Market Continues Surfing Despite Tsunami Warning

People become desensitized to certain things rather quickly.  The market now appears to have become entirely immune to the debt ceiling crisis (or debacle, or whatever term you prefer).  To illustrate why this happens psychologically, I need look no further than personal experience.

Since 2009, my family and I have lived in Maui, Hawai'i, and in the years we've lived here, there have been maybe a dozen tsunami scares.  I vividly remember our first big tsunami scare, since my adrenaline was pumping for hours.  We were awakened by the tsunami warning sirens at 6 a.m., and we rushed off to the grocery store to stock up on essentials like water, batteries, Rolos, etc.

The tsunami warning center said the first wave would arrive at 11:19 a.m..  We drove to high ground, where we'd have a good view of the ocean, and I sat there with my camcorder at the ready, anxiously awaiting the arrival of the first big waves.  As the clock ticked down, I turned on the camcorder, and zoomed-in on the beach.  To everyone's amazement, precisely at 11:19 a.m. almost to-the-second -- exactly when scientists said it would arrive -- there was nothing.  So we watched and waited some more.  Then we got hungry and went home to watch the local news.  Then we took naps, because let's face it, who gets up at 6 a.m. on a Saturday?   As it turned out, that tsunami was a complete non-event.

The next tsunami warning we experienced was slightly less exciting, but still tense -- but it also turned out to be a non-event.  By the third, the routine had become old hat (and I had amassed a stockpile of water and canned goods already, so no need to rush to the store anymore) -- so while there was still a little bit of nail-biting, I think the sentiment was best summed up by my wife who remarked, "Yeah, whatever, that's what they always say."  And it was indeed another non-event.

Ever since then, we've been pretty much immune to the drama.  And while we're not willing to completely throw caution to the wind like some folks (out here, you often see locals walking the beaches and surfing while the sirens are blaring), we really don't get too worked up about it anymore.

It's a mathematical certainty that one of these days, the warnings will actually pan out and a devastating tsunami will hit our shores and wreak havoc with our infrastructure.  But in the meantime, we've become largely desensitized to the whole thing.

I think America has collectively reached a similar psychological footing in regards to the debt crisis.  Nobody really believes anything will come of it.

And maybe it won't.  If we're really lucky, our leaders will decide on yet another "temporary" increase of the debt ceiling, so we can do this all over again in a few months.  That certainly seems like the most likely resolution, since it would allow the government to solve the problem by doing what it does best:  nothing.

Regardless of outcome, I find it interesting that the market seems to be pricing in the odds of US default at essentially 0%.

ConvergEx Chief Market Strategist Nicolas Colas recently wrote: “If there were even a 1% chance of a Treasury default, the VIX would be over 20 and stocks would be retreating, not advancing. Too much of the world’s financial system is predicated on Treasuries as 100% reliable collateral to believe anything else. Russian roulette with a 100 chamber revolver is still too dangerous a game.”

So the market is saying not only that default won't happen; it's literally saying that it can't happen.  I think watching the market rank the default potential at 0% bothers me for the same reason I'm bothered when I see people surfing during a tsunami warning.  Yeah, I agree, odds are good that probably nothing will happen -- but the odds are still most definitely higher than 0%.  Anyone who's studied quantum mechanics and is familiar with the Heisenberg Uncertainty Principle knows that the odds are never 0%, any more than they can be 100%: simply nothing in the physical universe can be quantified with those levels of absolute precision.

Still, I realize there's no sense trying to preach the Morality of Odds to the market -- as John Maynard Keynes famously said:  "Markets can remain irrational a lot longer than you and I can remain solvent."  In other words: the market's gonna do what it's gonna do, and it really doesn't care whether we judge it as careless or not.

So the market is clearly front-running a positive outcome with the latest rally.  That sort of front-running can sometimes create "sell the news" events.  If too many investors get on board with something before it happens, then there's not enough folks still left to buy after it happens, and sellers take over.

Here's an interesting chart of the Nasdaq Composite (COMPQ).  Last time I published this chart, I anticipated a rally, but also expected we'd later see a retest of the low, due to the RSI readings at that low.  COMPQ instead went on to overlap the key bearish price point, which suggested a new high; which it has since narrowly achieved.  But the question posed by RSI still remains: Can bulls cheat the odds entirely here?  Obviously it's not impossible that they could -- I can't predict the future, I can only examine the past and try to anticipate based on what the odds suggest is likely from prior examples.

  

Financials continue to lag the broad market, which hasn't been particularly bullish in the past.  Note that so far the Philadelphia Bank Index (BKX) is simply testing the black resistance zone.

The S&P 500 (SPX) remains within the multi-month noise zone.  A new high isn't out of the question, but presently, I would expect a correction to follow soon after.  Bears like to feel downtrodden about the market (seems to go with the disposition to a degree), but they might ask themselves: How many bulls have bought those last two breakouts to new all-time-highs, and how are they feeling after two immediate whipsaws?

If the market does sustain trade above the previous all-time high, then next resistance is indicated in the 1740-1750 zone.  On the bearish side, there's a small potential head and shoulders forming on the SPX 5-minute chart, which suggests a trip toward 1680-85 if 1695ish fails.

 
In conclusion, as I noted last week: I'm not closed to more bullish options.  But all I can work with is what's in the charts right now -- and there are a few things still suggesting that bulls aren't out of the woods just yet.  Trade safe.

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Friday's Projection Played Out; What Next?

On Friday, I drew a somewhat unconventional near-term projection, projecting the market would close at 1703 and decline first thing Monday.  Shortly after Friday's close, CME announced that it's raising margin requirements -- which is a bit of an unusual move, given the relatively low volatility we've had this year.  If we assume traders are net long after that rally, the newly-increased margin should impact bulls more than bears. 

