The hope for an agreement on a way to avoid the fiscal cliff has been driving the market higher. The closer we get to the end of the month with no agreement the more cautious traders will turn.
Without a clear political agreement as we edge closer to the fiscal cliff the market is starting to get a little nervous. The rally from last Friday has been based largely on expectations that some kind of agreement will be made. Throw in some Santa Claus expectations and the bulls jumped in with both feet. Now that the water is starting to chill it's looking like some of those feet are being taken out of the water.
The VIX can be unreliable as an indication of market sentiment during opex week but when I saw it climbing this morning as the market chopped sideways I became more cautious and suggested holders of long positions tighten up their stops. The pattern leading to yesterday's high supported at least a minor new high today but once we didn't get it in the morning I thought the bears were going to take advantage of the setup for a reversal. So far it's looking like the bears did just that. The key for them will be follow through into Friday.
Today's economic data was primarily housing related and the numbers did not look that good. The always volatile MBA Mortgage index was down -12.3% for last week, vs. +6.2% the prior week. Housing starts and permits were mixed but roughly flat. Starts for November, at 861K, were down a little from October's 894K but permits, at 899K, were up from 866K. Both numbers are up nicely from the summer. There's a lot of hope "building" for a housing recovery and while any improvement is welcome news (since the housing market is such a huge part of our economy, jobs, etc.) I can't help but wonder if the bounce off the November 2008 low is just a correction before the next leg down.
If the big bad bear is not finished with us yet I think the housing market is due another leg down. The chart below shows the strong decline in housing starts and permits from 2006 to 2008 and the recovery so far. I've overlaid a Fibonacci retracement of the decline and as you can see, the current recovery has now retraced what is considered the minimum for a correction -- 21.4%. The bounce can be viewed as a 3-wave correction to the 5-wave decline (the 5 waves are more easily seen on the permits). That wave pattern calls for another 5-wave decline (even if it means only a slight undercut of the 2008 low).
Housing numbers, Monthly chart, courtesy briefing.com
As already mentioned, the VIX was a warning sign this morning and as I'll get into later, the selloff in the metals this week has also been a warning to stock bulls. As for the VIX, the data supports the idea that some big players are at least hedging their positions as we near the point where we'll know whether or not a fiscal cliff deal will be made in time. It's quite possible we've been the audience to political theatrics as both sides take us beyond the first of the year and let tax rates go back up so that they can then work on a tax reduction and look like heroes to their constituents. Again, if you didn't vote to remove your representative from office then you have no one to blame but yourself for this mess. The people get the government they deserve. (And that ends my political commentary).
I've got more than the usual number of charts tonight, including a top-down review of AAPL, because I think the stock market is at a potentially important inflection point. What it does in the next couple of days will point to the direction the market will head into January so let's dive right in and see what the tea leaves are telling us. Starting off tonight's chart review with the DOW Industrials, the weekly chart below shows how the broken uptrend line from October 2011 has been resistance to the rally again this week. Yesterday's high near 13366 was a perfect tag of the trend line and it continues to act as an electric fence. There remains the potential for the DOW to rally to a new high in January (to slightly above its October high at 13662) but with the broken uptrend line holding as resistance it reduces the probability for the new high. The next leg down, if the bearish wave count is correct, will be a 3rd wave down (the 1st wave down is the October-November decline) and that will be a strong decline. All it waits for now is a catalyst to start the selling (Obama and/or Boehner flipping the royal bird to the other might do it).
Dow Industrials, INDU, Weekly chart
The daily chart below shows the test of the broken uptrend line last week and yesterday. Today's red candle leaves a bearish kiss goodbye following the back test. If Santa doesn't leave a lump of coal in traders' stockings we could see a pullback and at least one more try against the broken uptrend line (to complete a 3-drives-to-a-high pattern), if not a run to a new high in January (or at least a test of the October high). Below 13120 would be trouble for the bulls and below the 200-dma and 13K would leave a confirmed a-b-c bounce off the November low and point to a complete retracement.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 13,420
- bearish below 13,120
Focusing on the leg up from November, the 60-min chart below shows the wave counts I'm watching. The red count says we've now completed an a-b-c bounce correction to the October-November decline. The c-wave is the leg up from November 28th and it's a completed 5-wave move once it drops below last Friday's low near 13178. But the leg up from November 28th could be a 3rd wave (green count), which calls for just a choppy sideways/down pullback before heading higher again. So if we get a choppy pullback I'll be looking for another leg up but if the decline starts to drop sharply, and especially if it breaks below the high on November 23rd (at 13010, labeled as wave-a or (i)), it would confirm the 3-wave a-b-c is the correct wave count and that would confirm the bears are in control. It will be the next couple of days which will confirm where the market will be heading into January.
