Today's rally was brought to us, in part, by Goldman Sachs (GS) and their "less bad" earnings report. They reported income and earnings well below last year but slightly better than their lowered forecast. Wow, call me impressed. The other positive factor for the market was the news that the IMF is going begging for about $500B from various countries so that they can lend it to the countries that are in trouble. Wow, call me doubly impressed. More hopium on IMF's plan to find more money, somehow, somewhere. Hopium is a wonderful thing but not for the stock market.
And then not to be outdone, a member of the ECB told a German website that the European central bank is looking for a possible alternative to its bond-buying program. With all this good news breaking out all over, the bears didn't have a chance today. All these concrete plans for helping Europe deal with its debt problem (cough).
I won't even bother with GS's numbers since they're not to be trusted. The only thing that matters is the market's reaction and at least for now the positive reaction is bullish. It's also bullish, but dangerous, that the market found the IMF's "plan" to raise its lending capability to $835B from its current $335B after identifying the potential for the need for an additional $1T over the next two years. Oops, that's double their recent and previous forecast. Hey, what's a trillion dollars amongst friends. To maintain a cash buffer the IMF will actually be looking for handouts from other countries amounting to about $600B.
The most recent meetings over the IMF's need for more money left the G20 group with no agreement and the U.S. said it had no plans to make new bilateral loans (which perhaps prompted the Fed to step in and make more dollars available at reduced swap rates, effectively kicking off the ECB's back-door QE3). That leaves the IMF "studying options to increase funds available for lending". They will be going hat in hand to China, Brazil, Russia, India, Japan (has anyone seen their debt problem?) and oil-exporting countries to be the next top contributors. The hope, I mean plan is to have an agreement in place by the time the G20 gets together at their next meeting in Mexico City on February 25-26. Just what the market needed -- another plan to create a plan to get more money to throw down the debt sinkhole. But the market liked the news and rallied.
Opposing the hopeful message from the IMF was a prediction from the World Bank yesterday that said global growth would drop as much as -0.3% in Europe this year. It was the largest cut in predicted growth in three years. The rest of the world could grow about +2.5%, which I find hard to believe, knowing how integrated the global economy is. But the market ignored this news and would rather pin its chances for a higher stock market on the shot of hopium that was delivered by the IMF. A plan to make a plan -- you've got to admire the bull's optimism and tenacity. Just don't get sucked into their hope-based rally without your eyes wide open and one foot holding the exit door open.
I've shown long-term projections in the past for where I think the current bear market is going to take us, which is based primarily on chart patterns and previous history (fractal patterns tend to repeat). I use technical analysis first and fundamental analysis second, to help confirm or negate what I'm seeing on the charts. I've also discussed a multitude of reasons why I think the stock market (which is a reflection of the economy) has to work off the sins of the past before it will be healthy again. As Todd Harrison likes to say, we have to get through it in order to get to the other side.
We have way too much debt as a result of a few decades of maxing out our credit cards (government and personal) and the bill is due. The debt will be taken care of through either paying it down or defaulting on it. And a credit contraction, which is the process we're going through (even while central banks fight it every step of the way), is a deflationary process. Stock markets don't do well in a deflationary environment. I came across another reason why we could see a contraction in the economy and a drop in the stock market.
Doug Short (dshort.com) showed an interesting chart that has more to do with demographics, specifically a reduction in spending and investing due to a reduction in the number of people aged 45-49, an age group that is peaking in their spending (raising families, putting kids through school, buying bigger houses, putting money into retirement accounts, etc.). The chart below shows this age group peaked in 2006-2009 and will be dropping into a low around 2022.
Americans in the 45 to 49-year-old group, chart courtesy dshort.com
With the reduction in this age group there will not be the same level of support in the consumer spending department, which will have a depressing effect on the economy. While they move into a higher-investing group (saving towards retirement), the depressive effect on the economy will likely create more problems for local and state governments that are dependent on sales tax and business tax revenues. It's one factor among many that will be thwarting the government's effort to get people to spend more and save less (you know, to spend our way to wealth). Doug Short is predicting a 30%-50% haircut for the stock market in 2012, a far cry from most analysts predicting a positive year.
The housing market will continue to suffer as the baby boomer group ages and looks to downsize their housing needs. The high inventory of houses will likely be with us for many years to come and that will continue to depress the value of real estate. The reduction in the "wealth effect" from people seeing the value of their homes drop so much cannot be overstated when it comes to the effect on the overall economy. It has created another group that feels less secure about the future and less likely to overspend.
So we have many fundamental factors supporting my view that 2012 will be a down year and that the secular bear market that we've been in will likely continue into at least 2016, if not beyond. It doesn't mean there will be no opportunities to make money on the long side. Depending on your trading time frame there will be several buying opportunities along the way. But the more immediate opportunity that I see from here will be on the short side, potentially for a good ride down into the end of March.
