The market got what it wanted out of Germany's court approval of the ECB bond-buying plan and gave a ho-hum response. Now we wait to see if the market gets what it really wants out of Bernanke and it likely will not be a ho-hum response.
Germany's Federal Constitutional Court announced their decision today to not block the ratification of the ECB's 500 billion euro ($644B) permanent rescue fund, known as the European Stability Mechanism (ESM), and the ECB's implementation plan. That's the good news. The maybe bad news is that there are strings attached -- Germany will have a cap on how much it will contribute to the fund, which is 190 billion euros, without government approval. That's about a quarter of the total from all the EU members. This is a preliminary ruling with the final ruling expected in December. While no one expects the ruling to change, the approval can be considered a marginal green light.
At the moment the decision seems to have been priced into the markets, including the currency markets since there wasn't much of a reaction. The euro closed marginally higher while the U.S. dollar was only marginally lower, both correcting their initial move following the announcement. Now we wait to see what the FOMC decides to do tomorrow and how much of it is priced into the market. I'm thinking sell-the-news since a move by the Fed is priced in and if there's no move by the Fed the selling will simply be stronger. As I'll get into, the price pattern is now set up for a reversal as well. All it needs is for someone to light the match.
It was a very quiet day for economic reports with only export and import prices, wholesale inventories and crude inventories. Nothing out of line and nothing market moving. Nothing is moving this market except news on what the central banks are doing. It remains so disconnected from the world and only interested in how much newly created money is coming into the system. The central bankers have created a baby that refuses to wean itself, preferring instead Bernanke's nipple (although it will take Draghi's nipple if that's all there is). Prepare for a temper tantrum if the nipple is held back tomorrow.
Other than perhaps an extension of Operation Twist I don't see Bernanke doing anything tomorrow, especially now that the ECB has a green light to continue with their bailout plan. I've mentioned many times in the past that the Fed has a history of being reactive, not proactive. With the stock market challenging multi-year highs (and the stock market has been a target of the Fed) there's simply no reason for Bernanke to pull out the bazooka and fire it at...what? The stock market is not crashing and the economic numbers are weak but not atrocious (yet). If Bernanke were to use up a valuable bullet, perhaps his last one, and the market sells off and the economy contracts further what's he going to do for an encore? At that point the market would learn of the Fed's ineptitude, I mean incompetence, I mean impotence. We'd all see that the Emperor wears no clothes.
The majority of market analysts that I've read believe the Fed is going to implement the next phase of QE and I could be completely off base here but I think they're crazy. They're either crazy stupid or crazy smart in getting the masses to buy into the hype while they've been selling into the rally. This week's afternoon selling is the mark of distribution so one never knows about these things. But it's probably true that a lot of fund managers, many of whom act exactly like retail traders, have been buying into the rally and hype because they have to. They have to chase the market higher otherwise they'll be underperforming their peers and that's the quickest way to the unemployment line. They know they'd struggle to find another job.
The problem with so many fund managers chasing their collective tail to ensure they don't fall behind is that they become panic sellers when the market turns back down. They then start chasing it lower in order to protect themselves from further loss. Keep in mind that outperforming your peers could simply mean you lost less than the others or the S&P 500. It's why a rally built on hype and hope becomes a dangerous market that is susceptible to a sudden and uncontrolled selloff (another flash crash could be right around the corner).
Battling the bears is the Presidential election cycle which points to a rally into November, although that cycle pattern calls for a pullback from here before heading into a final high. The stock market doesn't do well after this cycle finishes but it's something for bears to keep in mind. I'll review some important upside levels the bulls need to climb over and if they do then I'll be looking for a stronger rally as well. It doesn't matter if the rally doesn't make sense in the short term; the only thing that matters is liquidity (such as from the central banks) and a collective desire to be long the market. Therefore, while I'm looking for a top this week I'm mindful that if it doesn't arrive then I'll be looking higher, at least into mid-October if not into November. October has been a very important turn month since the October 2002 low and we could be looking for one again this year.
Pictures usually speak louder than words so let's see what the picture looks like as we head into tomorrow's FOMC announcement. I'll start with the DOW tonight and first look at its weekly chart. Because the rally off the March 2009 low is a corrective wave structure there are a couple of ways to count it and not be wrong. I'm showing one way, which looks at the bounce as an A-B-C correction to the 2007-2009 decline and the c-wave is an ending diagonal (rising wedge) that calls for a 5-wave move up. The 5th wave is the move up from June. By the rising wedge pattern I see upside potential to about 13600 in October. But with the shorter term wave pattern looking complete (or very near complete) the risk is for the DOW to start down at any time. The A-B-C bounce pattern calls for a complete retracement (back below its March 2009 low at 6470) over the next couple of years.
