With the feared (expected?) tax increases coming in January, as part of the fiscal cliff and the tax changes, investors are taking their money off the table now to lock in their capital gains at the lower tax rate rather than wait until next year. Add European worries to the mix and it's a tough time to be a bull.
CSCO's earnings announcement after yesterday's close gave a nice little boost in the after-hours session, which carried over into the start of trading today. The bears were licking their chops the whole time and couldn't wait until they could take another bite out of any bull who dared to enter their turf (which is below the 200-dma's). This morning's gap up was sold quicker than you could say "who stole my rally?" Other than a little bounce/consolidation mid-morning and then another smaller one in the early afternoon, the sellers clearly had control of today's market.
Any stock that has had a nice capital gain this year (or past three years, which includes the majority of stocks) has been subject to selling pressure. Look at AAPL, down -24% from its September peak near 705 to today's close near 536. With the worries over the coming tax changes, capital gains and dividends will be taxed at a higher rate. Tax planning says you should sell those stocks now, take the capital gain and pay this year's tax rate, and then buy the stock in 30 days (to avoid the wash sale rule) if you still like the upside potential. Obama was out today talking about his plan for higher taxes on the wealthy and that prompted further selling.
But it's not just the stocks with big capital gains that are being sold. Many stocks are owned for the dividends and if those dividends are going to be taxed at a higher rate it might be better to own something else, such as municipal bonds. There's plenty of risk there but that discussion is for a different day. In the short term there could be a higher demand for munis (just be sure you know which ones you own so as to reduce your risk of trouble down the road with weak municipalities). The end result is that we have a lot of selling that's being caused by tax planning and much more selling than would typically be seen toward the end of the year.
Now we throw in the quants, who are essentially trend and momentum traders, mix in a little opex, sprinkle with European worries and put a cherry (bomb) on top and you have to wonder if it's a recipe for continued selling. There was a report in a German newspaper that said European authorities would probably not vote to give Greece another aid tranche at next month's meeting, as has been planned. One step closer for Greece...
In addition to the tax selling there may have been concerns that the Fed's QE-IB (QE-Infinity and Beyond) program might not accomplish what had been hoped for by stock investors. The new QE plan was to start today and the hope has been that about $40B per month would make its way into the stock market. The money was going to be created to purchase mortgage-backed securities (MBS) from banks and other financial institutions and the money would begin hitting the Primary Dealer accounts (JPM, GS, Citi, BAC, etc.) today. This money could then be unleashed into the stock market, providing a bid under it. But there might be a slight change in plans and I have to wonder if Big Money may have been aware of the change, providing further incentive to sell following the QE-inspired rally into the September/October highs.
The Treasury announced yesterday that it will auction $25B in Cash Management Bills (CMB), starting November 14th, the same day the MBS purchases were supposed to start. A CMB is a short-term security (a few days to six months maturity) sold by the Treasury to meet temporary shortfalls and it enables the Treasury to issue fewer longer-term notes. This may act as a vacuum, sucking up the extra cash the Fed is creating that was intended to buy MBS. In other words QE-IB may be on hold as long as the Treasury's need for more cash overrides the Fed's desire to pump more money into the purchase of MBS. If market participants start to believe the Fed won't be there to back-stop a decline (taking away the Bernanke put) it could spark more selling to remove risk.
The Federal deficit for October looks to be about $120B, almost $22B more than October 2011. If the government keeps spending like a drunken sailor it's going to continue sucking up the extra dollars from the Federal Reserve's latest QE program. The stock market will be sucking hind tit and with the lower-than-anticipated liquidity this fall it could be tough for the bulls to justify why the stock market should be rallying. The earnings reports and Q4 forecasts certainly don't justify a higher market. The selling we've seen in the past month is very likely reflecting all of this information. A chart shows you what the market knows at that moment and clearly the market has not liked what it's seeing and hearing.
This afternoon we received the minutes of the last FOMC meeting in October there had been a discussion about future QE targets and interest rates but mostly about the future. The $45B per month that's been used for purchases of longer-term debt under Operation Twist was to be rolled over into new debt as Treasury notes expired but the minutes show there is agreement to extend the purchases into outright balance sheet expansion once the program completes at the end of this year (no intention to sell the Treasuries back to the market any time soon). This confirms that the Fed is buying the U.S. Treasury's debt (monetizing it) and by holding longer-term debt they'll have every incentive to let inflation go higher so that paying down the debt will be cheaper for them. Japan also announced last night that they're going to raise their inflation target from 1% to 2-3%. All the central banks are preparing for higher inflation due to their accommodative policies. What a racket(eering).
Relative to the 200-dma's, which is the primary moving average used by many fund managers as their "in or out" gauge, we've seen those moving averages give way to the sellers. The tech indexes were showing early weakness in this regard as both the COMPQ and NDX snapped their 200-dma's with the gap below their averages on November 7th. The DOW and SPX also broke their 200-dma's on November 7th but only marginally on that day. Unfortunately the selling continued and with both the DOW and SPX below this critical support level it sounded the alarm signals in fund managers' offices. This technical signal combined with the more fundamental reasons for selling (if tax selling can be considered fundamental, along with P/E and other valuation models), has been a bull killer.
