Traders are feeling like they should just pluck flower petals to figure out which way this market is going to go. It all depends on which way the political winds are blowing. It was a positive day for bulls today but unfortunately for the market it's looking like we might find the answer from the flower to be "she loves me not."
We're in a period where it's difficult for traders to carry a position overnight since new headlines change the direction of the market rather dramatically, usually starting with a morning gap, which leaves many traders unable to trade the direction (the move is over before most can look for an entry and buying/selling the gap has left traders at risk for an immediate reversal. The best way to trade the market has been to simply go long, hang on during the sharp retracements (either overnight or over a few weeks), and expect the market to come back. It's been a winning formula (along with buying the dips) and now most traders believe it's the only way to trade.
The problem with most becoming more and more convinced that the market will not decline (or certainly not decline for long) and that the market will always come back is that it sets the majority up for disappointment and a major ding to their accounts when the real correction begins. We saw the same sentiment picture into the 2007 high -- traders became convinced that there's no reason to fight the Fed and that any problems we were seeing in the housing and banking sectors were "contained." Reality has a way of rearing its ugly head just when most believe in the good-times-will-last-forever scenario.
The last time we saw strong bearish divergences like we see today was at the market high in 2011 and 2007 before that. These divergences can continue for a long time but the longer they go the stronger the correction, such as what followed the October 2007 high and then the lower May 2008 bounce high. The market will correct the stock market imbalances, which have been due to Fed policies for the past 15 years, and the longer those imbalances hold the harder the decline that will follow. The next one that is due will be, I think, the most severe correction because of the cumulative imbalances over the years
The next correction will be the one that discredits the Fed and its policies and with the loss of faith in the Fed will come the final correction to the previous secular bull market (1982-2000). I strongly believe that had the Fed not stepped in with its highly-accommodative policies following the 2009 low we would have seen a multi-year bounce/consolidation off that low and then a minor new low to finish the bear market (still thinking 2016-2017). But because of the distortion with all of the monetary accommodation and bailouts of bankrupt organizations (auto, financials), the system has been further distorted than it would have been had those organizations failed. The money that goes into failed organizations fails to go into healthier organizations that will lift the economy out of recession.
Recessions and depressions are actually very good for economies -- they clean out the inefficiencies that have been allowed to continue with the Fed's help. Credit expansion (easy credit) is followed by credit contraction, which weeds out the weak and inefficient organizations. Think of it as allowing the burning of the underbrush so as to make the forest healthier and better able to withstand the next fire. Risky behavior, especially in the banks, has been allowed to continue and in fact has the banks are more vulnerable today then back in 2007. The underbrush is thicker and higher and the next fire has a better chance of wiping out the strong trees in the process.
The banksters of course feel there's no reason not to continue risky behavior. In a way they're forced to since they'll fall behind their competitors who are taking advantage of what the Fed is doing for them. If you knew Mom and Dad would bail you out with more money no matter how you gambled away what you had, and did not feel the moral imperative to correct your behavior, you too would keep going and keep asking Mom and Dad for more money. It's really no more complicated than that.
The Fed is not letting a recession happen and therefore the cumulative imbalances, which have only been aggravated by them, continue to get worse. The coming "correction" will be a forest-burner and expensive homes will be taken with it. Have you clear-cut around your home (moved into safer investments) to at least make an effort to protect your possessions?
The political shenanigans are causing many to believe we're heading for financial Armageddon if the U.S. defaults on its debt. What the stock market is suggesting, and I strongly agree, is that a default is highly unlikely. First of all, defaulting on our debt will be a political, not a financial, decision. Politicians, most notably the President and Senate Democrats, are suggesting that a failure to come to a debt-limit agreement will mean an automatic default. It's only automatic if the President forbids the Treasury Secretary from prioritizing payments to service the debt first and all other government expenses after that. Considering monthly income is probably 10 times the amount required to service our debt the President could quickly quash fears about a default by simply instructing the Treasury to pay the Treasury debt first. It would get all of our global partners (those who buy our debt) to relax. This of course is not being done because it's being used as a stick to get Republicans to cave.