Dow Industrials, INDU, Weekly chart
The daily chart below focuses in on the rise from June and as the 5th wave of the c-wave it too is forming an ending diagonal, which is very fitting for the end of a major rally -- a rising wedge to complete a larger rising. And keep in mind that wedge patterns tend to get retraced much faster than it took to build them. The June-September rally could be retraced in less than two months and potentially faster than that. Two equal legs up, labeled W-X-Y on the daily chart points to 13386 for an upside target, which the DOW came close to today with a high at 13373. There is higher potential to the top of its rising wedge, currently near 13500. So the two rising wedge patterns give us a 13500-13600 target zone if the bulls are rewarded for their faith in the Fed tomorrow. But if the bears take a bite out of market tomorrow and drop the DOW below Monday's low near 13251 it's going to signal that a top is likely in place.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,386
- bearish below 13,250
The move up from July 24th fits best as an a-b-c (for wave Y on the daily chart) and the c-wave is the move up from September 4th. At the moment it looks like the 5th wave is the move up from Monday and it achieved equality with the 1st wave at 13370 with today's high at 13373. It's not a clean finish yet and therefore I'm showing some more upside before reaching a top but again, a drop below Monday's low would mean the final 5th wave finished and it will be the bear's turn at the feeding trough.
Dow Industrials, INDU, 60-min chart
Since last week's update SPX shot out of its small descending wedge pattern as I had depicted and it head right for the 1435-1437 projections, where it achieved two equal legs up from June and the 5th wave of the c-wave up from July 24th is 62% of the 1st wave. Higher potential exists to 1459 where the 5th wave would equal the 1st wave but it will have to get through multiple trendline resistance levels near 1442 and 1450. It's been either consolidating this week for another run higher or it's in a topping pattern. Thursday could answer the question which one it is.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1437
- bearish below 1401
The 5th wave of the c-wave above is shown more closely on the 60-min chart below. It needs to be a 5-wave move and following Monday's low it looks like it's in the final 5th wave. That means once it completes we'll have a completed rally from June which will complete the rally from March 2009. That's the potential but it means SPX can't rally above 1460 and should fail at a lower level. The final 5th wave would equal the 1st wave at 1441.73, which crosses the trend line along the highs from June 19 - August 21 on Thursday. The next projection for the 5th wave, where it would equal 162% of the 1st wave (creating an extended 5th wave) is just shy of 1450, which is near the trend line along the highs from May 2011 - April 2012. If price chops higher in a small rising wedge pattern as depicted below it will indicate the end is very near and get ready for a breakdown.
S&P 500, SPX, 60-min chart
While SPX has made new highs in September it has not been reflected by new lows in the VIX. Following its low on August 17th the VIX broke its downtrend line from June 4th and the higher low on Monday was essentially a back test of its downtrend line. The bullish kiss goodbye from there supports a bullish interpretation of the VIX here and of course that means bearish for the stock market. The VIX typically leads the market by a few weeks and that's where we are now. Lows around 13-14 have marked highs for the stock since May 2008, even if for just a healthy pullback, so it all adds up to reasons for extreme caution by bulls right now.
Volatility index, VIX, Daily chart
Before getting to the regular NDX chart, I thought I'd show a quarterly chart of the Nasdaq Composite. The uptrend line from 1974 through the October 2002 low is where the rally off the 2009 low has been bumping up against since the end of 2009. Three years and all it's been able to do is hug the underbelly of that line, something that is typically bearish and when it finally lets go it usually does it with a bang. Similar to the monthly NDX chart shown last week, the sharp decline from 2000 followed by the a-b-c bounce off the 2002 low will be followed by another sharp decline. These a-b-c corrections tend to stay within a parallel channel, the top of which is being tested again (last test was the March/April high). So we've got the broken uptrend line and the top of its parallel up-channel (bear flag) intersecting near the current price. The higher probability pattern calls for another leg down to complete a larger A-B-C pullback from 2000, which means a decline below the 2002 low at 1108 (for at least a -65% decline). Nothing is certain in the stock market but that's the risk for those who want to stay invested for the long term (it could be a very long time before we see current levels again).
