With two strong declines in the past week we're seeing important support levels breaking. The bulls can still turn this around but Thursday is looking like the day they must do so.
The market started off with a big gap up but then immediately sold off. It then tried valiantly to reverse the early selloff and at least close in the green. The market has been under distribution since the September high and especially in the past week. We've seen the heaviest selling since June but since the market doesn't move in a straight line we're looking for the next potential support level since some important ones have already broken.
Today's FOMC announcement was a non-event. Has the market reached the point where it doesn't care (doesn't trust?) what the Fed says? The announcement of QE3 at the top of the rally was both a strategic and tactical error in my opinion and may have had more to do with politics than economic theory. I didn't see a reason for it then and warned that it would probably mark the top of the market's rally. And in the process of selling off (both the QE3 and Draghi's "I'll do whatever it takes" rallies have now been retraced) market participants are starting to wonder about the ability of central banks to accomplish any more.
The financial markets are fickle in that they are driven by sentiment (not fundamentals). Change the sentiment and the market follows. It's really that simple. The hard part is figuring out when the sentiment shifts but I think it's apparent, so far, that sentiment has shifted since the September high and we're hearing more cautiousness. Risk-on trades are turning into risk-off trades. Buzz Lightyear-Bernanke has promised to put Humpty Dumpty together again but poor Humpty might have just fallen off the QE wall. Bernanke is looking at all the broken pieces and now we're hearing leaks that regardless of who is elected president Bernanke will likely not be looking for another term as Fed chief.
The past twelve years (longer actually -- it's been since the Fed was created in 1913) have been one grand financial experiment, especially by Bernanke who was touted as the one who could prevent Great Depression II (before him was Greenspan who said he would become the man known for stopping the Kondratieff cycle). All of the Fed's programs have failed and we're much poorer as a result. For some reason both Bernanke and Greenspan felt they could do what no other country has been able to do and what Japan has failed to do. Such hubris. It's now looking like Bernanke would like to exit stage left and leave the mess for someone else to clean up. The market is losing support lines and it may be synched with the worries (?) that Bernanke is throwing in the towel. And if the head of the Fed throws in the towel what does that mean for the Bernanke put?
Our best hope is that our political representatives can rise above their own selfishness and come together to solve the problems. The optimistic side of me says they'll be spooked into doing something. The realist in me says the reason why the stock market is facing some bleak times in the next 4 years (to get to the end of the bear market cycle) is because the problems won't be solved in time, at least not by the politicians. The price pattern is very clear on this -- we've got another leg down coming and the severity of it is the only unknown. If we don't get our debt under control the market, especially the bond market, will force the changes. I'd rather see it controlled rather than forced and the coming fiscal cliff dead ahead will be the first test to see what our representatives are made of.
There's been some speculation that the selling in the past few days is a result of a big hedge fund going belly up and is liquidating its holdings before their fiscal year ends so that money (what's left) can be returned to investors. Hedge funds, as a group, have not had a good year. If you feel like you've been struggling with your trading in this market, you have a lot of company. Knowing that doesn't help you make money but know that it's not you. This is probably the toughest market to trade than anyone can remember.
Tonight I'm going to take a more thorough look at the Nasdaq Composite index, COMPQ, the index that most people watch (instead of the Nasdaq-100, NDX) and I'll start up high with a quarterly chart to show price action from its 1974 low and two important long-term trend lines. This is a log scale chart and yet you can still see how price went parabolic from the 1990 low at 323 and especially from the 1994 low at 691. Because it's a log-scale chart the Fibonacci retracements are crammed toward the top of the chart but the size of the retracement into the 2002 low was significant -- down to the 78.6% retracement of the rally from 1974. It bounced up to the 50% retracement (a little higher than it) in 2007, pulled back and now is up to the 38% retracement at 3192. The double top in September was at 3196.
Nasdaq Composite index, COMPQ, Quarterly chart
There are two long-term trend lines of interest: one is the uptrend line from 1974 through the 2002 low and the other is a trend line along the highs from 1983 and 1987 (the "little" decline in 1987 looks pretty minor from here). The upper trend line was resistance in January 1992 and then it was broken for good in April 1995 (the parabolic push). It was broken in 2002 but recovered in April 2003 and was used as support in each pullback on the way up to the 2007 high. It was broken again in July 2008 and has been resistance for each rally attempt since 2010.
The uptrend line from 1974 was broken in October 2008 and has been resistance on multiple back tests since 2009. Whenever you see price push up underneath a broken uptrend line like this, especially when momentum is waning (see the bearish divergence since January 2011 rate-of-change, ROC), it's a warning to not get complacent about the upside and to instead anticipate a breakdown. Admittedly the breakdown is taking far longer than I anticipated.