In the meantime the government lap dog (the media) continues their efforts to convince people that we're heading for default. It's a lot of misinformation but the stock market knows it's a misinformation campaign and doesn't believe it. Consequently we've seen the market rally (in fits and starts) through this and it continues to make new highs. Traders believe that once the government settles on a debt-limit increase, even if it's only for 6 weeks before we start all over again, the market will react positively with a big rally.
Herein lies the problem now. If most traders have been front-running the expected rally in the stock market, we have to wonder who will be left to buy once a settlement is announced. Very few is my answer. This is why we so often see a sell-the-news reaction to big news like this that has been front-run. And Lord help this market if the Republican-led House is unable to come to an agreement and we get to the point where the Treasury says it has run out of money to pay all our bills.
If no agreement is reached this week we'll be left to wonder if Obama will try to make a default happen as a way to crash the stock market (as many believe he'll do) in order to twist the arms of the Republicans (many of whom are big stock holders, even if it's in a trust fund) into an agreement. We might have seen a similarly-engineered stock market decline back in 2008 when Congress wouldn't agree to the initial TARP bailout. Was the stock market crash engineered by the banks to twist Congress' arms, forcing them to vote "yes?" It's certainly not difficult to believe in that possibility.
Everyone now watches the stock market to determine what course of action to take. By the time we reach the end of the secular bear market no one will care about the stock market but right now everyone cares. It can be used as a tool to manipulate consumer sentiment (the Fed has directly said that's been one of their goals -- through the "wealth effect") and to manipulate Congressional action. What a sad state of affairs we have presently. But this too shall pass.
OK, enough with the distasteful stuff going on with our government. I had to go take a shower before continuing here. With the stock market indexes making new highs, which are prompting calls for a continuation of the bull market into the end of the year, let's take a look at what the charts are telling us. At the moment we have some warning signs but obviously no reversal signs. I think by this time next week we'll have reversal signs and then we'll be looking for evidence to support just a pullback before heading higher into November or if instead we're putting in a more important high near here.
I'll start tonight's chart review with a look at the tech indexes, which have remained stronger but are now nearing potentially strong resistance. The weekly chart of the Nasdaq Composite shows price nearing the intersection of the tops of two up-channels -- one from the October 2011 low and the other from the November 2012 low. It's been a challenge figuring out what the wave count is (to help identify whether or not we're reaching the end of its rally) but by these channels it's saying there probably won't be much more to the rally. The lines are currently near 3848 and 3860 so not far above today's high at 3840.
Nasdaq Composite index, COMPQ, Weekly chart
A closer look at the two up-channels can be seen on the daily chart below. A quick pop higher on a government settlement would easily accomplish hitting those lines and then be followed by sell-the-news. We'll know in hindsight but be careful about getting pulled in by any bullish enthusiasm from here.
Nasdaq Composite index, COMPQ, Daily chart
Key Levels for COMPQ:
- bullish above 3860
- bearish below 3695
NDX has a very similar pattern and is also very close to the top of its parallel up-channel from November 2012, near 3291 Thursday morning. A rally above 3300 would be more bullish but only if it can hold above the top of its channel. A quick pop above 3300 followed by a drop below 3290 would create a sell signal (throw-over finish followed by a reversal, leaving a head-fake break to hit the stops above the line).
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 3300
- bearish below 3150
You can see the slowing momentum at the current high with the bearish divergence against the July-August highs and the September-early October highs (especially the latter). This is not a good sign for the bulls as price presses up against resistance. Better success for a breakout would come from a consolidation to relieve the overbought bearish divergence and then a rally out the top of the channel. But right now the odds suggest this is a good place to be looking to get short, not long. The 30-min chart below shows today's consolidation found support at its uptrend line from October 9th so a break below this afternoon's low (3273) would be a sell signal. Then we'd have to watch the move down for signals from the pattern as to whether we should expect just a pullback before heading higher again or the start of a more serious decline (an impulsive move down would suggest the latter).