Nasdaq Composite, COMPQ, Quarterly chart
Like SPX, NDX's 5th of its rally from July 12th has achieved 62% of its 1st wave at 2831 (a point shy of that last Friday and has since sold off a little more than the other indexes. I tweaked the wave count a bit (moving waves A and B) and found that the c-wave is 162% of the a-wave at 2829.16. The September 6th and 7th highs at 2829.71 and 2829.95, respectively, did a nice job meeting that target. NDX's rally could easily be considered done at this point but as with the other indexes I can't yet rule out another rally and NDX has a higher target zone at 2884-2891 that I mentioned last week. The 5th wave would equal the 1st wave near 2884 and the 127% extension of the April-June decline is near 2891. It takes a drop below 2760 to confirm it has broken its uptrend line from July 24th and its 20-dma, near 2780 on Thursday, as well as confirm the EW count has finished (unless the count morphs into some larger pattern that's not at all evident from here).
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2831
- bearish below 2760
Two potentially important sentiment stocks to watch from here, which have a large impact on NDX, are AAPL and GOOG. The first one I'll look at is GOOG since it has been in a rising wedge pattern since its November 2008 low (similar to the wedge patterns on the broader averages) and last week's rally had it rallying out of the top of the wedge, near 685. It hit a high of 712.81 on Monday and has since pulled back to the top of the wedge. A drop back below 680 would leave a throw-over finish for the e-wave, which is a common finish to these patterns. But a bounce off 685-ish that then heads to a new high would be a bullish breakout.
Google Inc., GOOG, Weekly chart
A closer look at this is shown on the daily chart below and just below the top of the wedge is its 20-dma, near 682, which was tested today. This moving average will hold as support if the bulls are in control. Therefore I think it's safe to say a close below 680 would be a confirmed bearish move and going back to the weekly chart above, the wave count calls for a complete retracement of the rising wedge (wave-(c) down to below its November 2008 low at 247) and likely just as quickly as the 2007-2008 decline.
Google Inc., GOOG, Daily chart
The next chart is AAPL's. Traders have been trying to run the stock higher in anticipation of today's announcement about the iPhone5. AAPL has a habit of rallying into these announcements and then selling off (sell-the-news) so we'll see how it does from here. The iPhone5 is larger, has better battery life and 4G/LTE capability but it doesn't have any new features and while the stock rallied today it only put it into the middle of its 3-week trading range.
My last update on AAPL, showing time frames from monthly down to daily, was August 22nd and in that update I mentioned the 675 level as potentially important if the bounce off its May low was part of a large corrective pullback pattern from its April high instead part of a new bull run. This is the 127% extension of the April-May decline. One other important extension is the 138% and this 127%-138% extension zone is important to watch because it's a common reversal zone. That gives us 675-688 to watch and since August 21st it has failed to get through it, reaching a high of 683.29 on Monday to create a double top with its August 27th high, with bearish divergence. Following Monday's high it then broke last Friday's low at 657.25, which should be an indication that its high is now in place. Its 20-dma is 663.55, which should be support if the bulls are still in control, especially since it hasn't been tested in the past 6 weeks. Closing below that level would help confirm we're probably in the early stages of a reversal and keep in mind that the correction pattern off the April high calls for a sharp two-month decline that should drop AAPL below 500. But if the bulls remain in control and run it above 688 we could see AAPL run another 100 points easily.
Apple Inc., AAPL, Daily chart
The RUT has been buddy buddy with the DOW lately. I expected to see the DOW holding up better than the other indexes near a high because money tends to rotate out of the riskier stocks and into the larger-cap blue chips. Either fund managers are trying to chase performance, believing the market will head higher into November (the Presidential election cycle), or the RUT has become the favored HFT vehicle and they're just pushing it around (higher has been offering least resistance) since it's easier to do. In any case, the RUT's chart shows some upside potential to 855.74 where it would have two equal legs up from June but at the moment it has satisfied the projection at 839.39 where the 5th wave of the move up from June 24th is equal to the 1st wave. The 5-wave move up can be considered complete and therefore a reversal back down could happen at any time.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 840
- bearish below 819
Following the drop in Treasury yields from the August 21st high and the bottom of the pullback on September 4th TNX has now made it back up to its downtrend line from April 2011, which stopped the August rally. In addition to the downtrend line, near 1.76%, I have two price projections for the bounce off the September 4th low based on a corrective wave count that coincide near 1.775%. Therefore the first sign of bullishness for TNX (bearishness for bond prices) will be a rally above 1.78% and confirmed bullish above its August 21st high at 1.863%. That would also be a break above its 200-dma, currently at 1.841%, in which case I would expect a strong rally and that would mean the Fed has lost control of rates. Today's high was 1.773% and therefore the target zone for the bounce has been met. If the FOMC decision supports a continuation of some kind of bond-buying program we should see a reversal of TNX from here and a continuation lower. If the Fed continues to only talk about how wonderful and powerful they are we could see bonds continue their selloff and yields head higher from here.