Then over the weekend, Congress and the White House indicated that the only point on which they both agree is that they still hate each other.  In the spirit of true bipartisanship, the President stated that he wouldn't be willing to work with Congress "even if it was the last Congress on earth," while Speaker Boehner was quoted as saying he'd be willing to negotiate "only if President Obama stops making fun of my tan."  This rhetoric was markedly less virulent than last week's, so pundits are arguing that these statements mean we're extremely close to an agreement.    

All that to say: the news over the weekend wasn't terribly good, and futures are suggesting a decent-sized gap down for Monday's open.  This means I hit the short-term projections exceptionally well -- but I would caution that my short-term work is based on (oddly enough) the short-term; so neither the close at 1703 nor the ensuing gap down will guarantee that the intermediate wave counts are also correct.

This is a truly difficult position for intermediate prognostication, because the market has been essentially range-bound for the past several months, and very little information is conveyed within a range-bound market.  To make matters even more challenging, markets often move quickly through thinly-traded ranges, which can give the appearance of greater strength (or weakness) than is actually present, causing indicators to give false readings.  These are some of the reasons this is boiling down to an instinct call for me: there simply isn't much in the charts to argue definitively for one outcome over the other. 


I still feel it's more likely that the decline isn't done at intermediate degree, and that a stronger sell-off is pending.  And I think it's safe to say I'm probably bucking majority sentiment with this view: from what I've been able to gather, most everyone is expecting that Washington will get its act together reasonably soon.  I think everyone expects a nail-biter which then gets resolved in the eleventh hour -- and maybe that will happen, who knows.  If Washington announces a satisfactory resolution, bears will almost certainly cover in droves and send the market straight up in a vicious short-covering rally.  For that reason, this is not a position where I would continue to hold my shorts in the face of a solid market reaction to good news.  I'm hoping my short entry north of 1700 guarantees me some profit no matter what happens heading forward -- and hopefully Friday's update afforded readers that same opportunity.     

Let's start off with the S&P 500 (SPX).  This chart shows the trading range quite clearly.  The market really hasn't made much upwards progress since May; so while bears seem to be feeling more beat-up, the bulls really haven't had too much to cheer about lately either.  Range bound markets don't favor bulls or bears: they favor short-term traders.

Next is the SPX 10-minute chart; the preferred red count is unchanged from Friday's update, but I needed to adjust the green alternate count slightly.

Finally, the Philadelphia Bank Index (BKX).  BKX is one of the main things keeping me leaning toward the bear camp.  The alternate count on the BKX chart is for a completed ABC decline.  There are two reasons that count is the alternate and not the preferred count:

1.  The Fibonacci relationship between waves A and C is still a bit weak.
2.  The last decline didn't act like a c-wave.  C-waves are third waves, and they are usually strong and scary.  One of the "jobs" of a c-wave is to convince traders the trend has changed.  While the last leg of the decline in SPX was strong, BKX merely lollygagged around support and probably wouldn't have frightened even the most faint-hearted bull.

In conclusion, there genuinely isn't too much to add down here.  Bears should stay alert to a three-wave decline as warning of the alternate count.  Hopefully Friday's entry was solid enough that even in the event of the bullish count, we'll be alerted to bullish developments in real-time and be able to lock-in profits.  Trade safe.

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Bulls Shake-up the Charts

Yesterday saw bears capitulate en masse, while bulls trampled and gored everyone who got in their way, in the hopes that Washington's issues might get resolved soon.  As far as I've heard, nothing actually got resolved -- but perception is reality in the market.

As I talked about yesterday, the market had reached the toughest type of inflection point in Elliott Wave, and from there, it then proceeded to plow right over my preferred near-term count.  Most of the traders I've spoken to since the close are now bullish.  And why not?  After all, the market has had a persistent bid ever since the QE-Infinity liquidity started pouring into the primary dealers' accounts, and every halfway promising-looking decline of 2013 has turned into a new high in fairly short order.

The rally appeared to be impulsive, which suggest it isn't over yet, and normally, I'd look for another leg of equal or greater length.  However, I'm favoring an unconventional near-term count which I'll outline momentarily.

Frankly, I'm a bit uncomfortable with this market right now.  There are times the charts make perfect sense to me, and there are other times that there are portions of the wave count that I can't comfortably reconcile.  When I look at the charts right now, there are two conflicting things that jump out at me:

1.  The decline from the all-time high reconciles better as an impulse than a correction, and that leads me to suspect it's not over.

2.  The signals I saw at the close on Wednesday led me to expect a snap-back rally, but that rally's strength exceeded my expectations.   Yesterday's rally was a face-ripper, and bulls recovered a ton of lost ground in just one day -- normally, that suggests they have "money in the mattress" (or in the printing press, as the case may be) for more.

It's probably going to take an event to turn this market back down.  In my opinion, the charts are still hinting at the idea that we could get one.  But this is as much an instinct call as anything, and trying to predict an event is like trying to predict the winning lotto numbers, so feel free to ignore me and trade what feels right to you.

First up is the Philadelphia Bank Index (BKX), which could have completed gray iv -- however, in my opinion, it has the wrong look for a completed correction.  I'm presently inclined to think this index makes another new low before it makes a new high.

Next up is the S&P 500 (SPX) near-term chart.  I'm favoring a somewhat unconventional resolution here -- but again, this is pure instinct, and my instincts can be wrong.

Finally, the SPX hourly chart.

In conclusion, I'm fully prepared to shift my intermediate footing depending on how the next couple sessions shake out, but I still feel the charts have bearish potential and, at the moment anyway, still feel that they'd look better with a new low.  Trade safe.

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Bad Moon Rising? Or Let the Good Times Roll?

I stole part of today's title from the famous CCR song "Bad Moon Rising," in which John Fogerty passionately sings:

Don't go around tonight, 
well it's bound to take your life,
there's a bathroom on the right.