Nasdaq-100, NDX, 30-min chart
The RUT has the same pattern as the techs (although I'm using a different wave count for it) and shows the same waning momentum in its drive higher (bearish divergence from July, especially at its October highs). It is now within spitting distance of the top of its rising wedge pattern, which is the trend line along the highs from February 2012 - July 2013. This line stopped its rally into the October 1-2 high and is currently near 1094.50 (today's high was near 1093). For a bear this is a sweet setup -- I'm daring it to do a little throw-over on news and then drop back below the line. It would be a signal to get short and use the throw-over high for a stop, making for a low-risk short entry.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1100
- bearish below 1037
The top of the rising wedge pattern that we've been watching for SPX is currently near 1734 so that's the upside potential for now and it provides more room to the upside than we're seeing for the techs and small caps. If I draw a trend line along the highs from August-September it's a little higher -- near 1744 by the end of the day Friday. I think this is one reason why many are projecting a move up to the 1740-1750 area and they could be right. It would mean more of a throw-over finish for the techs and small caps so it's going to be a balancing act between the higher-volatility indexes and the blue chips in determining which ones will be driving the boat here. The same bearish divergences as discussed for the techs and small caps exist on the blue chips, especially between this week's highs and last Friday's high.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1710
- bearish below 1678
We've got a full moon on Friday and that gives us a potential turn window between Thursday and Monday (+/- 1 day) and an emotional high (presumably on a government settlement) could give us the throw-over finish to the rally).
SPX MPTS Daily chart
Recently I've shown the big bearish megaphone pattern on the DOW's monthly chart. It suggests a very difficult time ahead for bulls. In addition to the DOW nearing the top of the megaphone (the trend line along the highs from 2000-2007) we have some timing factors at work. Jeff Cooper, who writes for Minyanville, has noted a 13-year cycle and pointed out this cycle with the following dates:
1. the 1929 high to the 1942 low
2. the 1942 low to the 1955 high, which was the first time the DOW made it above its 1929 high (it took nearly 26 years)
3. the October 1974 bear market low to the 1987 spike top
4. the 1987 high to the 2000 high
5. the 2000 high to the 2013 high
Referencing this 13-year cycle and the megaphone pattern, Cooper noted this pattern has marked the beginning of every major bear market since 1929. He also commented that the last leg up in the megaphone pattern is typically a strong move where investors believe a new bull market is underway. The run up into the 1987 high was based on the belief that portfolio insurance was the underpinning for a continuation of the rally, just as the belief in the Fed's money-printing support will ensure a continuation of the current rally. The imbalances leading into the 1987 high led to the biggest market crash since 1929 and I don't doubt that we could be heading for another market crash that will dwarf the 1987 crash (the megaphone pattern is larger and indicative of wilder sentiment swings).
But to give equal time to the bullish view (well, maybe not quite equal time), the DOW's weekly chart below is used to track the idea that we will in fact see a continuation of the rally into the end of the year. A spike up for the techs and small caps, that doesn't turn right back down, would support the idea for a continuation of the rally so that's one of the things we need to watch for when determining whether or not this intermediate-bullish idea for the DOW will hold.
When we look at the big megaphone pattern, the top of which is the trend line along the highs from 2000 to 2007 (the bold dark blue line on the weekly chart below), there is upside potential to about 16500 by the end of the month where it crosses the trend line along the highs from March 2012 - May 2013. We could be looking for a move up to there before the big bad bear shows up hungry and growling again. Two equal legs up from the 2009 low (with the 2nd leg being the rally from October 2011) points to 16686 (red projection on the chart). For the leg up from October 2011 it is another a-b-c and the c-wave would be 162% of the a-wave at 16702. The price correlation at 16700 crosses the trend lines in November, which is the price path I'm depicting on the chart. MACD has pulled back to the zero line while price has run sideways since May, which is a bullish setup. Bears keep this one in mind so that you're not fighting the tape all the way up.
Dow Industrials, INDU, Weekly chart
Key Levels for DOW:
- bullish above 15,215
- bearish below 14,850
Bond prices spiked back up today after making an early-morning low, which is when TNX (10-year yield) tagged its broken 50-dma. It's currently trapped between its 20- and 50-dma's but it looks like it could be ready for its next leg down. A drop below its October 3rd low at 2.58% would be a confirmed break of a H&S neckline and the downside objective from that pattern would be 2.157%, or perhaps slightly above that at its 200-dma. There's much lower potential into next year but I'll be watching this one leg at a time to get a better feel for its longer-term chart, which currently supports my opinion that we'll see TNX down to about 1% before it puts in its final low.