10-year Yield, TNX, Daily chart
Last week I showed the BIX daily chart to point out resistance near 159 and why it would be more bullish above 161. With the strength in the banks this past week the BIX broke above 161 (Monday's high was 164.43) and is so far holding above that level. Now the question is how bullish it will be. The weekly chart below shows the April 2010 high was 165.89 and I have to wonder if the BIX will be able to do any better than that. The previous highs in 2011 and March/April 2012 were 160-161 so we could be talking about simply another test of this level and this time with bearish divergence. The wave count shows a 5-wave move up from August 2011 and therefore the rally could be finishing here, right at resistance again. Based on this I am not bullish the BIX above 161.
S&P Banks index, BIX, Weekly chart
What's going on with the transports? Last week's decline turned into a big head-fake break of its uptrend line from June and caught shorts by the short hairs. It's been a non-stop rally over the past 5 trading sessions and I'm not sure why. I'm wondering if we're going to get a head-fake break of the downtrend line from July 2011, near the August 21st high at 5224. This is just one big choppy mess with no clear direction so it's useless to us at the moment.
Transportation Index, TRAN, Daily chart
The dollar's break of its uptrend line from August 2011 looks bearish but based on the corrective wave structure for the pullback from July 24th I continue to believe it's just a pullback correction before heading higher. The next potential support level to watch is the price projection at 79.43 which is where the second a-b-c of the pullback is 162% of the first a-b-c. Today's low was 79.50.
U.S. Dollar contract, DX, Daily chart
Gold has been consolidating this week and that supports the idea that it could rally up to its broken uptrend line from October 2008, near 1771, which is the 62% retracement of the September-December 2011 decline. A rollover from that level would make a good short entry but it will be interesting to see if it rallies further if the Fed balks at doing any more QE right now.
Gold continuous contract, GC, Weekly chart
Oil has been consolidating around its 200-dma for the past three weeks and I can't figure out if it's bullish or bearish. I see the potential for a rally to a price projection at 102.58 where trend lines and two equal legs up from June 28th cross on September 20th and a rally above 98 would support that idea. It takes a drop below 94 to suggest the consolidation was not bullish.
Oil continuous contract, CL, Daily chart
Unless the PPI numbers that are reported tomorrow, before the bell, are unexpectedly high, they should have no impact on the market. But a higher than expected number could give the Fed the cover they need to say they need to wait before implementing the next QE program. The big report the market is waiting for is the FOMC decision that will be announced at 12:30 and then Bernanke's press conference that starts at 14:15. The market will then have all the information it's been waiting for and we get to see what it does next.
Economic reports and Summary
The market has been rallying on the hope for more money from both the ECB and the Fed. The ECB will implement a bond-buying program but it will be "sterilized" which means no new money created -- they'll sell assets to cover the purchase of sovereign debt. If the Fed announces they'll start a new QE program, probably buying bonds, we should see the bond market rally. I don't believe the Fed will announce something the stock market will like and that could cause the stock market to sell off. A QE program is priced in so announcing something kind of new program could be met with the same ho-hum response we saw with the German court's decision. But if the stock market doesn't get what it wants we could see a little temper tantrum with selling.
Bernanke will likely continue his efforts to jawbone the market higher without committing to anything. He likes the virtual QE program and how well it works. The market might not be satisfied with verbal intervention anymore. They want money and they want it now. Bernanke is walking a tight rope here and the bulls are holding one end of the rope. They'll drop their end in a hurry if Bernanke doesn't play their game from here.
Expect the usual cha-cha-cha dance around FOMC and probably in the afternoon as well. The price pattern is set up for a reversal and the FOMC announcement could be the catalyst. But clearly we can't know how the market will react and oftentimes we see the market go the other way from the post-FOMC direction. And if the Fed knows the market is likely to react negatively they'll be prepared to stuff the channels with buy orders to prevent a selloff. All of this means trading will likely be difficult tomorrow and waiting at least until Friday may be the more prudent thing to do. Wait for a prettier bus to come by before you get on for a ride that you may wish later you hadn't taken.
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