Market Wrap, Thursday, 04/16/2009 Techs Lead the Way Higher by Keene H. Little Click here to email Keene

HAVING TROUBLE PRINTING?

With average volume today and good market breadth there was little to complain about during today's rally. How much of it had to do with opex can only be guessed but certainly it was no surprise to see SPX rally above 850 for option expiration tomorrow morning for that index. Friday could see the market get pinned as various stocks settle near key levels. The only market breadth number that is still not supportive of a new bull market is the number of new lows that continue to swamp new highs. Not until that turns around the other way will we have a stronger clue that more stocks are beginning to participate in the rally (and at least stop making new lows).

Because it's opex week it's a little harder to discern what's real buying vs. what's being done in the market to support some options positions. Short-term strategies during opex are often completely reversed either by the end of the week or the following week. It's often why we see a market hangover following a bullish opex week. One could say there's manipulation holding the market up during opex (to collect the premium on short puts and long calls) but that's pure speculation. Oftentimes it's more a matter of short-term trading rather than any longer-term market view.

The market's rally over the past three weeks has been very choppy and this is usually an indication of a topping process as the buyers start to fade away, but haven't given up yet, and the sellers start to nibble but are easily scared away. What we end up seeing is waning momentum, visible in the negative divergences in market breadth and various momentum oscillators. Tops often create a rounding over appearance whereas bottoms are often v-shaped. The bearish head and shoulders or diamond pattern can be thought of as a rounding top. The rising wedges that are appearing on most daily charts is the left side of a potential rounding top.

So we're getting plenty of signals that the market is getting tired as it nears or hits some important resistance lines such as 200-dma's. But the rally isn't over until the fat lady sings and she's waiting for uptrend lines to break before she starts singing. We've got a bullish stock market and any attempt to short it right now is based solely on picking a top. I like to look for turns and play them but I'll be the first to admit the method can be frustrating as the market keeps pushing up for "one more high". But I think we're there and it's time to nibble.

Last week I pointed out a hammer candlestick on the weekly chart, which considering price was at potential resistance warned us that we could have a reversal in the making. But the bulls were not to be deterred and negated the reversal candlestick pattern which requires confirmation with a red candle the following period (could still happen if Friday sells off). Now we've got another hammer forming so once again the setup is there for a reversal but it won't be confirmed until it's followed by a down week next week. Considering where so many indexes are located I see that as a distinct possibility.

It's bullish that price has broken the downtrend line from November and the top of a parallel down-channel, both located at this week's low. So a bounce off those broken trend lines is bullish. If the rally continues next week we could see a strong push higher as it works its way up to the 950-1000 area in the next few weeks. Otherwise a roll back over from here could give us a sell signal on MACD if it turns back down from the zero line. This is an important point for the market.

S&P 500, SPX, Weekly chart

On the daily chart I've added a parallel line to the one along the November and March lows and attached to the January high. It's hard to see but there's also a price projection at 869.62 which is where the November-January and March-April rally legs are equal in size. That level was tagged today (with a high of 870.35 right where it intersects the top of the parallel channel. From a short-term perspective, even for the bearish wave count, I see the possibility for a push up into the 880-885 area to meet some internal Fib projections for the rally leg.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 885
- cautiously bearish below 815

Because of the choppy price pattern for the rally since mid March (with plenty of overlapping highs and lows within the rally) it's either incredibly bullish or very bearish. If it's bullish we should see price blast out the top of the rising wedge pattern shown on the daily chart (which are visible on many indexes and could have too many participants leaning bearish because of them) and that would fully support the green wave count calling for a sharp rally over the next few weeks.

But because of the bearish divergences showing up, the broken uptrend line on RSI and Fibs and trend lines being hit I'm inclined to believe at the moment that the market is topping and not getting ready to blast higher. However, I certainly won't stand in the way of any rally that gets above SPX 885 and shows no desire to turn back down.

Another channel of interest is a parallel up-channel based on the uptrend line from March 17th, shown on the 120-min chart below. Today's rally did not make it to the top of the channel and could easily do so tomorrow or Monday (near 880 tomorrow). In the meantime keep an eye on the uptrend line from April 1st, which is creating another potential rising wedge pattern, with bearish divergences supporting the bearish implications here. That trend line is near 844 tomorrow morning and the 845 level is proving to be pivotal, just as it has since the October low.