I'll get my longer-term charts updated and try to get them to you next week. For now we're focusing on the shorter term to see where the current bounce might finish so that we can climb aboard the southbound train for a nice ride to warmer climes (some bulls might say that would be Hell). Keep in mind that playing the short side is actually more difficult than the long side but you can make more money in a shorter period of time. So let's start off tonight's review with the DOW to see what's setting up.
The DOW's weekly chart shows it testing its broken H&S neckline from last year for the 3rd week in a row. It's breaking it slightly as it reaches up to tag its downtrend line from 2007-2011, currently near 12600 (today's high is 12582). It's a very good setup for a reversal so we'll see if the bulls take advantage of it this week. The week's closing price is the important one.
Dow Industrials, INDU, Weekly chart
Moving in closer to the DOW's rally, the daily chart below shows it had stalled since the beginning of January below its May-July downtrend line, as well as its broken H&S neckline, until today's break above them. Now it's running into the top of a small rising wedge from the January 3rd high and is less than 20 points away from its 2007-2011 downtrend line near 12600. It can certainly press higher but with slowing momentum and volume behind this move I think it would be pressing your luck to bet on a rally much above 12600. But a rally above 12600 that holds above would be a bullish move and would indicate that as slow as the trading volume is, there would obviously be enough money flowing into the market (the central banks have been busy again) to keep the stock market elevated.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 12,650
- bearish below 12,311
Before moving on to the other charts I wanted to show a couple of reasons why I think it's smarter to be turning bearish here rather than holding out for more upside. I'm looking at sentiment, short interest and volume and the picture is not bullish, even (or maybe I should say especially) if we see the market move marginally higher into the end of the week.
Last week I showed the AAII survey results for trader sentiment, showing a significant widening of the spread between bullish and bearish sentiment. This week's numbers didn't change much but widened slightly further. As a reminder, the spread is now as wide as it was at the May 2011 high.
Following the 1st wave down, which was the May-October decline, we've been in a 2nd wave bounce correction since the October 4th low. It's very common for bullish sentiment at the top of the 2nd wave correction, which is a lower high, to be in excess of that seen at the previous high and that's what we currently have. The lower high is being met with more bullishness and fewer bears because the belief is so strong that the market is heading for new highs above last May's high. The sentiment picture fits the wave count and both say we should be looking for a market high rather than a continuation higher.
The 2nd leg of the bounce off the October low, from the end of November, has been driven to a large degree by short covering, which makes sense when you see the significant drop in bearish sentiment. The chart below shows the sharp drop in short interest (black bars) vs. the stock market's rise since October (SPY in red).
NYSE Short Interest vs. SPY, chart courtesy zerohedge.com
It's hard to see the dates at the bottom so I added the years. Each bar is two weeks' of data. The last bar is for the first two weeks of January. I suspect there will be a lot of bearish options positions that will expire this Friday and most of those bears will not initiate new bearish positions. That will make next week particularly vulnerable since the lack of short interest and other bearish positions will make the market more vulnerable, not less, to a downside disconnect.
The short interest in the techs shows the same picture. The chart below shows short interest in QQQ dropped off the cliff at the end of December and I suspect it's much lower today. It sits at a level not seen in 11 years. The level of short interest is below the 2010 low and at a level not seen since early 2001 when most in the market were still feeling very bullish. The lack of support under the current market is very scary. The HFT traders drive this market (they're essentially momentum players) so the short covering combined with the hopeful bulls has been pounced on by the HFT traders. When this market reverses, and it eventually will, the market will likely drop fast, exacerbated by the HFT traders and no support underneath. It could be a fun ride.
QQQ short interest, 2000-2012, chart courtesy zerohedge.com
The very low trading volume that we've seen as the rally has progressed can be seen on the SPY chart below. Notice that many of the higher volume days are the red bars, meaning SPY closed below its opening price. Today's rally has volume only slightly stronger than yesterday's and considerably less than Friday's, which closed down for the day but above its gap down opening price. As for the price pattern, I'm showing an idea for a pullback and then a final high around early to mid February and near 133. This is just an idea that I'll be watching for once the pullback gets started.
S&P 500 ETF, SPY, Daily chart, looking for rally conclusion
The next SPY daily chart is the same as the one above but with an EW (Elliott Wave) count that calls the rally near complete if it did not complete today. Today's high at 130.84 came very close to the 131.09 projection for two equal legs up from November 25th. This is a potentially important level because of the a-b-c count from that low. Notice how close it is to the downtrend line from May-July as well. The bearish divergence at the new high supports the idea that resistance will hold.