Or that's what it always sounds like to me, anyway.  I assume he's singing about one of those highway rest-stop bathrooms, in which case this chorus is very sound advice.

On a more serious note, this is the toughest type of inflection point in Elliott Wave.

We've reached a point where the market has a clean three-wave decline.  Because of the nature of the bigger picture wave structure, we can't be certain whether to expect this decline to become five waves, or whether this ABC decline was all the market wanted here.  Let's start with the Nasdaq Composite (COMPQ) for illustration purposes:

 
Strangely, the part of this move that had lots of folks confused (last week) felt pretty straightforward to me, and I couldn't find any high probability outcomes that didn't require a continuation of the decline.  That has now changed, and we can see on the chart above that the market currently has potential for a fairly clean, and possibly complete, ABC decline.  We also see that it has so far found support where it "should."  Most of the markets I look at have reached similar support zones, with NYA, INDU, and SPX among them.

But not so fast -- when we look at RSI on the above chart, it suggests the market will want to retest or break yesterday's low.  And that fact is one of several that leads me to give the edge to the bears and assume we're dealing with a reaction rally until proven otherwise.  Additionally -- not to get too far ahead of the market -- but some of the charts I've studied suggest the possibility that this is yet another second wave bounce.  If that's the case, the market is actually gearing up for a mini-crash.

This is dangerous territory for bears here, though, because this is an inflection point where bulls genuinely have a chance to grab the ball at intermediate degree.

Thus my confidence in what's coming next is lower than it has been to this point.  If I had to pick a side, I'd say the bounce is going to be short-lived, and bears are going to reclaim the market in fairly short order.  That logically leads me to consider the two big news events: the ongoing government shutdown, and the debt ceiling deadline on Friday.  Futures are up big right now on the news that the President and the GOP are going to meet and talk -- if my bear thesis is correct, then I suspect those talks will end in failure.

It's always easy to talk theory, but as traders, how do we approach the market when the charts are ambiguous?  With the charts at larger inflection points and major "blow up the tape one way or the other" news announcements coming, I generally do one of two things:  I either avoid the market entirely, or I look for areas that I'd consider as lower-risk near-term inflection points which could reverse a move.

The two zones that jump out at me on the S&P 500 (SPX) are 1670-74 and 1680-85.  Both of those zones have the potential to offer resistance and reverse a rally.

And as I'm writing this, I can't seem to get 2008 out of my head, and I'm reminded of the monster rally we had just before the crash started.  That rally was a Gift from Above for me, and I shorted into it with every dime I had.  In 2008, though, I felt almost 100% certain we were about to crash -- so certain, in fact, that I literally couldn't even comprehend who on earth was buying the market there, or why.  I don't feel anywhere near that level of confidence here at the present inflection point, but I do think there's potential for a solid risk/reward play to catch either a fifth wave down to new lows, or a much more serious decline.

In other words: this is not the type of place where I'd bet the farm with no stops, but certainly the type of place where I'll take a crack at things if I can find ways to limit my potential losses.

Let's take a quick look at the other side of the trade, though.  While I'm still in the bear camp for the moment, the ratio chart below suggest bears should indeed approach this market with caution:

The Dow Jones Industrial Average (INDU) has reached the bottom of a large trading range -- this is one of the charts I referenced earlier regarding markets that reached support zones yesterday.

Finally, the SPX chart.  As noted, I'm inclined to favor the bears -- but this isn't a clear-cut slam dunk to me the way last week's charts were.  Yesterday's market found support about a point shy of where it "should have" for the bullish alternate ABC decline.

In conclusion, the charts are clearly lining up for "an event," and we have two big news items on the horizon.  The bulls have potential here, and I'm not closed to that; so if the present rally forms itself into five larger waves, then we'll have to start thinking bigger rally and start looking at new upside targets beyond the two noted zones.  That bull potential makes me a cautious bear, but we're still just dealing with a potential and we aren't actually to the point where it's become high probability.  On balance I presently think the odds still favor the bears; and that means we have to take that thesis to its logical conclusion:  if the bearish wave counts are correct, then bears are getting ready to hit the market hard.

So to close out the question posed in the title of today's article:  There may indeed be "a bathroom on the right" in the market's not-too-distant future.  Trade safe.

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S&P 500 Reaches September's Downside Target -- What Next?

Let's get one thing straight: The stock market is not anyone's friend.  The stock market is a vicious and brutal killing machine which chops the unwary into tiny bits.  Then, after it takes their last dime, it proceeds to head the direction they were hoping it would before they got chopped up.  The stock market hates you -- especially when you make money from it.  When you win, it wants that money back, and it will try to goad you into taking higher risks afterwards.  Even as it pays you your winnings, it will laugh the way John Malkovich did in Rounders and say:  "Fine.  It's a joke anyway.  After all, I am paying you with your money." 

One of the great cultural illusions still left over from the Great Bull Run is that the stock market is a friendly place, where ordinary folks can get rich.  This illusion has been reinvigorated recently by the recovery of equities markets to fresh all-time-highs.  But the market is not a friendly place: Equities are a process of price discovery, a whirlpool of liquidity, a zephyr of global uncertainty, and a casino-full of seemingly-friendly dealers who are happy to take your money and leave you with nothing.

Every trade has two sides, and the person or institution on the other side of the trade you just took isn't buying or selling so that you personally can make money.  Quite the opposite: Their goal is to make money too; so while it's not anything as insidious as "trying to make money at someone else's expense," the reality is that every single trade has a losing side.  Which makes the stock market a financial battleground.   