S&P 500, SPX, 120-min chart

I'm using the DOW's weekly chart to show a slightly different wave count that I've been tracking and it not only suggests one more new low but actually two more new lows before bottoming and giving us a bigger rally into next year. The intermediate bullish wave count calls for only a pullback and then a continuation higher (shown in green). The DOW's weekly candle is also another bearish hammer at resistance (the top of a parallel down-channel from October/November) and MACD is showing the same potential bearish setup if it rolls back over from the zero line. The bulls clearly need to keep the rally alive next week.

Dow Industrials, INDU, Weekly chart

The daily chart sports the same little rising wedge pattern since the end of March. The choppy price pattern inside it is indicative of an ending pattern but watch out above if price busts a move to the upside out of that wedge. I suspect it would catch a lot of bears leaning the wrong way. A break of the April 8th low near 7750, or even yesterday's low near 7870, would be a sell signal and then we'd have to play it a leg at a time to see what develops to the downside.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 8300
- cautiously bearish below 7400

We've got a very interesting setup on NDX this week now that it made a new high above last week's and right at the time where we could meet the turn window of the week of April 12th (based on the Fibonacci number of weeks from previous turns). To me the wave pattern is very clear from here and calls for a new low for the 5th wave in the decline from 2007. Based on today's high, that 5th wave would equal the 1st wave, which is the move down from October 2007 to March 2008, at 782 which is only 13 points below the 2002 low near 795. If NDX gets a little higher on Friday, to 1366, the downside projection would be on top of that 795 low.

Nasdaq-100, NDX, Weekly chart

Setups don't get much sweeter than this one and I continue to like the potential for a very good short play from here. Only next week will we know whether it worked or not. Its 200-dma is up at 1413 which is too far for a stop and therefore I would use 1375 for now (just above a price projection at 1371 for two equal legs up from the April 7th low). A break of this week's low at 1295 would be a good time to lower your stop to just above wherever this rally stops.

Key Levels for NDX:
- cautiously bullish above 1375
- cautiously bearish below 1268

I continue to keep my eye on the semiconductor index, especially since I had recommended a short play on it. The price pattern over the past three weeks has been very choppy with overlapping highs and lows as it has chugged higher. This is either very bullish price action where it's getting ready to explode out the top of its rising wedge pattern or else it's an ending pattern and getting ready to fail hard. Since I recommended a short play on the semis and NDX above (play the QQQQ) I guess you know which way I'm leaning.

The market was held up into opex and we might see it held up into the weekend, including the possibility for a new high for the SOX. That would obviously make it a tricky decision to hold short over the weekend or not. I think a stop just above its 200-dma at 259 continues to be the right place for a stop. We could see a little throw-over finish in which case a drop back inside the wedge would be a sell signal. It takes a break below Wednesday's 241.48 low to confirm it's breaking down.

Semiconductor index, SOX, Daily chart

The RUT poked its head above the downtrend line from November and its rising wedge for the latter part of its rally from March. A drop back inside the wedge tomorrow would be a sell signal. But obviously I'm trying to catch a top as I point out potential sell signals to watch for. Keeping it simple for now, for those who want to get some better evidence of topping, keep an eye on the uptrend line from the March low. A break below 450 would confirm the likely start of a stronger decline and below 408 to point to the likelihood of a stronger pullback if not a new low.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 480
- cautiously bearish below 408

Today's rally for the banks, and minor new high above Monday's, has now met the requirements to consider the bounce pattern off the March low as a complete a-b-c correction. There is a Fib projection for the move up to 102 so a little more rally on Friday could do it. If the BIX were to make it much above 102 I think there's a good chance we'll see it head for 120 and the top of the larger parallel down-channel from 2007. Otherwise the banks could be looking at a pullback or the start back down to a new low (quite likely the final one for the year if it happens).