S&P 500 ETF, SPY, Daily chart, looking for final high in February
Now we move to the SPX daily chart to show another level that was achieved today -- the 78.6% retracement of the May-October decline, at 1307.28. This is a deep retracement that has been common in this market. Today's high is about 6 points above its broken H&S neckline, about the same amount of the throw-over at the October 27th high. The market has been rallying steady since mid December and closed at the high today, but with little volume and waning momentum. This has often been followed by an immediate reversal the following day as the mini-capitulation of shorts (and longs chasing the market higher) into the close leaves nothing for follow through the next day. Based on where the indexes are, treat a reversal tomorrow, whether immediately or after a minor new high, as a potentially very important reversal. Only after a decline gets started will we be able to get some clues as to whether or not there could be another press higher into February.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1310
- bearish below 1277
Slightly above the 1307.28 Fib retracement is another potentially important level. Two equal legs up from the November 25th low, for the 2nd a-b-c in the double zigzag count shown on the daily chart, projects to 1310.76. That projection crosses the top of a rising wedge pattern tomorrow morning and makes for a very good setup for a reversal (if not immediately lower from here). Any higher than 1311 that holds above, would be a bullish statement, in which case the upside projection is to the downtrend line from 2007, near 1330. We could see a minor throw-over above the top of the wedge and then drop back inside, which would be the first reversal signal.
S&P 500, SPX, 60-min chart
NDX pushed above its price projection near 2402 where it achieved two equal legs up for the a-b-c move up from November 25th. It stopped at the top of a parallel up-channel based off the uptrend line from October 4th and is only about 12 points away from testing its July high near 2438. But keep an eye on 2429.45, less than 4 points above today's close -- that's where it would close the gap left on July 27th (the big down day following its high on July 26th). It would obviously be bullish above but it could be setting up a double top pattern. One thing we've seen at major market highs is a new high for NDX not matched by the other indexes, including its late July high, which sets up a bearish non-confirmation. It's possible the market is going to do it again.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2440
- bearish below 2352
The next three charts are just examples of some of the things I'm noticing as the indexes hit what could be significant resistance. Looking for the drivers behind the rally I've pulled three examples -- NFLX, CMG and the SOX. As the leaders of the pack this month, it will be instructive watching what they do from here. NFLX's weekly chart shows the steep decline from July to the low on November 30th. It has bounced up in a 3-wave move to its broken uptrend line from November 2008 through the January 2010 low, currently near 101. Slightly below that trend line are its 20 and 200-week MA's, near 99. On the daily chart it's looking like NFLX could form a double top with last week's high with bearish divergence. Normally I prefer to use the log price scale with a longer-term chart and a big price move but I noticed price respecting the trend line and MA's and I like the setup here for a reversal back down (with a stop slightly above 101).
Netflix, NFLX, Weekly chart
Chipotle Mexican Grill has also been doing well but as can be seen on its daily chart below, the rally from last August has created a bearish rising wedge pattern, with bearish divergence supporting the bearish interpretation of the pattern. It has now pushed up to the top of the rising wedge and its broken uptrend line from July 2010. If resistance holds and CMG drops from here it will be a good signal that traders are moving to "risk off."
Chipotle Mexican Grill, CMG, Daily chart
The semiconductors were strong today and the SOX was up +5%. That certainly gave the tech indexes a boost and when the SOX and NDX are bullish it tends to carry over into the broader market, which it did today. But the SOX has now rallied up to resistance and the big move up might have been a capitulation with more bears throwing in the towel. That's just a guess and it would not be confirmed until today's rally is retraced. But the SOX has now achieved a Fib projection for the 3-wave move up from November 25th where the 2nd leg is 162% of the 1st leg at 405.52 (today's high at 405.25 is actually 27 cents shy of that target). It also hit its April 2010 high at 404.70. This 405 area could be tough resistance and potentially the conclusion to its rally.
Semiconductor index, SOX, Weekly chart
The RUT's rally from the November low looks very similar to SPX. Even though the squiggles are a little different, the wave count for an a-b-c move up and an ending diagonal c-wave (rising wedge from December's low) looks very solid. Today's rally up to the top of the rising wedge, near 779, looks like a good finish. So a rally above its 760-770 resistance zone looks bullish but only if it can continue higher from here. If we get a brief throw-over above the top of the wedge, near 779, followed by a drop back inside the wedge we'll have a reversal signal. Short with a stop at the daily high would be the suggested play. A drop below Tuesday's low near 764 would confirm the top is in place.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 770
- bearish below 763
At first the banks were AWOL in today's rally. But they joined up with the bulls in the afternoon and helped them out with a further rally. But while the other indexes are making new highs the banks are lagging. I see the potential for the banks to make it at least a little higher and drive the BKX index up to 44.22-44.43. This would have it achieving a 50% retracement of its February-October decline and two equal legs up from the October low. But a close back below its 200-dma at 42.84 could spell trouble for the bulls. Follow the money.