The first leg down (2000-2002) saw the NAZ drop 78.4% and if we get an equal leg down, in percentage terms, from the September high at 3196.93 that would drop it down to 690.45. Interestingly, a parabolic rally most often returns to the start of the move, which is arguably the 1994 low at 691. Is it pure coincidence that a large A-B-C pullback from the 2000 high would have two equal legs down at the same level? I think not -- this is the kind of mathematical "balance" that I see over and over in the market.
Now we move in closer to the leg up from 2009, which is the c-wave of the A-B-C bounce on the quarterly chart. Actually it's a little more complex wave count (double zigzag W-X-Y) but for all intents and purposes we can consider it as a simple A-B-C. It's clear to see the influence of the trend line from 1983 and the broken uptrend line from 1974. Price is now approaching the uptrend line from March 2009 through the October 2011 low, currently near 2945.
Nasdaq Composite index, COMPQ, Weekly chart
In addition to the 38% retracement on the quarterly chart, at 3192, the NAZ retraced 50% of its 2000-2002 decline, at 3120. So the Fibs and trend lines, along with the wave count, strongly suggest bulls need to be very careful here. The wave count for the rally from March 2009 counts complete at the September high but because of the corrective nature of it I can't yet rule out another new high into the end of this year. The bearish divergence that's quite evident on the weekly chart above could continue with another new price high with even less momentum but that's not the way I'd want to bet my money here. For the bears though, confirmation of a trend reversal to the downside doesn't come until the NAZ drops below the uptrend line and stays below it.
The daily chart below shows the location of the uptrend line from 2009 more clearly and also the uptrend line from October 2011 through the June 2012 low, which the NAZ broke last Friday. On Monday and Tuesday it back tested the broken uptrend line and almost did it again today. Each back test has been followed by a kiss goodbye so the bears are holding. The next test for the bears is to break the 200-dma, near 2974 on Thursday and then it will be able to test the uptrend line from 2009, near 2945 tomorrow. Keep in mind the upside potential for another rally leg is above 3200 as long as the NAZ stays above 2940 and especially if it gets back above 3110. But consider closing long positions and look to play the short side if support breaks.
Nasdaq Composite index, COMPQ, Daily chart
Key Levels for COMPQ:
- bullish above 3110
- bearish below 2940
The short-term (intraday) pattern has me thinking we'll see one more low for SPX, which is setting up for Thursday, that will then complete a small 5-wave move down from the October 18th high. Its uptrend line from October 2011 through June is near 1400 and makes for a good downside target. A bounce from there into next week, potentially making it up to the 1440 area by the 1st of November, would then be a good setup for the next leg down into the end of November (maybe to set up a Thanksgiving rally from a much lower level). I also show the potential for a bit more of a choppy decline into early November (green dashed line) and then another rally leg into December to a new high but that's just an idea I'm currently considering. I think it takes a break below the 200-dma near 1376 to negate any further bullish potential. The bearish thing that we have going on at the moment is the breakdown from the bull flag pattern and the break below the 1425-1430 range, confirming the double-top pattern. I show a bounce off support near 1400 but it might not happen.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1464
- bearish below 1400
Like SPX, Tuesday's break below the bottom of its bull flag pattern is bearish. I had mentioned last week that it's been a common topping pattern at major highs -- we see these bullish consolidation patterns and traders start leaning long in anticipation of a breakout. The failure of the pattern then gets all those traders abandoning their positions in a hurry, which is why failed patterns tend to fail hard. But I still can't rule out another run by the bulls, especially if there's a strong bounce off support near 13K. Between the uptrend line from October 2011, near 13025, and the 200-dma, near 12970, there should be solid support. The question is what kind of bounce we'll get. If it's a choppy consolidation that essentially hugs the uptrend line then we can expect lower. But shorts need to move into defensive mode and wait to see if support breaks or not. Bulls can buy support and use a stop relatively close by. At a minimum, the bulls are going to want to see the DOW back above support-turned-resistance near 13300-13350 (the level of the breakdown on Tuesday).
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,590
- bearish below 12,970
Looking closer at the DOW's move down from the October 5th high, it's currently a 3-wave move and as such it could be an a-b-c pullback that will lead to another rally (green). The bearish pattern says it's a 1-2-3 and we'll be looking for a flattish correction that will then lead to another leg down next week. As for a short-term price target I like the 12995-12998 projection shown on the chart below. The 2nd leg of the move down from October 5th would be 162% of the 1st leg down at 12998. For a 5-wave move down from last Thursday, the 18th, the projection at 12995 is where the 3rd through 5th waves would be equal to the extended 1st wave. And of course 13K is a psychologically important level where bulls will buy and shorts will cover.