We follow the charts here and with this week's added selling we are now looking for possible levels of support and what will likely be resistance to any bounce attempts. I'll start off with the most-watched index, the DOW, and see where the bears are taking us.
With last week's break of its uptrend line from October 2011 the DOW has emphasized the break with this week's decline. Last week the DOW closed below its 50-week MA at 12881 (closing at 12815) and unlike the last time it broke it marginally, in June, there's been no recovery this week. In fact, Tuesday's rally attempt in the morning was rejected at its 50-week and today's selloff leaves a slap in the face following the back test and kiss goodbye. Assuming we've seen a major high for the market, as indicated on the chart, a decline won't be in a straight line of course but a retracement of the rising wedge pattern should be quick and price-level support near 10700 is the downside target in the next few months.
Dow Industrials, INDU, Weekly chart
The DOW's H&S topping pattern, running from the left shoulder in August, has a downside objective near 12400. A Fib projection for the 3rd wave of the move down from October 18th is at 12403 (162% of the 1st wave) so we've got nice correlation between the two projections. From there I would expect to see a choppy multi-week consolidation/bounce into early December before heading lower again (12K is the downside target to test the June low for a December low and then start a higher bounce into the end of the year -- Santa Claus rally). It takes a rally above 12900 to convince me the bulls are doing something more than just a bounce correction.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 12,900
- bearish below 12,400
To show the change in character of the market now vs. the decline in June, the chart below is a clean version of the above chart, showing just the 200-dma. As noted on the chart, the June break below the 200-dma resulted in a close that was 1.1% below that average. It was then followed by a doji day and then a rally that reversed the big red candle that broken the 200-day. Last Thursday the DOW closed 1.4% below the 200-day and then on Friday we had a doji day. Monday needed the bulls to step back in and start the market back up but it was just another doji day. Tuesday followed with some selling and today was strong selling. The fractal pattern setup has been broken and it's bearish.
Dow Industrials, INDU, Daily chart, 200-dma
Not mentioned above for the DOW is the fact that today's selling had it dropping out the bottom of its parallel down-channel, which is the same for SPX, shown below. I like to use channels because a correction (pullback in this case) will usually stay within the channel and you'll often find two equal legs down for an a-b-c pullback. The projection for two equal legs down from October 18th is shown at 1372.64, which made that a key level to the downside. SPX consolidated near that level for three days before breaking today. It was why I was paying close attention to the bounce pattern off 1273 last Friday; I wanted to get a heads up for the possibility we'd get the start of another rally leg. Today's decline answered the question emphatically -- there will not be another rally leg (only bounce corrections). Breaking below 1272 had it also breaking below the bottom of its down-channel, which significantly increases the probability that the leg down from November 6th is a 3rd wave. That in turn significantly increases the odds that the decline from the September/October highs is in fact a trend change to the downside.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1396
- bearish below 1335
For now I'm looking for potential support near 1335, consolidate/bounce for 1-2 weeks and then head lower (1290-1300 downside target). Unlike the DOW I'm counting the start of the decline from the truncated high on October 18th (vs. the October 5th high for the DOW) and the SPX pattern calls for a Santa Claus rally to begin in early December. If the DOW's wave count is correct we'll see the market stair-step lower through at least mid-December. I'll be watching the pattern, bullish divergences, price support levels, etc. to help identify which pattern will be the favored count. For the next couple of weeks it doesn't make a difference since both patterns will be looking for lower lows.
Now that SPX and the DOW have broken below the bottoms of their down-channels they become resistance (typically). The bottom of SPX's channel is near 1364 Thursday morning and 1362 by the end of the day. The equivalent level for the DOW is higher -- near 12685, so keep an eye on both. If we see a bounce up to the line watch to see if it acts as resistance, which should be a good setup to short it for a ride down to the 1335-1340 area. That kind of move should then be a good setup for a larger bounce/consolidation next week before heading lower again.
S&P 500, SPX, 60-min chart
This is a very risky spot for the market since significant support levels have given way. It could bring out the sellers en masse since so far we've seen very controlled selling with no signs of panic. We've only seen mildly higher volume during the selling, leaving many sellers-in-waiting out there. Indicators such as TRIN and VIX are showing no signs of concern by investors, who apparently believe the current decline is of no concern (we've been conditioned to ignore declines since the market always comes back). If thinking about trying to buy the dip, I'd much rather miss a v-bottom reversal than attempt to catch falling knives here. The SPY chart below shows the volume. Note the increasing average in volume since the market high in September. Dying volume in the rally and increasing volume in the decline is another clue of a trend change.