Dow Industrials, INDU, 60-min chart
Using the log price scale on the SPX daily chart it shows how price has made it up to the broken uptrend line yesterday and was followed by a bearish kiss goodbye today. At the same level it reached the top of a parallel up-channel for price action since November 28th. Yesterday it also poked above its broken uptrend line from November 16th through the December 5th low, near 1448 today, but was not able to hold it. The combination of these 3 trend lines crossing near 1447 yesterday proved to be too much for the bulls to hold onto. Further upside potential exists to about 1490 but today's reversal could be a significant turn.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1452
- bearish below 1411
As compared to the wave count for the DOW, SPX can't be viewed the same. While the bounce off the November low can be considered a 1-2-3 (instead of an a-b-c) for the DOW, which keeps the upside potential alive following a pullback, SPX is not an impulsive wave count, including the leg up from November 28th. Because it's a corrective count (two a-b-c moves separated by an x-wave for the November 29-December 5 pullback) it keeps me bearish. A corrective bounce following the October-November decline keeps it bearish and looking for where to short it remains the higher-odds play. For the second a-b-c part of the correction, which started from December 5th, two equal legs pointed to 1452 but it stopped a little shy of that level with yesterday's high of 1448 (at the trend lines). Today's turn down could be followed by one more attempt at that 1452 target but the bulls will need to jump back in immediately on Thursday. Any bounce followed by a new low below the first leg down here will immediately turn the pattern bearish. Below 1428 would be the first sign that last Friday's low near 1412 will break, which would confirm the bounce off the November low has finished.
S&P 500, SPX, 60-min chart
NDX does not have a clear pattern except that it looks potentially very bullish. It needs to break below 2620 to negate the bullish potential but if it pulls back to correct the leg up from last Friday and then continues higher we could see a strong rally. For this case I'd like to see it hold a back test of its downtrend line from September, near 2680 on Thursday, and its 200-dma at 2673. For reasons I'll get into at the end of tonight's wrap, I don't think the bullish scenario has much of a chance of happening but I'll be keeping it on the chart as a reminder of why I don't want to get aggressively bearish yet. A drop below 2620 and I'll be all over it like a bear on honey.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 2732
- bearish below 2620
AAPL has lost of lot of its luster since it peaked in September but many attribute the selling to tax savings and there's a chorus of analysts looking for higher prices for the stock. It's still a good measure of sentiment, although now that sentiment may soon be viewed as measuring bearishness instead of bullishness. As we know, as AAPL goes so goes the NDX (and to a great extent, SPX as well) so it's an important stock to continue watching. I'll do a top-down look at the stock tonight and show why I think it's heading lower.
Starting with AAPL's monthly chart, the rally from 1997 can be satisfactorily be called a completed 5-wave move. The bearish divergence at the 2012 high vs. the 2007 high supports the count. Once a 5-wave move completes it calls for a correction of the move. This is a log-scale chart and therefore the retracements are jammed up toward the top of the chart. A 38% retracement is near 437 and a 50% retracement is near 354. The 20-month MA is currently near 501 and offering support. It's uptrend line from 2003 is currently near the 38% retracement near 437.
Apple Inc., AAPL, Monthly chart
The weekly chart is very interesting from a technical analysis perspective because of how it's behaving around trend lines. The trend line along the tops from 2000, shown on the chart above, is the bold line on the weekly chart below. Notice how it was broken to the upside in February and then used as support on a back test in May. It was a nice bullish setup for a run higher into September. But that September high left a very bearish negative divergence on MACD and RSI, which fit well when viewing it as the 5th wave of the 5th wave up from 2009. The breakdown from there broke the trend line along the highs from 2000-2007 in early November and then the trend line became resistance on the back test at the end of November. It found support last week and this week at a trend line across the lows from May and November, which looks ominously like a H&S neckline. For lots of reasons a break below 500 would be bearish and the downside objective out of the H&S pattern is to about 304.
Apple Inc., AAPL, Weekly chart
There are two other downside targets, one of which is typically achieved in a pullback. The 4th wave of the rally from 2009 is near 354 and the 4th of the 3rd wave is at 310, with the lower level being close to the H&S objective. As mentioned earlier, a 50% retracement of the 1997-2012 rally is at 354, which is exactly where the 4th wave low is located. That makes that level a particularly strong downside target in the coming year.
The daily chart for AAPL, shown below, is not very clear at the moment but again, it's interesting how it's battling trend lines. The uptrend line from November 16th was broken last Friday but recovered yesterday and acted as support today, near 528 (a slight break of it into today's close). The downtrend line from September through the October 17th high was broken on November 26th but then AAPL dropped back below it on December 5th and it's been acting as resistance on multiple attempts since then to get back above the line. I've got the downtrend line from December 3rd on there but I'm not sure it's of any value. But I'll be watching to see if it acts as support on a back test. It will be near 510 on Thursday and 503 on Friday. If AAPL breaks below 500 then the bullish potential for NDX can be thrown out the window.