Banking index, BIX, Daily chart

The charts of bonds (and yields) are showing we're getting ready for a big move. Which direction is of course the question. Using TLT as a representative of the bond market, it continues to consolidate in a sideways trading range since the early February low. Based on where this consolidation is occurring I think we'll see prices break down from it but I don't discount the possibility for a quick jab higher (shown in pink) before turning down. I believe a rally out of this consolidation pattern would be a bull trap.

20+ Year Treasury ETF, TLT, Daily chart

Of course if bond prices drop then yields will head higher, which is exactly what the Fed is trying to prevent. This whole sideways consolidation could be a fight between the market and the Fed (although I may be giving the Fed too much credit by saying that). But a rise in rates would be detrimental to our economic recovery, especially the recovery in the housing market. John Mauldin showed the following chart in a recent newsletter and it's eye-opening when you see how many mortgages will reset over the next two years.

Mortgage Rate Resets, 2007-2016, Monthly chart

I placed a vertical brown line at today and you can see we're in a lull period as far as resets go. But heading into next year and peaking in 2011 the number of resets could trigger widespread problems for the housing market. To the left of the vertical line, what we've already passed, is the spike in sub-prime mortgage resets. That was the first shock to the financial system. Round two is about to start as Alt-A and especially option-adjustable mortgages start resetting. Any guesses now many of those people will be able to remortgage their homes? This chart alone shows why stock market bulls are whistling past the graveyard right now, hoping no boogey monster jumps out from one of the graves and drags them under.

Markit indices, October 2008-April 2009

There is fear of a greater number of defaults coming but it's not reflected in the stock market or the rally in bank stocks (yet). But bond holders know what's coming and they're clearly afraid. In last weekend's wrap I showed the Markit indexes for the prices on mortgage-backed securities and the spreads for commercial mortgage-backed securities. Neither is showing a pretty picture at the moment and there's been no improvement this week. In fact the spread on CMBX has climbed even a little higher since last week's.

To me the last two charts present a scary picture if I wanted to be bullish the stock market. These charts tell me the rally off the March low is built purely on hope that all is better and will get better and that we've seen the worst that can be thrown at the market. The two above charts tell me we ain't seen nuthin' yet.

Jane reported today on the Market Monitor that RealtyTrac reported March had the largest number of home foreclosures since it started tracking the data in 2005. RealtyTrac's Rick Sharga said "we think, in fact, the foreclosure moratoria that we'd seen, and some of the legislative delays, actually contributed to the March numbers being as high as they are" and he compared government's efforts to "trying to dam up a waterfall with bubblegum". One could imagine the foreclosure problem being similar to the New Orleans levees during Hurricane Katrina and the government's response to both situations is having a similar result.

Last summer, Congress passed the Hope for Homeowners Act, which set aside $300B to help people refinance their mortgages. But like most government programs it seems, this one has been a total flop. When it was first introduced, the Congressional Budget Office estimated that the program could help 400,000 people keep their homes. Now more than six months into the program, the Federal Housing Administration says only one homeowner has made it all the way through the government program and received the FHA guarantee. How's that for confidence inspiring data?

Housing starts was reported today and it was not at all encouraging. Building permits, which of course is an indication of what kind of building number we can expect in the next few months, dropped to a record-low level of 513K from last month's 564K. This was a big drop and right at a time when most are expecting the spring season to see a pickup in building. Housing starts dropped to 510K from last month's 572K (which was revised lower from the previously reported 583K). Both numbers were lower than expectations.

Gold dropped sharply today after several days of bumping its head against the downtrend line from its March 20th at 967.80. It gave up a little more than $12, closing at 879.90 today. The price pattern of the pullback from the February high of $1007.70 remains potentially bullish since it could be forming a descending wedge. This is why the downtrend line from March 20th will be important--a break of that could lead to a stronger rally back up. In the meantime I continue to lean short the yellow metal with an expectation that it will head to $700 or below in the next few months.

Gold contract, GC, Daily chart

Gold stocks are following the price of the metal more than the broader stock market and the gold miners ETF broke an important support level today. Price had been consolidating above its uptrend line from November and its 200-dma but broke below both in today's selloff. The price pattern calls for a little lower and then a bounce back up which will probably retest the broken uptrend line. Following that move should be a much stronger selloff into May/June. I continue to like the short side on gold stocks.

