exclude by calling them "one off." There's a reason they call them non-GAAP earnings reports and it should be setting off strong warning flags, just as they were warning flags heading into the 2000 top. These 14 Dow companies actually had earnings that were 26% below what they reported. Take those "earnings" away and the P/E ratio skyrockets even higher.
An egregious example is Merck, which had an actual loss of 2 cents a share but through some hocus-pocus financial engineering and "one-time" charges they were able to report a profit of $1.11 a share. Just don't look behind the curtain to see who's actually pulling the levers.
The tech companies in particular are back to the shenanigans that got them in trouble as the light shone on their actual earnings back at the turn of this century. They're pulling the wool over investors' eyes again with the same tactics, made easy when investors don't care to lift the veil and take a look at what's really happening. They prefer to simply chase prices higher and hope things will continue for at least a little longer.
Twitter is an example of a tech stock that's doing this -- they had a loss of $21M in Q3 but with a little pixie dust and a wave of their magic wand they were able to report non-GAAP earnings of $78M. And investors eat this up!
Compounding the problem with actual vs. fake earnings has been the strong push by corporations to buy back their own shares, thereby reducing the number of outstanding shares and increasing their earnings per share. Instead of investing their earnings and borrowed money in added production (because there's not enough demand for their products) they have been buying back their shares to make it look like they're doing better. It also pads executive compensation since they can show "improved" earnings per share.
Amazingly, all the corporate buybacks has resulted in them being the only net buyers of stocks since 2009. I'm sure this will all end well (said sarcastically). Ah, the web we weave...
While all of the above is discussed to simply point out the weak foundation of this bull market, there's no arguing with the bulls right now. That's an exercise that's getting a lot of bears into trouble. It might be an irrational market but that doesn't prevent it from becoming more irrational. I think the market is approaching a significant top but it could be here or it could be another couple thousand points higher for the Dow. The rally is going parabolic (like bitcoin) and I believe the coming "correction" is going to scare the cr** out of everyone.
Stick with the long side as long as it continues to look like higher prices are coming. Choppy pullbacks/consolidations tell us to keep looking higher, including from here. But as I'll show on the charts, starting with the Dow, there are some potentially important levels to watch carefully since they're potential areas where the rally could run into trouble.
Dow Industrials, INDU, Weekly chart
The Dow's weekly chart shows a rising wedge shape to the rally from January 2016 and it could make it up to the top of the wedge (the trend line across the highs from April 2016 to March 2017), which will be near 24250 by the end of the week. Slightly below that level is a trend line along the highs from May 2011 through the 2013 and 2014 highs, which is approaching 24100. These two trend lines give us a target zone of about 24100-24250, which also means it would be more bullish above this zone.
Dow Industrials, INDU, Daily chart
The Dow's daily chart shows a little closer view of the rally and the trend lines mentioned above. There's another trend line along the highs from April-October of this year, which is currently near 24020. This opens our target window for a possible high to roughly 24000-24250. I would expect a final high, if that's what we're going to get, to show bearish divergence against the October-November highs since the pattern looks to be in the final 5th wave.
Key Levels for DOW:
- bullish above 24,300
- bearish below 23,250
S&P 500, SPX, Daily chart
Tuesday's rally pushed SPX above its trend line along the highs from June-November 2017, which was back-tested with today's low at 2620. As long as that level holds there's a good chance we'll see SPX rally at least to the top of a parallel up-channel for the rally from August, which is nearing 2650. The pattern of the rally can be considered complete at any time but I continue to see potential for higher prices if the next multi-day pullback remains choppy and more of a correction than something sharper to the downside.
Key Levels for SPX:
- bullish above 2650
- bearish below 2566
Nasdaq-100, NDX, Daily chart
Even though the market is expecting a tax reform package (which I think is setting the market up for disappointment), the tech stocks will generally not benefit since they've been gaming the tax system. Today's selloff might have been partly related to an expectation that their tax loop holes are about to be closed or it was simply selling of profitable stocks before the end of the month. Regardless of the reason, the selloff leaves an ominous looking chart.
There were two price projections that I've been watching for NDX to see if it might top out there. One, which is shown on the daily chart below, is at 6452, which is where the 5th wave of the rally from August equals the 1st wave. Tuesday's high at 6426 failed to make it that high. The rally from August is a rising wedge pattern inside a parallel up-channel for price action since July and the top of each was also nearly tagged with Tuesday's high.
Because the rally from August is a rising wedge pattern I was looking for just a 3-wave move up for the 5th wave (the rally from November 15th) and two equal legs for that move pointed to 6426.36 for a final high. Tuesday's high at 6426.04 missed it by only pennies. The pieces were in place for a top at any time and today's decline has it looking like a top is in fact now in place. The decline is a breakdown from the rising wedge and it closed below its 20-dma at 6326. It could turn into just a one-day drop but at this point it's bearish until the bulls can get NDX above 6426.