Apple Inc., AAPL, Daily chart
The RUT's daily pattern is not much clearer than for NDX. But looking at its up-channel from November 28th and the broken uptrend line from October 2011 we've got some trend lines to watch. Yesterday and today it was stopped at the top of its little up-channel. Today's doji at resistance could turn into a reversal pattern if Thursday gets a red candle. There is higher potential to its broken uptrend line from October 2011, which crosses the top of its up-channel near 860 next week. It remains bullish above 837, potential trouble below that level and bearish below 821.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 838
- bearish below 821
Bonds have sold off strong since the high on December 6th, more than I thought they would. So much for confidence in the Fed's ability to hold up bond prices to keep yields low. With yields going the opposite way, the chart below of the 10-year (TNX) shows a bullish break of its downtrend line from April 2011 and an attempted breakout of a parallel down-channel from September, currently near 1.8%, which is where it closed today. It could simply head higher from here but I think it's due at least a pullback. As with the stock market, a choppy sideways/down pullback correction will point the way higher (green) whereas a sharp decline will have it looking like an a-b-c bounce off the November 16th low is going to be completely retraced as bond prices head higher and yields head lower. If TNX drops below its November 23rd high at 1.695% it would be a bearish sign.
10-year Yield, TNX, Daily chart
The banks have been bullish with the help of the Fed and BKX looks like it could hold up and head higher into January. The weekly chart below shows an upside projection at 53.35, which is where the 2nd leg of the rally from June would be 62% of the 1st leg. It's the same relationship between the two rally legs from October 2011 to the September high. The 53.35 projection crosses the top of a rising wedge pattern in late January so a little throw-over finish earlier in January could finish off the rally. But so far all it's done is retest its September and October highs and there's plenty of bearish divergence since the March high that should be a big caution flag here.
KBW Bank index, BKX, Weekly chart
The TRAN finally made its move and might have finished it today. I've been tracking a wave count that calls for a price projection to 5333, which was achieved with today's high at 5352. The daily candle at this price projection is a potentially bearish shooting star reversal. The price projection at 5333 comes from an a-b-c bounce off the June low with two equal legs. If the TRAN pulls back and then heads higher we'll have a bullish pattern calling for at least a test of its March high at 5390 but for now it's a setup for a reversal back down that will break below the June low at 4795.
Transportation Index, TRAN, Daily chart
The dollar dropped lower this week and reached a price projection at 79.02 (with an overnight low at 79.01) where it has two equal legs down from the high on November 16th. For the larger bullish pattern that completes an a-b-c pullback correction and sets it up for the start of its next rally leg. Today's candle is a bullish dragonfly doji, which is a strong reversal candlestick so a white candle on Thursday would be confirmation that a bottom is in (and bearish if 79 support breaks).
U.S. Dollar contract, DX, Daily chart
While the dollar dropped further this week we did not see a corresponding move in commodities, except for oil. The metals both sold off and the commodity index, the DJ UBS index, did as well. Are the commodities telling us something? Each time in the past three years that there has been a negative divergence between commodities and stocks (with stocks making new highs without commodities) the stock market reacted with a selloff. This time we have the stock market rallying in anticipation of a fiscal cliff resolution as well as more Benny Bucks shoved into the market. But Benny Bucks have been losing their effectiveness in sustaining a market rally so depending on it this time might not be a good bet.
Looking at a chart of SPX vs. the commodity index (CRB) since 2010, it shows the periods of divergence that I'm talking about. This past September's high for the stock market was matched by a lower high for commodities, relative to the March high, and the rally from November in the stock market is out of whack when compared to the commodities, which have been consolidating sideways since November while the stock market does another hope-filled rally. When wondering whether commodities will catch up with the stock market or if instead the stock market is going to drop to join the commodities, history shows us it's the latter scenario we should be thinking about.
SPX vs. CRB, Daily chart
Gold (and silver) has broken its uptrend line from November 5th (and for silver, that uptrend line started from July) and its November low, leaving a confirmed 3-wave bounce into the November high. That keeps the trend to the downside and the bottom of its down-channel is the downside target for now. Two equal legs down from October points to 1629.40, which crosses the bottom of the down-channel next week so watch for that possibility. Currently gold is finding support at its 200-dma at 1663 but I don't expect it to hold. I think gold will head for stronger support near 1525 by February but first it will need to break below 1629. Back above 1684 would begin to look bullish and above 1725 would point to at least a retest of the October high near 1800.