Recently, we discussed that the charts were suggesting a pattern of buying that was premature, also known as a bearish nest of first and second waves.  These 1-2 wave patterns are not only vicious to bulls because of their ultimate resolution lower; they're also vicious to unwary bears.  The pattern tends to get shorts covering right when they should be holding.  That's the psychology of the beast. Shorts have held through each of the wave two rallies and experienced lots of draw-down along the way, so they become increasingly anxious and skittish, and they become conditioned to expect another rally right when the third wave down hits.  It's a war; the market wants everyone's money.

Yesterday, the White House announced that Obama will nominate Janet "Stop with The" Yellen as next head of the Federal Reserve.  Futures put in the obligatory "oh, hurrah" bounce on this news, which strikes me as a non-event.  I doubt this announcement came as a big surprise to anyone who has cable television, though futures remain green as of this writing.

The first chart we'll look at is the S&P 500 (SPX) which has now captured September's downside target.  A small reaction rally, perhaps to revisit the key trend line which broke yesterday, would not be out of the ordinary.  If the most bearish 1-2 count is unfolding, bounces should remain fairly muted for a time.  The next downside target is 1640-45, which would be the target for the alternate bullish ABC count, and it will now require sustained trade above 1675 to call that into question.

On October 2, I noted that the wave count appeared to be even more bearish than I'd anticipated up to that point, and added a lower target for the preferred count of 1600-1610.  I've updated this chart to reflect that target, though part of me wants to add an asterix behind it, since it may need to be adjusted in real-time as the wave unfolds.

 The next chart provides a closer look at trend lines and channels:

Finally, the Philadelphia Bank Index (BKX) is, interestingly, still a bit shy of reaching August's preferred downside target.  The red annotation was added for today's update.

In conclusion, sellers accomplished exactly what they needed to yesterday, and broke through a key intermediate support line.  Most of the charts I've looked at suggest further downside awaits -- and if this is indeed a nested third wave, we still have a ways to go.  Trade safe.

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Why the Buy-the-Dip Mentality Could Lead to Trouble

Last week, I remarked to a few other traders that the "buy the dip" crowd seems to have been out in force lately, and that if and when support broke down, those buyers should provide heavy resistance to any rallies.  When observing the price charts, it appears every dip has been bought quickly.  This is leading to a halting decline that doesn't seem to want to get rolling.  From this behavior, we can extrapolate that most everyone is anticipating a positive resolution to not only the government shutdown, but also to the approaching debt ceiling deadline (October 17). 

This psychology of positive expectation is consistent with the latter stages of a bull run.  Contrast the current psychology with the last debt ceiling crisis, at the end of 2012.  The markets were fearful and panicky then, and lots of folks were convinced we were about to crash.  Of course, the ultimately-positive resolution then kicked off a massive rally which has continued largely unabated through the present.  That psychology of fear was consistent with the early stages of a bull run.

I've talked about this many times, but in order to grow legs, bull runs need sellers just before the move starts.  Those sellers then become buyers on the way up, and actually fuel the move.  Conversely, bear runs need buyers positioning themselves wrong ahead of time, so those buyers can become sellers on the way down.  The majority simply has to be on the wrong side of the trade for any extended move to occur -- and that's where the psychology comes in.  Expectations have to be the inverse of the ultimate reality, in order for traders to position themselves incorrectly in the first place.

So sentiment has to be bullish for a bear move to start, and it has to be bearish for a bull move to start.  Just as we watched sellers position for the negative outcome back in December, we may now be witnessing buyers getting positioned for a positive outcome that never materializes.

Obviously, I can't tell the future -- but what I can tell is that if things go south, they're going to go south quickly, because the charts are showing us this.  Frequent readers have heard me use the term "nest of first and second waves."  That's Elliott Wave terminology -- in simple terms, (in a decline) a nested series of waves shows us buyers jumping in at each new low, which prevents the move from gaining steam early on.  This has a coiling effect on the market, and the price charts show us how the majority of traders are positioning themselves.  Since they're on the wrong side, when the move finally breaks and kicks off the third wave, it runs hard and fast as those early buyers suddenly exit en masse. 

On Friday, I noted that it's difficult to find a pattern that doesn't require new lows, and mentioned that we may see a big gap down come Monday.  Right now, futures are suggesting a double-digit gap lower for the S&P 500 (SPX) -- and Friday's action has allowed me to narrow down the potentials further, and also to provide some qualifiers to help sort one from the next.  The chart below outlines the details (on #2, "idea" should be "ideal."  A lack of typos would be "idea," but I can't seem to live up to that ideal.)

It's worth noting that the NYSE Composite (NYA) has dipped below the first key pivot, and if Monday's gap down sticks, will have been firmly rejected on the back-test.

The first blue-box target zone on the legacy SPX chart has come within a few points of capture, and presently looks likely to be captured in the upcoming sessions.  If the nest of first and second waves is unfolding, the market will ultimately blow through that target.

In conclusion, I still feel it's unlikely the market will escape new lows.  To the contrary, the pattern continues to appear to be a bearish coiling pattern, and trade below 1665 is likely to lead to an extended sell-off.  Presently, the most bullish pattern I can find (of good probability) is simply an ending diagonal c-wave that grinds a bit higher to start off the week.  Trade safe.

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How Many Fed Chairmen Does It Take to Replace a Light Bulb?

Q: How many Fed Chairmen does it take to replace a burnt-out light bulb?

A:  None.  The Federal Reserve is not currently forecasting any darkness, and feels the fundamentals support continued illumination.

Last update expected lower prices, and the market has since delivered.  Looking at the charts now, I still find it difficult to locate a pattern which suggests a meaningful bottom has occurred.  There's one potential pattern that's intermediate bullish, but the short-term charts suggest even that pattern would still require a new low.

We'll start off with the S&P 500 (SPX).  Most of the details are in the chart annotations, but to quickly summarize:

1.  The decline from 1696 is clearly three waves right now.  That leaves open the potential of an expanded flat (shown in blue).  The market will need to break out over the black and red trend lines to give that pattern legs, and the possible targets in that event are noted.