SPDR S&P 500 Trust, SPY, Daily chart
NDX also broke below the bottom of its down-channel and looks like it could head lower to its uptrend line from 2009, near 2475 (arithmetic price scale). Lower than that would be much more bearish. The short-term pattern supports the idea that we'll start a bounce/consolidation from here into next week before dropping lower.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2660
- bearish below 2475
The RUT was the leader to the downside today, which is never a good sign for the bulls. I dropped sharply out of its down-channel, also not a good sign for the bulls. Once it gave up support near 790 it's looking like it's making a bee line for next price-level support near 765. That would make a good setup to get the bounce/consolidation into next week before heading lower. Back above 790 would be at least short-term bullish and back above 808 would be bullish as it would negate the bearish wave count and be a break of strong resistance. I'll believe it when I see it.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 790
- bearish below 765
I've been showing the Treasury yields in my updates and for tonight I'll show bond prices with the 30-year Treasury emini futures (ZB). Trading TLT, the Treasury ETF, would be similar. The weekly chart below shows the bond prices since the lows in 2008 and the longer-term pattern for the rally from 1984 is a parallel up-channel. The chart below is with the log price scale, which distorts the parallel channel, but it does a better job showing how price has been reacting to the top of the channel at the June and July highs. The top of the channel is currently near 154'10 (for reference, 154'32 would be 155'00) and for the a-b-c move up from March the c-wave would be 62% of the a-wave at 155'08. That gives us roughly a 1-point range for a possible top to the rally (bottom for yields).
30-year Treasury emini futures, ZB, Weekly chart
There is higher potential for bond prices, as shown on the chart. If the c-wave is to achieve equality with the a-wave (for two equal legs up from March), that will target 161'29 (161.906 projection shown on the chart). We could see a rally into March/April 2013 where that upside projection crosses the top of the rising wedge pattern for the rally from February 2011 (note the confirming bearish divergence with this wedge). A break of the uptrend line from April 2011, confirmed with a break of last week's low at 148'03, would be the first bearish heads up and then below 146 would confirm we've seen the high for bond prices. Keep in mind that this will be a multi-decade high, which in turn means a multi-decade low for yields. Lock 'em in when we get that signal.
Looking at the BKX index with the log price scale it shows the uptrend line from October 2011 was where it had closed yesterday and then broken with today's strong decline in the banking sector (one of today's weaker sectors). It also closed beneath its 200-dma. But switching over to the arithmetic price scale shows today's decline was stopped by the uptrend line. A break below today's low at 46.54 would therefore be a break of multiple levels of support. It's a good place for a rest and to get the bounce/consolidation into next week before heading lower again.
KBW Bank index, BKX, Daily chart
There's no resolution yet from the TRAN as the months-long sideways triangle pattern continues to hold. The bottom of the triangle is near 4900 so look for at least a bounce on Thursday. Below its September 28th low near 4870 would be a confirmed breakdown from the triangle pattern. This index is building a lot of energy for a big move.
Transportation Index, TRAN, Daily chart
The dollar's rally since its October 31st low has formed a bearish rising wedge so there are some short-term bearish signs at the moment. The trend is still up and the parallel up-channel for the rally from October 17th can easily handle a small pullback/consolidation and as depicted on its chart, there's still upside potential to the 81.64-82.13 area before a larger pullback correction. I continue to expect the dollar to rally higher into next year.
U.S. Dollar contract, DX, Daily chart
Gold's bounce made it up to just shy of its broken 50-dma and stopped short of a Fib projection at 1740 that I had mentioned last week. The bounce also retraced 50% of its October decline, at 1735.30. It's a good place to roll back over and it's had a small start so far. Higher bounce potential exists but I wouldn't want to bet that way.
Gold continuous contract, GC, Daily chart
Oil's choppy consolidation since October 24th looks like a bearish continuation pattern, which has worked off some of the oversold condition. I expect lower prices for oil but would stand aside if the downtrend line from September, near 87.80, is broken.
Oil continuous contract, CL, Daily chart
Other than the Thursday unemployment claim numbers we'll get the CPI numbers (flat to slightly lower is expected) and the Empire Manufacturing and Philly Fed indexes, both of which are expected to show deterioration (further slowing in our economy).
Economic reports and Summary
In tonight's charts I'm showing a "normal" downside pattern with a typical wave count on the charts and the potential for a bounce/consolidation to take us into next week. But keep in mind that we are in a period of significant downside risk that runs through this week. A mini crash is not out of the question. The market is oversold and that's what makes it vulnerable to a crash (they don't come out of overbought), especially since we have not yet seen any capitulation in the selling. TRIN remains subdued and VIX is not showing much fear. Complacency still reigns. Even today's volume, while a little higher than average, was hardly panic selling. That makes the downside even riskier, especially if today's selling brings out those who thought we were only going to get a Bernanke-controlled decline and they start to worry now that important support levels have given way. Don't be a hero and try to catch any falling knives.
Gaps this week, and last week, have been fading opportunities -- whichever direction the market starts has been a head-fake move. Of course Tuesday we got two head fakes as the rally off the gap down was itself reversed. Reversals of reversals generally lead to a strong move in the direction of the second reversal and that's what we got today (follow through to Tuesday afternoon's reversal to the downside). So if Thursday starts with a gap down, especially considering indexes are at or near potential support, it could be a setup for the bigger bounce/consolidation into next week.
It's a tough spot here -- we could break down hard or a gap down could get reversed to the upside in a bigger bounce. The bottom line though is that downside risk dwarfs upside gains, something I've been warning about for a while now. I do not view this as a buying opportunity, at least not yet. Good luck with the rest of opex 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