The market has been rallying a long time in anticipation of the tax reform bill, which appears to be heading to President Trump for his signature. We now wait for the final market response once the tax changes become law.

Today's Market Stats

This morning started off with another gap up, thanks to another overnight rally in the futures (which started again as soon as the market closed on Tuesday). But as soon as the market opened and gapped up it got hit with some strong sell orders. I'm sure the overnight rallies and selling the opening gaps is just a random pattern since we know it's too hard to manipulate the market (cough).

Following the morning selloff there was a bounce attempt to keep the bears away and the net result this week has been a corrective pattern that suggests the pullback from Monday's high will be followed by another rally leg into next week. This pattern supports the idea that we'll get the Santa Claus rally but as I'll review in the charts, the rally could be short-lived and might not even make it into the end of next week.

There were no significant economic reports this morning other than existing home sales, which were stronger than had been expected and November's number showed growth from October. The home construction sector was one of the stronger sectors today.

The metals, energy and transportation sector were the stronger areas today while dragging the bottom was the utility sector. Interestingly, the REIT index was at the bottom of the pile today, which might have been a result of a jump in Treasury yields. The selling in bonds remains supportive of the stock market.

Assuming the tax reform bill will be signed into law today or tomorrow, the market will have received what it's been looking for and why it's been rallying. But even as the tax bill heads for signature the market's response this week has been ho-hum (not quite bah humbug) and we could get a sell-the-news reaction once it's all said and done. But the price charts support the idea that Santa should arrive, even if he has to leave early.

There has been a bullish expectation that the tax reform bill will enable the repatriation of corporate earnings from overseas. The general belief is that a flood of money will come from across the oceans and make its way into our markets. The estimated amount held oversea is $2.6T and that's a lot of money. But there are a couple of unknowns about what will happen with that money.

The first unknown is how much of the money will actually be brought back to the U.S., especially since many companies are expanding their operations overseas, not here at home, and they will use some of their earnings where they feel they'll get the biggest bang for the buck (or euro, yen, yuan, peso, etc.). The second unknown is how much will be rotated out of U.S. Treasuries, which is where much of that money is already parked. In other words much of that money is "already here," as mentioned by Jim Rickards on Fox Business News recently.

Some of the money will surely be used for paying shareholders dividends and buying back more stock. Very little is expected to be invested in additional capacity here since there hasn't been enough demand to warrant it (it's part of the problem with economists saying the economy is doing well and the reality of companies not seeing that growth). But it's been the expectation of more stock buybacks and special dividends that has encouraged investors to bid the market higher. The reality vs. expectations could be very different.

As far as bond buying goes, very little of it is going into the riskier junk bond market and that continues to warn us of trouble ahead. A review of the junk bond index, using the High Yield Corporate bond ETF, HYG, continues to show why bulls should remain a little more cautious than usual. The "animal spirits" of the market is a good sentiment measure to track since the willingness to be in riskier assets, such as high-beta stocks and higher-yielding bonds, is generally a good signal to watch when gauging how much you want to be long other asset classes. HYG has been warning us for some time that the uber-bullishness we're seeing in the stock market is only stretching things further and the correction is likely to be more significant.

Investors have been ignoring HYG but it will be hindsight that many will come to recognize the warning sign. With junk bonds significantly underperforming the stock market we'll either see a return to a desire to invest in these riskier assets or the stock market's whistling past the graveyard will be followed by a sudden wave of panic as investors go screaming and running through the woods in the dark. We all know what's out there in the woods in the dark (wink).

HYG has been shifting from a "risk-on" environment to "risk-off" while stock market investors continue to plow ahead, bidding stocks higher based on what they believe the new tax bill will provide. That could be a dangerous assumption but obviously we won't know until it's behind us.

For now the HYG chart is simply a warning sign, especially since it dropped below its 50- and 200-dmas in late October and has only been able to bounce back up to its broken 20-dma, which tells us the intermediate trend is down.

The weekly chart below shows it's still holding price-level support near 86.30, which was tested on November 15th, but daily MACD remains below zero and the bearish divergences on the weekly chart suggest lower prices ahead. A drop below 86 would likely be followed by stronger selling, in which case some astute stock money managers might take notice. The last time HYG dropped below 86, other than the quick pullback in October 2016, was in August 2015 and it was at that time that the stock market suffered one of its strongest corrections (into the February 2016 low) since mid-2011. Keep HYG on your radar.

High Yield Corporate Bond ETF, HYG, Weekly chart

Along with the junk bonds, the RUT is a great market sentiment indicator since it also reflects the animal spirits of investors. I'll start tonight's chart review with a top-down look at the RUT.