Key Levels for NDX:
- bullish above 6453
- bearish below 6228
Russell-2000, RUT, Daily chart
If the tech indexes look like they've topped they're opposed by the RUT, which looks like it will continue to head higher. Based on the weekly pattern there is a price projection at 1562, which is where the 5th wave of the rally from February 2016 would equal the 1st wave. On the daily chart I'm watching to see if a projection at 1572 will be reached. This higher projection is based on the width of the October-November expanding triangle and projecting that distance from the breakout point. So we have a 1562-1572 target zone to watch. As long as the RUT stays above its November 22nd high at 1524 it stays bullish. A drop below 1509 would tell us the rally is finished.
Key Levels for RUT:
- bullish above 1525
- bearish below 1509
30-year Yield, TYX, Weekly chart
The Treasury market has been directionless all year and it's still not clear which direction the next big move will be. I continue to believe we'll see lower yields, especially if the stock market tips over and scares a lot of investors into the relative safety of Treasuries (driving prices higher, yields lower). But short term I can see the potential for yields to pop higher before turning back down.
Looking at the 30-year yield, TYX, I see the potential for a pop up to about 3.07%, which is where the bounce off the September 3rd low would achieve two equal legs up. It would also result in a test of the downtrend line from 2011-2013, which stopped the previous rally into the March 2017 high. Above 3.1 would be a bullish breakout. But a drop below the September low near 2.65 would indicate it's breaking down sooner rather than later.
KBW Bank index, BKX, Weekly chart
The banks have rallied strong this week and BKX has once again poked above the trend line along the highs from 2011-2014, as can be seen on its weekly chart below. With today's high at 105 it's only about 60 cents from hitting the trend line along the highs from 2010-2017 (bold green line). The daily RSI is now overbought and the weekly oscillators are showing significant bearish divergence. Unless BKX can strongly break above 106 it's looking vulnerable here.
Transportation Index, TRAN, Daily chart
The TRAN is looking like BKX with the spurt back up this week. It too has dragged daily RSI into overbought as it approaches the top of a rising wedge pattern (trend line along the highs from last December), currently near 10150 and about 60 points above today's high (today's rally was 322 points (+3.3%). The wave count fits well for a top at any time but it would be more bullish if it breaks out above 10150.
U.S. Dollar contract, DX, Daily chart
The US$ is giving us some mixed signals at the moment but I'm leaning toward a continuation of its rally off the September low. On October 26th the dollar had broken out of its down-channel from January 2017 and so far has successfully back-tested the top of the channel with Monday's low at 92.43. That was also a 62% retracement of the September-November rally and sets up the dollar for a strong rally into next year.
The bearish interpretation of the pattern is a failed breakout from the inverse H&S pattern that developed from August through October with the neckline at 94. The dollar then proceeded to drop back below its 20- and 50-dma's as well and the current bounce could fail with a back-test of its broken 50-dma at 93.50. A drop below 92.50 would suggest the decline will continue to support near 90.
Gold continuous contract, GC, Daily chart
I continue to think gold will consolidate a little longer to finish a sideways consolidation pattern since its October 6th low. As long as it stays below 1300 I think we'll see another leg down to at least match the September-October decline, which points to about 1235. Further downside pressure could drop gold to its uptrend line from December 2015 - December 2016, near 1211, and maybe to price-level support near 1205.
Oil continuous contract, CL, Daily chart
Oil's rally into last week's high had it achieving a 38% retracement of its 2013-2016 decline, at 59.06 (with a high at 59.05). It's also price-level resistance dating back to 2005, 2006 and 2009. The strong rejection from that level, especially with today's close below its 20-dma, near 56.60, looks bearish. The real test for the bears will be break below the uptrend line from August, currently near the November 14th low at 54.81. Until oil gets below that level there remains upside potential to the $62 area where it would hit trendline resistance.
Thursday's economic reports include the unemployment claims data before the bell, along with some inflation data (PCE prices) and personal income/spending. No significant changes are expected, although the personal spending is expected to show a decline in October. If there was a slowdown it's not being reflected in the retail sector (XRT), which has had a strong 3-week period. The Chicago PMI report will be released shortly after the open and is expected to show a slowdown from October.
The market is bullish and could remain bullish into at least next week. Other than the tech indexes, which suggest a top was made with this morning's quick highs, the choppy pullbacks in the other broader indexes suggest higher prices are yet to come. We could see a multi-day pullback/consolidation but as long as the pattern remains choppy we should expect higher prices. This has been true for a long time -- choppy consolidations have consistently led to another push higher and that should continue until we see a sharp impulsive decline (like we saw for the tech indexes today).
It's quite possible, if not probable, we'll see the indexes make highs individually and the bifurcation we're seeing between indexes is telling us the rally is not healthy. Rotations between sectors will keep individual stocks/sectors/indexes making new highs while others start their reversals. This looks to be starting and a rising VIX is another reason to be very cautious about the upside. I see further upside potential but not enough to warrant new long positions. Day trading the long side and not carrying new positions overnight seems the safer way to go right now. Long the RUT and short NDX could make a good pairs trade right here. Just be careful about a long RUT position since we know how quickly that index can reverse.
Bears should be sharpening their knives but not trying to catch the rising ones yet. Expect some whippy price action as we go through a topping process (assuming we'll see the market top this week or next), which will likely make it difficult for both sides to trade without getting whipped out of positions. There are better times to trade than what we're currently seeing. Stay safe and protect your capital.
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