2.  The mega-bear potential is that the market is winding up for a big, sustained decline (a bearish nest of first and second waves).  That option is shown in black.

3.  There's really only one bullish potential I can find, which also results from the three-wave decline: an ending diagonal c-wave which tests the blue trend line.  Bears don't want to see another three-wave decline here, or that pattern gains traction.  Below 1657, and we can probably forget the bullish alternate for the time being.


Given the complexity of the options, I've tried to simplify this chart as much as possible -- and the main simple point to convey is: I find it hard to locate a pattern that doesn't still require new lows. 

 

 
The Philadelphia Bank Index (BKX) also still appears to want new lows.  This chart is virtually unchanged since early July.

The Dow Jones Industrial Average (INDU) has been a real dog lately, and the decline off the all-time-high has been relentless.  We've previously discussed the massive potential broadening top/megaphone pattern.  While INDU managed to clear August's engulfing candlestick last month, it's interesting to note that INDU has formed another bearish-looking monthly candlestick for September.  The long wick shows INDU's advance to the all-time-high was met with strong selling pressure... again.

In conclusion, I don't see much that suggests the market can escape another new low.  If bulls can form another three-wave decline here and stick save SPX at the major trend line, they could finally put a stop to the decline.  If they can't, then what we've seen so far has only been the warm-up, and the market is going to run into some serious selling pressure very soon.  Trade safe.

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Reaction Rally or Meaningful Bottom?

If W.C. Fields were still alive, he might change his famous punchline to: "I went to Washington D.C., but it was closed."  On Tuesday, the market acted as if Washington's shutdown was the best thing it had heard in weeks -- a clear case of "sell the rumor, buy the news."  However, I think the rally was a second wave fake-out, and continue to believe we're headed for lower prices.  I don't believe we're headed lower because of the situation in D.C., per se -- I follow charts first and news second, and I felt the charts were pointed lower before all this started.  However, the situation in D.C. could be the catalyst the psychological shift the charts were suggesting was due to occur. 

How long will the shutdown last?  Well, in one sense, politicians have already crossed the Rubicon and are past the hardest part of actually letting the government shut down.  Now that the deadline has passed and the worst has happened, one would think the immediate psychological pressure to reach an agreement is at least somewhat lessened.  In other words, if politicians couldn't reach an agreement when they were under the gun, it seems unlikely that they'll suddenly reach one tomorrow.  I obviously have no idea how long it will continue, but by this reasoning, it could drag on for a while -- and this type of event tends to increase market volatility.  Markets are generally uncomfortable with gross uncertainty, and the government shutdown is creating lots of future uncertainty.    

There are some other effects from the shutdown which will impact the market in both subtle and obvious ways:

1.  Economists estimate a loss of 0.3% of GDP for each month Washington remains shut down, so there is a direct and negative economic impact.

2.   The Labor Department won't be reporting September's nonfarm payrolls (NFP), which impacts us as soon as Friday.  This is probably fine, since they'd only need to revise the number later anyway.

3.  The Commodity Futures Trading Commission (CFTC), which is the agency that regulates the trading of options and futures, has only 28 of its usual 680-member staff monitoring for market manipulators and unusual activity.  Since they're no longer watching, I wanted to personally verify there was nothing suspicious going on in the futures market -- so last night I put in a couple small orders, both to be filled at market. I'm happy to report that the market was functioning smoothly, and my ES (E-mini S&P) market buy order was filled instantly and seamlessly, at ES 25,392.50.  I likewise had no trouble selling those same contracts later with a market sell order, and was quickly filled at ES 105.75.  Maybe I'll stick to limit orders until the CFTC returns...

On top of the shutdown, we have the debt ceiling crisis still approaching.  On October 17, the government has to stop borrowing money if an agreement isn't reached.  This is of course a problem for a government that borrows .40 of every dollar it spends.

The charts continue to suggest to me that further downside awaits, and the first chart I'd like to share is the 5-minute S&P 500 (SPX) chart.  The action on Tuesday caused me to revisit the short-term wave count, and there are presently two main options which could fit the structure.  My preferred count is that the decline represents five waves, while the last rally was an ABC correction to that decline.  The first alternate is just a variation on the theme, and an option that's simply unforeseeable:  the market can string together a series of three corrective sequences to form a larger ABC, thus creating a more complex corrective rally.  I can't predict that in advance; I can only anticipate it as it unfolds in real-time.  There are already enough waves in place for the reaction rally to be complete, so I'll stick with that interpretation until proven otherwise.

The more truly-alternate count is shown in green, which considers the possibility that the market has declined in a somewhat oddly-structured ABC fourth wave.  That option will start to gain more traction if the market reclaims 1697, especially on a closing basis, but I'd have to see the form it takes to determine whether a break over 1697 is simply the black alternate playing out (which would be my first inclination).  The only thing that looks even marginally iffy for bears here is the breakout and thus far successful back-test of the black channel; bears need to push the market back through the upper black trend line and keep it there.

That's a lot to digest -- so under the "keep it simple" philosophy: it appears most likely that the rally is over, and we're headed for new lows.

   
Next up is the Philadelphia Bank Index (BKX), which still looks like it needs further downside before we can start considering the potential of a complete fractal.  Even if this is the intermediately-bullish ABC, one generally expects to see a much better Fibonacci relationship between waves A and C than there is currently.

There are a few things worth observing on the SPX hourly chart.  First, notice the breakdown and apparent back-test of the red uptrend line (bearish); second, RSI confirmed the low at 1674, which usually indicates that prices will break that low heading forward (bearish); third, note that black wave (1) hasn't been overlapped yet, which still allows the potential for a final thrust toward "alt: (5)" (this is not bearish or bullish, it's simply a fact).  The black uptrend line appears to be absolutely critical for the bulls over the intermediate term, and of course we're not there yet.  If my near-term preferred count is right, we should at least test that price zone in the upcoming sessions.