Russell-2000, RUT, Weekly chart

Since pushing to new highs in September and rallying above the longer-term trend line across the highs from 2007-2015 the RUT has been showing a slowdown in the momentum of its rally. As I'll show on the daily chart further below, the rally from August has formed a rising wedge pattern, which fits as the final part of the rally from February 2016 and why the negative divergence is a warning sign.

The leg up from August fits as the 5th wave of the rally from February 2016 and it would equal the 1st wave at 1562. The December 4th high missed that projection by 3 points and I think the chances are good that the projection will be achieved with one more push higher. But the wave count and bearish divergence suggest one more push higher will be a good opportunity for the bears, not the bulls. The coming correction could be sharp, strong and fast, which is just the kind of move bears love.


Russell-2000, RUT, Daily chart

The rising wedge for the rally from August can be seen on the daily chart below and while the price pattern since the December 4th high is not clear, it does continue to support the idea for another push higher to the top of the wedge, which is currently near 1575 and will be close to 1580 by the end of next week. From here, only a drop below 1505 would we have confirmation that a significant high is already in place.

Key Levels for RUT:
- bullish above 1553
- bearish below 1505


Russell-2000, RUT, 60-min chart

If the RUT continues higher from here it could rally to 1583 if it's to achieve two equal legs up from December 14th. With the top of rising wedge near 1577 next Tuesday (Monday is of course closed) we have an upside target zone at 1577-1583. But keep in mind the 1562 projection on the weekly chart since it's possible that's all we'll see for the RUT.

Once the RUT makes a new high above Monday's, at 1553 (assuming it will), all the pieces will be in place to call a major top at any time. We have the upside target zone but there's no guarantee it will get there, just as there's no guarantee it will stop there. For now we simply have a level of interest to watch if reached and bulls should recognize the significant downside risk with a reversal from there.


S&P 500, SPX, Daily chart

SPX is also pushing higher inside a rising wedge pattern and while I see upside potential to the 2725 area, any new high from here, like the RUT, would then put the pieces in place to call a major top at any time. I like the crossing of trend lines near 2725 on January 2nd since it would be a "pretty" finish for the rally but there are reasons to doubt it will make it that high. It's certainly a level of interest if reached.

For now I'm assuming this week's pullback will be followed by another push higher. We could see it chop a little lower to about 2671, where it would hit the bottom of its rising wedge and the previous high on December 13th, and then look for another leg up (the Santa Claus rally). If it rallies all week next week then the 2725 upside target will be in play for a high on January 2-3. But before that level I'll be watching a couple of upside projections for potential trouble.

For the rally from August there's a wave relationship that points to 2704.94, which is where the extended 5th wave would equal the 1st through 3rd waves (noted on the chart). Interestingly, the 5th wave of the rally from 2009 has also extended and it would equal 162% of the 1st wave at 2704.87. On the Gann Square of 9 chart the next important level for SPX is 2704. This confluence of these projections, along with the Gann chart, is potentially very important and a solid reason why SPX will not rally higher than 2705.

Another level of interest, if reached, is 2718, which is where the 5th wave of the rally from February 2016 would equal the 1st wave. These multiple projections give us a relatively wide target zone of 2704-2725 to watch carefully for a top to this rally, with 2704-2705 being especially important to watch. This upside target zone also means SPX would be very bullish above 2725 since it would indicate we are truly into a blow-off move, the top of which would be anyone's guess. But in that case the bears will need to stand back in awe as the bulls ride it for all it's worth before it flames out.

Key Levels for SPX:
- more bullish above 2725
- bearish below 2652


S&P 500, SPX, 60-min chart

The SPX 60-min chart shows the little bull flag for this week's choppy consolidation, which suggests we'll get another leg up in the coming days. The light-green dashed line is a projection to the top of the rising wedge pattern by Friday, finishing near 2705 (to match the first 2704-2075 target zone). A pullback and then larger move higher, shown in bold green, could see a rally at least to 2715 to hit the top of the rising wedge before the end of next week. Only a break below the December 14th low near 2652 would have me turning bearish since it's possible Monday's high was THE high. I consider that to be a lower probability but it's certainly a possibility.


Dow Industrials, INDU, Daily chart

The Dow looks similar to SPX with only small differences. Its pattern supports the idea we'll get a little more of a choppy pullback into the end of the week and then Santa will arrive next week to deliver presents to all the good little bulls who believed. The bears will get their lumps of coal, a kick in the ass and told to go back to their caves. A final rally to the 25200 area by January 2-3. From there the bulls will feel some pain but that possibility will obviously be reevaluated next week. This bullish expectation would have to be seriously questioned if the Dow drops below its December 14th low at 24511.