Gold miners ETF, GDX, Daily chart

Oil has been consolidating since its 32.16 high on March 26th. So far this looks like a bullish consolidation in a sideways triangle pattern and as shown in green we could see another rally leg that takes USO up to about 38. But a break below 28, the April 1st low, could be followed by strong selling instead. Let price lead the way here.

Oil Fund, USO, Daily chart

Other than the home building numbers today there was the usual unemployment claims number, which came in a little less than past weeks but still high, and the Philly Fed index which was "less bad" than expected and not as bad as last month's. It's still showing an economy that is slowing. Tomorrow we only have the preliminary Michigan sentiment number.

Economic reports, summary and Key Trading Levels

John Murphy literally wrote the book on technical analysis and I like to follow his market musings. Today he showed two charts which I've duplicated on stockcharts.com to show what he was pointing out. The first chart shows the percent of stocks in the NYSE that are trading above their 200-day moving average (with the chart of the NYSE at the bottom). You can use technical analyses tools on this chart just as you can on any other chart. I've drawn a downtrend line from June 2007 and you can see there's room to run higher. BTW, notice the clear divergence as the stock market was making new highs in October 2007 but not this chart.

NYSE Percent of Stocks Above 200-dma, Daily chart

As John Murphy pointed out, a good way to determine whether or not the market is in a bull or bear market is to look at the percentage of stocks above or below their 200-dma's. Anything below 50% says bear market and anything above 50% says bull market. Forget about the bubbleheads on TV talking about a 20% rally or decline. Bullishly the low in March was a higher low than the one in October and that bullish divergence is providing a heads up that the market may have seen its low for the year (doubtful in my opinion but possible). At least it's a warning to longer-term bears not to get complacent in the next pullback.

Today's number is about 18% so obviously well off the 50%. The downtrend line is currently near 25%. Right now the percentage has stalled at the level is last saw in early 2008 so it's resistance for now. Seeing this while seeing prices for so many indexes nearing potentially strong resistance is another potentially bearish setup.

Now looking at a similar chart but using the 50-dma you can see that the market is clearly overbought at the moment. The current percentage of stocks over their 50-dma's is 85%, matching previous highs which occurred at market highs. In fact it's more overbought now than any time in the past three years. Button up those stops if long the market! The market could clearly continue higher and trailing stops up if you're long from lower prices is a good way to milk it for more if there's to be more. But I would be reluctant to add any new long position up here.

Summarizing, I see a strong potential for a reversal and the only thing that could be holding the market up at the moment is opex. There could even be a little government assistance in holding it up in order to let their banking friends rake in some capital through their sold puts and long calls. That's obviously pure speculation but what a clever way to help recapitalize the banks and not have to go to the taxpayers to do it. Expect more of the same. But next week could experience a hangover if the buying dries up.

However, I've seen enough of these bearish rising wedge patterns get blown out of the water with a strong rally out the top of them to issue a warning to everyone who's banking on a breakdown from them. Most everyone is reporting on these wedges and I hate obvious setups as too many times people get caught leaning the wrong way. But a quick blast above the pattern (throw-over) followed by a collapse back inside the patterns (creating a bull trap) is a sell signal that I would take. We've been getting false breaks to the downside so those you have to be careful with.

I'm seeing resistance by trend lines and Fib projections, waning momentum (bearish divergences), overbought indicators and a slew of other technical indicators that tell me we could be on the verge of at least a significant pullback. Sometimes the obvious setups work very nicely and for those who like to play the short side of the market we're being presented with a very nice setup. Just don't assume anything or get complacent and use good risk management for your trades.

Good luck and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 885
- cautiously bearish below 815

Key Levels for DOW:
- cautiously bullish above 8300
- cautiously bearish below 7400

Key Levels for NDX:
- cautiously bullish above 1375
- cautiously bearish below 1268

Key Levels for RUT:
- cautiously bullish above 480
- cautiously bearish below 408

Keene H. Little, CMT
Chartered Market Technician