In conclusion, I can see there's outlier potential present for a bottom, but I don't feel it's likely the market has put in a meaningful bottom yet, so I remain in "sell the bounce" mode for the time being.  If the preferred count is correct, the market is on the precipice of continuing the decline, and should pick up momentum heading forward.  Since nothing is ever a sure thing, stay alert to the alternate counts if the decline starts to look like it's three waves instead of five, and bears can't crack 1675.  Trade safe.

Reprinted by permission; Copyright 2013 Minyanville Media Inc.

Is Social Mood Turning?

In Friday's updated, I noted that the charts suggested further downside was imminent.  Friday's market indeed closed in the red, and as of Sunday evening anyway, futures are implying a 10+ point gap down for the S&P 500 (SPX) cash open on Monday.

The big news item right now is the looming threat of government shutdown.  I'm not going to comment on the sides in this debate, but I do find the reaction of the public extremely interesting:  A recent NY Times poll shows that 8 in 10 Americans disapprove of the threat of government shutdown, from either Congress or the President.  I have no intention of debating who's right or wrong here, however, I do have some thoughts I'd like to share about a larger trend in American philosophy.

A different, yet conceptually related, Gallup poll ostensibly shows that 53% of Americans think that compromise in Washington is more important than sticking to principle.  In my mind, that poll result is at least partially suspect, though, since the way the question was phrased almost certainly impacted the result.  The question is reprinted below: notice how "compromise" was linked to "in order to get things done," whereas "stick to beliefs" was linked to "even if little gets done."  The poll would probably have turned out at least slightly differently if they had linked "stick to beliefs" with "in order to get things done" and vice-versa.  But being the crazy radical that I am, I'm going to challenge the entire question. 

I believe two presupposition behind the above question are fallacy.

First: when did compromise for its own sake become any kind of meaningful ideal?  Pardon my French, but what a bunch of balderdash.  Compromise isn't an ideal -- by definition, it's what happens when you bend your ideals.  Of course, compromise can be a good thing, as it often is in a marriage -- but it can also be a very bad and harmful thing, depending on what you're compromising, and with whom you're compromising.  If my neighbor suggests that he wants to burn my house down in order to improve his view of the ocean, I'm not going to compromise simply to live up to the ideal of compromise.  And I'm not going to compromise for the sake of "getting things done."  I'm going to stand on principle and try to subvert his intentions, even if he accuses me of being "an argumentative obstacle to progress."

Which brings us to the second fallacy: Even if compromise were an ideal, compromise simply for the sake of "getting things done" is not necessarily positive, because "getting things done" is not unilaterally synonymous with progress.  I can drive my car off a cliff, or smash all my toes with a ball-peen hammer, and I'm "getting things done." 

Further, my idea of progress may not agree with yours.  Progress, whether in Washington or elsewhere, is really nothing more than someone's opinion.  And since opinions will always differ, we simply cannot "all just get along" via the vague ideal of compromise as the solution.  Nor should we want to.  Do any of us really want to live in a country where nobody stands on principle, and nobody truly fights for or against anything?  I don't think the majority really want that; I think they simply haven't thought it through.

In my opinion, ideals which have real value are those which are always the right course of action regardless of circumstance: ideals such as honesty, integrity, kindness, etc.  Those are things we can and should strive toward at all times.  But compromise simply cannot be an ideal that stands unto itself, because it's not always the right thing to do. 

The fact is, the seemingly-painless solutions we sometimes reach with "win-win compromises" are often only painless over the short run.  Over the long run, bad ideas eventually have lasting consequences if put into action.

We face a possible government shutdown, and most Americans feel a shutdown would hurt them -- so compromise seems to offer some vague solution as a way to subvert that pain.  We may not really know what compromise looks like in this situation, but we know (at least over the short run) that it probably won't be as painful as a shutdown.  And thus we get 80% disapproval.  I don't personally know whether a compromise here would be good or bad in the long run -- I don't pretend to have a solution, and that's not really my point.  My point is simply that I don't believe we should automatically assume that compromise in general is necessarily always better than the alternative.  

Sorry, rant over.

From a chartist perspective, it's interesting that we had the threat of the fiscal cliff near the second wave bottom, and now we have the threat of government shutdown near the (assumed) fifth wave peak.  One of the concepts behind Elliott Wave Theory is that social mood goes through predictable cycles (human nature doesn't change) -- and those cycles leave patterns on the charts indicating the psychology of the masses is reversing from positive to negative (or vice-versa) at major peaks and troughs.

No change in the charts and projections from the last few updates:

Near-term, it appears the market is about to enter a smaller-degree nested third wave.  This suggests selling pressure should continue for the foreseeable near-term future, as the market will need to unravel several low-degree fourth and fifth waves before finding a meaningful bottom.

In conclusion, the projections from last week are tracking well so far, and there's presently no sign that any type of bottom is imminent.  As noted previously, I continue to suspect we've seen a turn in the higher degree wave structure, and that the market is in for an intermediate decline.  Trade safe.

Reprinted by permission; Copyright 2013, Minyanville Media Inc.

Charts Suggest Further Downside Awaits

It's unusual that I feel this confident about the market's future.  Doesn't mean I can't be wrong (long time readers know I'm quite capable of being wrong sometimes; and according to my wife, I'm wrong exactly 100% of the time, so she'd probably fade me) -- but I'd say I'm roughly 75% certain that the market has another leg down in its not-too-distant future.
 