Key Levels for DOW:
- bullish above 24,500
- bearish below 24,100


Nasdaq Composite index, COMPQ, Daily chart

The Nasdaq looks the same as the others with an expectation for one more push higher to complete the 5th wave in the rally from August. The 5th wave would equal the 1st wave at 7034.71 so that's a level of interest if reached. There's higher potential to the top of its up-channel from August, which will be near 7090 by the end of next week. Much above 7100 would be a bullish breakout from the up-channel (look for an acceleration higher if the breakout is more than a head fake) but a drop below the December 14th low at 6851 would indicate a top is likely already in place.

Key Levels for COMPQ:
- more bullish above 7075
- bearish below 6850


KBW Bank index, BKX, Weekly chart

Keeping an eye on the money (the banks), I find it curious that higher bond yields the past two weeks (Treasuries have been selling off) have not helped the bank stocks and that should be a little worrisome. The past three weeks have left little doji candlesticks for BKX and right at resistance at its trend line along the highs from April 2010 - March 2017.

Short term I see the potential for only a minor push higher, such as 108.50 (maybe $0.50 above yesterday's high). That would complete a small rising wedge pattern for its 5th wave in the rally from November 13th and in turn complete the 5th wave of the rally from last April, which in turn would complete the 5th wave of the rally from February 2016. That in turn will complete the 5th wave of the rally from March 2009 so this is going to be a potentially very important high, one which should lead to a multi-year decline.

The bears will have lots to prove before that bigger bearish picture becomes reality but that's the kind of downside risk I see and why I strongly recommend protecting/hedging long positions.


U.S. Dollar contract, DX, Daily chart

Following last week's back-test of price-level S/R for the US$ (the failed inverse H&S neckline) we've seen the dollar fail to hold support at its 20- and 50-dmas, all of which has the dollar looking weak. A rally above 94 would turn things around and have the dollar looking bullish but at the moment it's looking like the higher-probability move is lower, maybe down to the $90 area.


Gold continuous contract, GC, Daily chart

Today's rally in gold got it above price-level S/R at 1265, which is bullish, but now it's dealing with resistance at its broken 20- and 200-dmas at 1268-1270. Slightly higher is its broken 50-dma, near 1276, and broken uptrend line from December 2016 - July 2017, near 1275. Next Tuesday the broken uptrend line crosses the downtrend line from September at 1276, all of which makes a strong wall of resistance for gold bulls.

The multiple reasons for resistance near 1276 is also why gold would be much more bullish if it can get above it and then hold above that level (long gold would be the play). But if resistance holds and gold drops back below its December 12th low at 1238 we'll likely see it head down to the 1205-1215 area where it would test its uptrend line from December 2015 - December 2016 and the next price-level S/R.


Oil continuous contract, CL, Daily chart

For the past 5 weeks oil has been battling resistance 58.50-59.00, which includes price-level S/R, the 38% retracement of its 2013-2016 decline and its 200-week MA. I continue to see upside potential to the top of a rising wedge pattern, near 62, and potentially much higher if it rallies above 62.50. But the larger pattern for oil suggests we'll see a strong decline into next year once the current bounce completes, either here or I think more likely somewhere in the 62.00-62.50 range.


Economic reports

Thursday and Friday will see several potentially important economic reports but whether anyone will be watching or caring is another matter. I suspect very few will care since end-of-year concerns about portfolio balance/protection will be of greater concern than worrying about the economy. No significant changes from previous reports are expected tomorrow.


Conclusion

The price patterns for the indexes support the idea that Santa will arrive on schedule for all the good little bulls and shower them with more money with which to buy more stocks. The setup is for a rally to begin at any time but I don't think any later than next Tuesday. But as a sick joke, Santa may be getting ready to lure the bulls into a bull trap since the price patterns suggest we'll get just one more leg up for the rally and then a fast and strong reversal back down. January could be a painful time to be a bull. Conversely, if you're a bear and tired of eating grubs and you're ready for some steak tartar you could be very close to getting your opportunity to kick some rump.

Considering how stretched this market is (well above standard deviations), the coming correction could come two ways -- chop sideways and let the overbought condition work its way off slowly or all the excesses are going to get reversed quickly as investors panic out of their positions. Keep in mind that this market has not been tested since the majority of investors moved into passive investing with the multitude of ETFs. When the selling starts in those ETFs we could quickly find a no-bid situation as all those stocks in the ETFs must get sold.

We have a vulnerable market and while a choppy consolidation in January is clearly a possibility (even a continuation of the rally), I think the odds are high for a stronger correction. By this time next week I expect to have a better idea for how January should look. Be careful out there.

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


 

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