Dow Industrials, INDU, 60-min chart
To follow up on the NDX chart from previous wraps, like the NAZ it has now dropped down to the bottom of a down-channel for its decline and its 200-dma. There is the possibility we'll see it chop its way lower before starting another rally leg (green dashed line). But if the bearish wave count is correct (red), which says we're into the 3rd of a 3rd wave down, it's about ready to bust a move to the downside. Short term there are some bullish divergences (not apparent on the daily chart) and that has me feeling cautious. Watch for the possibility of a slight break of the 200-dma, tag some stops and suck in some shorts, and then rip back to the upside. It's a tricky spot so be careful here. What is bearish so far is the break of the uptrend lines from March 2009 and the one from June, followed by back tests on Monday and Tuesday and then a further drop today. Now we watch to see if support at 2645-2650 holds.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2785
- bearish below 2640
The semiconductor index is an important index as far as being a good economic indicator (chips are found in so many products) and unfortunately it's not looking like it supports the idea of a strengthening economy. Monday and Tuesday it had dropped down into a price-level support zone at about 360-365 and this morning it gapped back up. Unfortunately the gap was immediately sold into and it closed lower, but still at support. Bulls want to see it hold here otherwise look for a drop down to support near 350. In addition to the bottom of its down-channel from September it's where its H&S neckline from August 2011 is located. The August/September double top is the right shoulder of a big H&S pattern running from mid-2011. The head is the March 2012 high and what's particularly bearish about this setup is that the H&S pattern is the right shoulder of an even larger H&S top, with the same neckline, that runs from mid-2009. That makes the 350 area very important support for the bulls to hold. A drop below that level would also mean a drop out the bottom of the relatively steep down-channel from September, something that would confirm the bearish wave count calling for the same 3rd of a 3rd wave down mentioned for the tech indexes and the RUT. Have I mentioned how important it is for the bulls not to let the SOX break below 350?
Semiconductor index, SOX, Daily chart
Like the NDX and NAZ, the RUT is testing the bottom of its down-channel from September as well as its uptrend line from June, both near 812. Only slightly lower, near 806 on Thursday, is its 200-dma. It's fighting price-level resistance near 820 so a break of this range could set the trading direction for at least the next several days. Like the tech indexes, if the bearish wave count is correct, we're in the early part of a strong decline in a 3rd of a 3rd wave down. If the pullback from September is just a choppy correction then we could be getting ready for another rally into November/December. Let price lead the way before making any big bets right here.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 843
- bearish below 805
In last weekend's wrap I showed the BKX banking index and how it looked to be consolidating since September in a sideways triangle, indicating it should rally higher. But it failed instead with a breakdown from the triangle on Tuesday. In last Wednesday's wrap I showed the BIX banking index and how it had held support at the top of a 158-159 support zone. Well, the bears said otherwise and broke support on Tuesday, although it closed at support, and then broke lower and closed below support today. Unless it does another quick recovery we could be looking for a drop to its 200-dma, near 153.60 on Thursday, by next week (if not sooner).
S&P Banks index, BIX, Daily chart
There was a really nice setup yesterday on the TRAN that I had posted elsewhere and want to review it today because it's a very good lesson on a setup that has a high probability of success for a trade. As I've been showing for TRAN, price action has been extremely choppy and whippy this year as it has consolidated and sunk lower while the broader averages pursued new highs (bearish non-confirmation from the TRAN). The last thing you'd expect out of the choppy mess is a good trade setup (IYT can be used for trading the transports but my preference is to use the main index for analysis).
In the weekend wrap I pointed out how the TRAN had achieved its upside target for an a-b-c bounce off its September low, with two equal legs for the bounce, and at the same time it hit its downtrend line from July 2011. That was good for a short play as Friday's sharp decline was a bearish kiss goodbye following that back test and it broke back below its uptrend line from June. Following Monday's low it bounced back up and tagged its uptrend line for another back test of that uptrend line. Today's sharp decline leaves another bearish kiss goodbye and s complete retracement, and then some, of Tuesday's sharp rally. There's no other way to look at this chart right here as anything other than at least short-term bearish.