Gold continuous contract, GC, Daily chart
Oil has defied the trend in commodities and has rallied for the past week with the stock market. It broke through its 20- and 50-dmas yesterday and its downtrend line from September today, all bullish. The top of a shallow up-channel from early November is currently near 91 and its upside target for now. It would turn a lot more bullish with a break above its 200-dma, currently at 92.53. I think the bounce off the November low is just an a-b-c bounce correction and will be followed by more selling once it's done. Confirmation of that will be a break below 85.
Oil continuous contract, CL, Daily chart
The rest of the week will be busy for economic reports as several that would normally be published next week have been brought forward. In addition to the unemployment claims numbers we'll get the 3rd GDP estimate (no change is expected), existing home sales (slight increase expected), the Philly Fed (expected improvement) and the Leading Indicators (expected deterioration). And then on Friday we'll get personal income and spending, durable goods orders and Michigan Sentiment (final). The recent trend has been showing a slowing in the economy and that will probably continue into the new year. But the stock market is not paying attention and is instead focused on short-term events, such as the fiscal cliff. So much for looking out 6 months.
Economic reports and Summary
In the category of "misery loves company," I'll pass along some information that shows trend traders the world over have been struggling mightily. If you've had a rough time trading in the past couple of years and wondered what you're doing wrong, you're not alone. The Institutional Advisory Service Group (IASG) compiles data for their institutional clients and one of their charts shows the performance of trend-following strategies (they aggregate the data from their institutional clients who are using trend following strategies). The chart, shown below, and the data can be found at this link: IASG trend following.
Trend Following Strategy Index, Monthly chart, 1983-2012, courtesy iasg.com
Basically it shows the trend-following strategies lost money in 2011 and 2012, only the 4th time in 25 years. Typical returns have been double digits (+17.2% average for the past 15 years) and have had very high returns (40-50%+) in some bear market years. But for 2009, 2011 and 2012 the average return is -1.2% annually. That's quite a shift from a long-term positive record. So if the big boys, with their multi-million trading systems and programmers can't make money in this market, stop beating yourself up if you've also struggled. If you're still in the game (haven't blown up your account), you're still a winner. Hang in there -- things will get better.
Before finishing, there are two more charts I want to show because I think it's a fair warning to bulls in this market. It has to do with market sentiment and right now we've got a boat that's about to tip over with all the bulls on one side and a few lonely bears trying to keep the boat from rolling over. On Monday the ISEE call/put ratio closed at 208 and that's the highest it's been since the v-bottom reversal on March 9, 2009. It's a sign of a lot of call buying and when it happens off a decline it's often a good sign of the rally kicking into high gear. But when it's found at the end of a rally it's usually a good sign there are too many bulls jumping in at the end of a run, thinking it's got much higher to go. The chart below shows how many times the ISEE ratio closed above 200 and how many times it has marked a high for the stock market (typically within days).
SPX vs. ISEE call/put ratio, data courtesy ise.com
In addition to the above warning that there are too many bulls joining this party, the chart below shows the strong interest by hedge fund managers. Hedge funds haven't been doing well in this market and therefore I do not consider them the smart money. According to Bank of America's Chief Investment Strategist Michael Hartnett, "Hedge fund net exposure to equities jumped to its highest level since August 2006 (net 45%)." Hartnett also says that "More broadly, the percentage of investors who say they are taking higher-than-normal risk in their portfolio is now highest since April 2011." The chart below shows the net exposure to the stock market, which has spiked up since June and shows some heavy betting on the long side. When everyone who wants in is already in it becomes more difficult to keep the pyramid scheme going. All those holders of stock become sellers-in-waiting. Give them a reason to sell and it can start in a hurry and the exit door suddenly becomes very small. This is NOT a good time to be thinking long the market. As some very savvy investors have stated over the years, "sell when everyone is buying and buy when everyone is selling."
Hedge Funds Net Exposure, chart courtesy BofA
The wave counts for the stock market's bounce off the November low can be called complete and currently I'm viewing it as a correction to the October-November decline. That interpretation calls for another decline to below the November lows and it's likely to be a much stronger selloff than the one from October. Considering the tax changes coming (regardless of what's agreed to), it's not a bad idea to get into cash before the end of the year and see how it plays out between now and the end of January. If you like playing the short side, get ready to rock and roll if support levels and key levels to the downside start breaking.
Good luck through the rest of opex week and I'll be back with you next Wednesday. Merry Christmas and keep in mind whose birthday we're celebrating. And after the school shooting tragedy it's another reminder for us to keep in mind the really important things in life (our kids and grandkids) and how really insignificant the stock market is. It's a way to make some money but it should never become the focus of our lives. Enjoy your kids and say a prayer for the families who will be in unimaginable pain this Christmas season.
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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