10-year Yield, TNX, Daily chart
Many economic reports are not coming out because so many of them are government reports and deemed "non-essential" so we're left to wonder how the economy is doing. In truth it doesn't matter much to the market at the moment because all eyes are on the government to see how the shutdown worries will resolve. But one report out today shows us the economy continues to slide backwards -- the NAHB Housing Market index (HMI), which is a measure of builder confidence, has pulled back from September's reading. It dropped from 58 (it was revised lower to 57) to 55 this month. Above 50 is positive but the direction is not. But the real worrisome fact with this index is that it is disconnected from reality, as can be seen in the chart below. The red line is the HMI and the blue line is the number of single family home starts.
NAHB Housing Market index vs. Single Family Home Starts, chart courtesy calculatedriskblog.com
I circled the previous times when builder confidence got out ahead of the actual number of housing starts. It seems they reach a point where their hopes for improvement hit the wall of reality and confidence plunges. The current separation between the lines is even larger than it was in the beginning of 1994 and 1999. In the past I've pointed out the small bounce in housing starts, identified as a 3-wave correction to the 2006-2009 decline, and that another leg down is very likely. Confidence should crash lower and both measures will likely drop below 400 (the 2009 low) before a final low is reached. Now is Not a good time to own the home builders. LEAP puts maybe, but not long positions.
The home construction index has been coming down since its bounce high on September 19th and I see the potential for a test of its August low followed by another bounce correction to a lower high and then a breakdown. Currently the index is finding its broken 50-dma, near 417, to be resistance.
DJ Home Construction index, DJUSHB, Daily chart
The U.S. dollar has been chopping sideways since its October 9th high and that has it looking at least short-term bullish. Whether it will be able to break its downtrend line from July, near its 20-dma at 80.38, or just tag it and start back down remains to be seen. I'm expecting a breakout but have trouble arguing for another low (down to about 79) before it will be ready for a bigger rally.
U.S. Dollar contract, DX, Daily chart
Some gold traders are referencing a bearish H&S pattern from July-October and in this case it would be considered a continuation pattern (bearish) rather than a topping pattern. The neckline, as I've drawn it, gives us a downside price projection at 1152, which is on top of the 62% retracement of the 2008-2011 rally (1155), a level gold came close to at its June 28th low. A minor new low below the June low at 1179.40, would be a good setup for another bounce/consolidation. But what looks like a bullish descending wedge for the decline from August points to a rally up to the 1505 and a rally above its 20-dma at 1307 would be a reason to turn bullish on gold.
Gold continuous contract, GC, Daily chart
Oil has been chopping lower since its October 2nd high and that has it looking like a small ending pattern to the downside. It could be setting up for at least a bigger bounce before heading lower (my preferred wave count) or it might drop a little lower to its 200-dma, currently at 98.49, before getting a bigger bounce. Back above its 50-dma, at 105.37, and its broken uptrend line from April-June would have me thinking a little more bullishly.
Oil continuous contract, CL, Daily chart
There are quite a few economic reports due on Thursday but I'm not sure which ones will actually be released. Besides, I don't think the market really cares about these reports this week.
Economic reports and Summary
If the market is going to make a very important top it's likely to do it this week. The charts show a good setup for a reversal (except the DOW, which I'm using to show the potential for a rally well into November) and a government settlement could be the spark for the reversal (quick pop higher on the "good" news and then a sell-the-news reaction). I'm currently leaning toward the scenario that calls for a top on Thursday, maybe Friday, which even matches up with the full moon on Friday.
It's a headline-driven market right now so it's risky holding positions intraday, let alone overnight. It's a day-trader's market until we get through the shenanigans the politicians are up to. While there's upside potential, as shown on tonight's DOW chart, it is a risky time to hold long positions since I think the move down, when it comes, is going to be violent. Trade very carefully.
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