Transportation Index, TRAN, Daily chart
Another reason that I liked the setup yesterday for a short in transports is that in addition to testing its broken uptrend line from June, the bounce off Monday's low was another a-b-c where the 2nd leg up achieved 162% of the 1st leg at 5113. The high was at 5120 and not only was it a back test of its broken uptrend line from June but it also tested its broken uptrend line for the bounce off the September low, which crossed Tuesday afternoon at 5120. The TRAN could not have hit it more perfectly and it was the reason I recommended shorting it there. This is the kind of setup where you take the trade 100% of the time and then simply set your stop in case it doesn't work.
Transportation Index, TRAN, 30-min chart
The U.S. dollar got a little more follow through to the upside the past two days after consolidating for a day at its 20-dma on Monday. It's now approaching its 50-dma, near 80.28 on Thursday. A pullback/consolidation would be typical but should then lead to another move higher. The bullish case for the dollar remains alive as long as it stays above 79.
U.S. Dollar contract, DX, Daily chart
Last Friday gold had dropped to its 50-dma and consolidated there on Monday. But then it broke down on Tuesday and dropped a little lower today. The next line of support is the bottom of a parallel up-channel, near 1680, that was created off the trend line across the highs from June 6th to October 5th, with the parallel attached to the August 15th low. This channeling technique will often provide a very good trading guide. Gold could be ready for a bounce to correct the decline from October 5th but if it breaks below 1680 it should continue down to about 1625 before it will be ready for a bigger bounce.
Gold continuous contract, GC, Daily chart
Gold bulls argue that gold is going to rally very strong into next year because of the inflation created by the Fed's monetary policy. My argument for years has been that the Fed has been pushing on a string in an effort to stop deflation but will ultimately fail. In this coming weekend's report I'll discuss why the Fed is failing in their effort and why the gold bugs are correct but not this time (it truly is different this time). Deflation will win out in the end and with deflation comes deflated asset values, including gold.
As of last weekend, with oil holding above it October 3rd low at 87.70, I had thought there was a decent chance for another bounce up to its 200-dma near 95.50 before rolling over. But this week's decline below the October 3rd low significantly reduces that possibility. If it's in its 3rd wave down for the decline from September 14th it should head quickly down to its June 28th low at 77.28 before consolidating for a couple of weeks and then drop lower into December. The weekly chart shows how a bearish move might unfold into 2013 -- a decline to about 67 before the end of the year and then a big bounce into the first quarter of 2013 before heading lower again. But the bears don't own the pattern until oil drops below its uptrend line from October 2011, near 78.50, since that line could be the bottom of a big sideways triangle pattern that will play out into the first half of 2013 before it will be ready for another big rally into 2014.
Oil continuous contract, CL, Weekly chart
Following today's lackluster economic reports we'll have unemployment claims and the durable goods order and pending home sales. There are expectations for a big recovery in the durable goods orders, from -13.2% in August to +7.4% for September. If the number comes in negative again it would not be market friendly.
Economic reports and Summary
The indexes are at/near some major support levels and it's looking like at most we can expect a minor new low on Thursday and then the start of a bounce into next week that will then set up another leg down (or not). But the market is very nervous here and there are more than a few fund managers with their fingers hovering over their sell buttons. They've quickly moved from wanting to buy every dip, in hopes of outperforming the market in the next rally, to selling every blip. They figure if they can get out with most of their profits intact and let the market sell off without them onboard it will be another way for them to outperform the market. The trouble is they're all thinking the same thing.
The tech indexes and the RUT show a potentially very bearish pattern that calls for a strong decline from here. Call it a disconnect to the downside, a mini crash or just relentless selling for at least a few days. I don't like planning for that kind of trade since the event is so rare but until the market starts a bounce in the next day, ideally after only a minor new low tomorrow, be aware of the risk for something to spook the market into hard selling (sometime selling simply begets more selling, especially if stops below support start getting hit). The exit door gets very small when everyone wants out at the same time. Throw the quants in there and the HFTs would have a field day with a strong move, which would only exacerbate the move.
It's an important spot and the next day or two will tell us what we need to know as to whether or not support will hold and in turn whether or not the year's high is behind us. As for the longer term, the following chart shows a 7.25-year cycle that has timed the market lows with uncanny accuracy since the 1970s. We're now in the middle of the cycle and it points down into 2016, which times well with an expected completion of the secular bear market (2015-2017). There will be plenty of bull and bear market cycles to trade in the coming 4 years but from a longer-term investment perspective, do you want to be a buy-and-hold investor right now?
7.25-year market cycles, chart courtesy elliottwave.com
Good luck, trade safe and I'll be back with you this weekend (filling in for Jim one more time).
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