I'm going to start off with the Philadelphia Bank Index (BKX), which I watch closely since it has performed as a leading indicator of the broad market for the past several years.  On September 23, I wrote:

The Philadelphia Bank Index (BKX) continues to look weak, and may be the canary in the coal mine here.  Long-time readers know I believe that trouble for BKX equates to trouble for the broad market, and BKX still looks like it wants new lows.  

BXK has since made new lows -- and the decline there doesn't look finished.  Based on the mid-term historical evidence, I simply don't believe any rally in the S&P 500 (SPX) can grow legs if the banks aren't participating.

Further adding to my confidence is the fact that the decline from the all-time-high in the S&P 500 (SPX) appears to have been an impulse.  This suggests at least one more leg down of equal or greater length.

This has been a market that's difficult to get too far in front of, but I continue to feel that a larger intermediate decline is pending.  The chart below shows my first target zone only, but I suspect we're headed into the 1500's at the minimum before it's all said and done.  I'll reassess that thesis if and when the blue box target is reached.

In conclusion, I feel fairly confident that the decline from the all-time-high was impulsive, and I thus expect the market has at least one more leg down still to come.  Further, I suspect this is actually the early stages of a larger decline.  Nevertheless, once another leg down forms to allow the potential of a complete ABC (assuming I'm not dead wrong, of course), I'll reassess that intermediate outlook.  Trade safe.

Market Continues to Look Toppy

In the last update, I ended with the thought:

I continue to feel that downside risk outweighs upside risk at this moment.  Bulls could do a few things to change that -- for example, a breakout in BKX would go a long way toward causing me to rethink my position.  Barring that, I remain unconvinced that the present rally has staying power; and the market hasn't shown me anything recently to change that view.

The market action since has been encouraging to my thesis, and if I had to sum up the present market with one thought, it would be: "The top appears a lot closer than the bottom."

I want to lead off the charts with the NYSE Composite (NYA), because it represents the broad market much better than the S&P 500 (SPX) does.  The pattern here also appears somewhat cleaner.  We can see there's a pretty clear five-wave structure now in place, complete with a classic third wave overthrow of the upper channel boundary (red iii).  The chart annotations contain most of my thoughts.

 
The preferred count suggests the top is in, but the structure allows for a marginal new high without creating any material changes in the intermediate picture.  Near-term, I suspect we're going to see the market begin a snap-back rally soon.

The SPX preferred count remains unchanged from the past few updates, but I have deleted the mega-bull alternate count for the moment -- right now that alternate count looks like a low-odds long shot.  Obviously if that changes heading forward, we'll take another look at it as needed.  I still feel the apparent bearish rising wedge (between the converging black trend lines) has merit, and the minimum expectations of that pattern are for prices to return to the point at which it began. 

In conclusion, the charts continue to suggest the market is forming a meaningful top, but as the old saying goes, "They don't ring a bell at the top."  Important turns actually require the majority of players to be caught wrong-footed -- which means the market will do everything in its power to confuse and misdirect before a turn.  That tendency makes nailing important turns particularly challenging -- and tops in particular tend to be very whippy and frustrating affairs, which virtually always drag on longer than you think they will.  The market of the past few months has certainly lived up to that billing.  Trade safe.

The Real Taper Problem

My last article was a tongue-in-cheek look at the lighter side of how to handle the "tapir" of Quantitative Easing; this article will be a bit more on the serious side.

Scientists tell us that the highest number the average human can comprehend, without counting or guessing, is (are you ready?):  4.  When we get to 5, people can figure it quickly by counting, but most of us don't instinctively comprehend numbers larger than 4.  To quickly validate this research, imagine the last time you stopped at a restaurant for an impromptu dinner with a group of family or friends.  Most likely, when the host asked, "How many in your party?" you had to run a quick count in your head, even though it may have only been eight or nine people.  When it's just you and your significant other plus one other couple, you automatically know the party size is 4; but when there are kids and grandparents and aunts and uncles, we have to count.

My point is, when we start dealing with the types of numbers we deal with in finance, the quantities become incomprehensible to us.  To my knowledge, scientists haven't drawn an exact line as to where numbers reach the point of being completely unfathomable, but I think we can draw our own rational conclusions with a bit of mental experimenting.

Consider that on an unusually clear night, there are "only" a few thousand stars actually visible to the naked eye -- yet to the human mind, their numbers seem infinite.  Weigh that visualization of "a few thousand" against a number such as two trillion.  We quickly find we can't wrap our heads around it and mental tricks fall short.  Try it:   A million is a thousand thousand, so: let's start with something we can visualize, like the night sky.  To reach a million, simply multiply the number of stars in the entire night sky by a factor of three hundred or so.  Theoretically, that gets us to a million, but our minds are already cheating and we end up visualizing something akin to "a whole bunch."  To get to one trillion, we have to visualize a million million -- so we have to multiply a number we can't visualize by another number we can't visualize (and then we have to double the sum!)  Our minds don't even really try, and all they can come up with is: "Wow, a whole bunch more!"

I would argue that when it comes to the huge figures we're dealing with in programs like Quantitative Easing (and things like the national debt), we just flat out have no clue what the numbers mean.  The numbers are so big, in fact, that we can't even understand how big they actually are (if that makes sense).

So, with all that said, the Fed now holds over $2 trillion in Treasuries.  Fed holdings of mortgage-backed securities now total over $1.3 trillion, as seen on the chart below:

 

Since 2009, the Fed's total holdings (of both) have increased by about $2.8 trillion -- roughly a factor of six.  Do those numbers find any traction in your head, beyond, "Wow, that's a lot of money"?  Because they don't in mine.  The main thing my mind does is look at the graph and pretend those were numbers I could understand in personal or business finance, and then it comes up with:  "That doesn't look healthy."