KBW Bank index, BKX, Daily chart
While the Transports had a positive day the index is still struggling with the Fib projection at 5222, which is where the 2nd leg of the move up from October is 62% of the 1st leg up. For the 2nd a-b-c up, which is the move up from November's low, it would have two equal legs up at 5285. A 78.6% retracement of the May-October decline is at 5269. So there's tough resistance in the 5222-5285 area and that's where it's currently stuck. Above 5300 would be bullish and back below 5094 would be bearish.
Transportation Index, TRAN, Daily chart
As one who has been bullish on the dollar, I'm getting worried about it. As reported last week, the commercial position is huge net long the euro, which in turn is net short the dollar. On top of that, the rally in the dollar is losing momentum and the rally has been choppy, which is more indicative of an ending pattern. I'm showing a continuation higher in a choppy move up to the top of a parallel up-channel from August, near 83 by early February, but I'm not feeling confident about it. A break much below 80.50 would have me looking for at least a pullback to its 50-dma at 79.52 and the mid line of its up-channel. Below that would be even more bearish and potentially a move back down to the bottom of the channel and its 200-dma near 76.60. Below that and it will be lights out for the dollar. What impact a declining dollar would have on the stock and commodity markets would then be the next big question. Both the dollar and the stock and commodity markets look like they're ready for a decline and that means everything will decline together or one of them is not bearish. Trade each chart on its own merits is about the only thing I can recommend at the moment. We'll figure out the intermarket relationship as it develops from here.
U.S. Dollar contract, DX, Daily chart
If the dollar does pull back a little more, such as to its 50-dma, it would support what I see as a little more upside for the metals and oil. Gold's bounce is struggling at the 50% retracement of the leg down from November but I see at least a little more upside potential to its downtrend line from September, currently near 1687. Once the current bounce is finished I'm expecting another leg down for a larger decline in gold (below 1400).
Gold continuous contract, GC, Daily chart
Silver has broken and retested its downtrend line from September, which is a bullish move. I see a little more upside potential to 32.13 where the bounce off the December low would achieve two equal legs up. A drop back below its 20-dma near 29.17 would be bearish.
Silver continuous contract, SI, Daily chart
Oil has pulled back from its January high in a choppy corrective pattern, which points to a higher move. I've got its broken uptrend line from February 2009 low, which it tested in November, December and January, for an upside target, near 105. Perhaps it will tag its 78.6% retracement of its May-October decline, at 106.30. Unless it rallies above that level I am looking for another leg down once the bounce off the October low finishes (like the stock market).
Oil continuous contract, CL, Daily chart
With a slew of big earnings reports tomorrow and a full slate of economic reports, there's likely going to be a market reaction. The CPI data, housing starts, building permits and Philly Fed, all before the market opens, could move the futures enough to start the day's direction. As for the unemployment claims data, no one believes the numbers anyway.
Economic reports, summary and Key Trading Levels
The indexes (and a couple of stocks that I used as examples) all show the market has now rallied up to potentially strong resistance. The market has been rallying steadily since mid December and closed at the highs today. That kind of setup in the past, especially when at resistance, has resulted in an immediate reversal the following day. I call these days mini-capitulation days where the bears throw in the towel and cover their shorts, disgusted that the market simply won't drop.
We've got near record low short interest and a wide spread between bullish and bearish sentiment. We've got low volume and waning momentum to the upside and stronger volume on selling days. And now we've got the indexes pressing against upside targets and resistance. It's a recipe only the bears could love (what few remain that is). If the resistance levels can be broken, preferably with increasing volume, and pullbacks hold above resistance, we'll have a confirmed bullish breakout. In the meantime, shorting resistance is a trading tactic and that's where we are right now. Obviously picking a top is risky (and has been frustrating) as they take much longer to get put in. Bottoms are easier to identify and they reverse quickly. Tops are grinding affairs.
The market could hold up into the end of opex as there's been a strong effort in the overnight sessions to keep the bears back on their heels. Any threat of a selloff is immediately followed by another buy program. There's an agenda and it seems this week's agenda has been to negate the high probability for a decline (10 of the past 13 years have seen a decline during January's opex week). With the sudden drop in short interest and with the excessive bullish vs. bearish sentiment, next week is going to be a challenge for the market if it's held up into the end of the week. Trade carefully over the next few days.
Good luck and I'll be back with you next Wednesday.
Key Levels for SPX:
- bullish above 1310
- bearish below 1277
Key Levels for DOW:
- bullish above 12,650
- bearish below 12,311
Key Levels for NDX:
- bullish above 2440
- bearish below 2352
Key Levels for RUT:
- bullish above 770
- bearish below 763
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