The present upwards trend simply cannot continue infinitely in a linear fashion, because the Fed does not have the ability to take on an infinite balance sheet.  So, from that simple fact, we know the present moment is fleeting and cannot continue.  That presents problem one: what happens when the Fed stops expanding its balance sheet?  Problem two is how does the Fed backtrack and shrink its balance sheet in order to engineer a 'soft landing' at some point?  Can they?  Many would argue that the Fed is now trapped by its own machinations. 

The Fed has become a bit like DeBeers is with diamonds: they can control prices as long as they can absorb and regulate the supply.  The advantage DeBeers has is that diamond production is much, much slower than Treasury production.  And unlike the Fed, DeBeers "only" has several billion dollars worth of diamonds in its vaults -- yet if by some chance they were forced to liquidate the entire vault tomorrow, diamond prices would drop like a rock (pun intended).  The Fed faces a similar dilemma.

Further, just like DeBeers, if the Fed were to abandon the business of purchasing new supply, prices would fall because a huge source of demand suddenly disappeared.  On Friday we saw how Bernanke handles the dreaded Tapir (it's handled just like everything else: feed it money) -- but the real question is: how does the Fed handle the taper of QE?

I don't think there are any easy answers.  

Chart-wise, there isn't much to add to Friday's update: presently the decline works as a passable ABC, but a bit more downside will begin to give it an impulsive appearance -- and as I noted Friday, there are enough waves in place for the upwards move to be complete.  Theoretically, support lies in the 1695-1705 zone, and bulls could start to run into more serious problems if the market sustains trade beneath that zone.

It's getting hard not to notice that the pattern, presently at least, appears to be a bearish rising wedge (it could also pass for a Three Drives to a Top pattern).  The normal expectations of a wedge are for the market to return to the point at which it began; in this case the mid-to-high 1500's.

The Philadelphia Bank Index (BKX) continues to look weak, and may be the canary in the coal mine here.  Long-time readers know I believe that trouble for BKX equates to trouble for the broad market, and BKX still looks like it wants new lows.

In conclusion, I continue to feel that downside risk outweighs upside risk at this moment.  Bulls could do a few things to change that -- for example, a breakout in BKX would go a long way toward causing me to rethink my position.  Barring that, I remain unconvinced that the present rally has staying power; and the market hasn't shown me anything recently to change that view.  Trade safe.    

Bernanke Claims Investors Misunderstood "Tapir Talk"

The big news since last update is, of course, the surprise announcement from Bernanke that there will be no taper of the QE program.  This announcement came after months of "taper-talk" -- and burned investors who bet the market would decline as it was weaned off the Fed's bottle.  On Thursday, critics blasted Bernanke for his lack of clear communication.  Chris Low at FTN Financial was quoted as saying: "Despite Bernanke's effort yesterday in the press conference to paint the FOMC decision as entirely consistent with earlier communication from the FOMC, it was not...  the Fed's communications credibility is shredded."

My sources have provided us with an exclusive photo that helps explain the miscommunication.  The problem stemmed from the fact that the words "taper" and "tapir" are pronounced the same, but have entirely different meanings.  Bernanke communicated perfectly -- it was we who misunderstood. 

Taper means: diminish or reduce or cause to diminish or reduce in thickness toward one end.

Tapir means: a nocturnal hoofed mammal with a stout body, sturdy limbs, and a short flexible proboscis, native to the forests of tropical America and Malaysia. 

When Bernanke talked about how to handle the Tapir, anxious bears simply heard what they wanted to hear ("taper").  After seeing this photo, I have to disagree with Chris Low -- the Fed's communication credibility is, in fact, wholly intact.   

If it weren't for the discovery of this honest miscommunication, one might have started thinking the Fed was actually trying to bait bears with all its taper-talk.  Luckily there's no need to start any blindly speculative and completely unfounded conspiracy theories, since we now know that simply wasn't the case.

Where does all this leave the market?  Well, we're into territory where bears will need to make a stand fairly quickly.  If this wave begins to appear that it's subdividing into a larger five wave form, we'll have to start giving serious weight to my big picture bullish count from February and its long-term target in the 2100's. It's worth mentioning that the fourth waves we've had to date have been somewhat pathetic -- typically we'd have expected a bit more downwards movement than we've had each time, and a couple have caught me looking (to borrow a baseball term).  Welcome to the Fed's humbling New Normal, I suppose.  

The hourly chart shows more detail.  Frankly, it looks likely that there will be at least a bit more upside, but there are enough waves in place to count the last rally as complete.

The Philadelphia Bank Index (BKX) continues to look uninspired, and is still keeping me from jumping on the "rah rah, we're going to the moon" bandwagon.  A breakout over the key 65 zone could change all that, though. 

In conclusion, the intermediate term will hinge on how the market behaves in the directly upcoming sessions.  If the rally is a straightforward five-wave form, then it should be nearing completion.  If it instead subdivides, the market will be off to the races again and headed for the 1800's.  We'll have to see how the structure develops over the next few sessions.  Trade safe.

A Closer Look at the Big Picture

At times like this, it's easy to get lost in the day-to-day market nuttiness, and I've found it's sometimes helpful to take a step back away from the one-minute charts and look at the big picture.  So today we'll start off with the old reliable NYSE Composite (NYA).  NYA is a great representation of the broad market, since it contains all the common stocks on the New York Stock Exchange -- and it often tells a different story than the big-cap indices like the Dow Jones (INDU) and S&P 500 (SPX).

It's very interesting to note that NYA has still not made a new all-time-high.  The chart below is a weekly chart, and the notes contain most of my thoughts.  Just glancing at the chart, the main thing that jumps out is how quickly and effortlessly NYA plummeted back in 2008, versus how it has seemingly struggled to regain that ground.  This is especially noteworthy given the massive Fed money pumping that's occurred during the past five years.  The picture suggests that the fits-and-starts nature of the rally is caused by the fact that it's a correction to the last decline -- one of the ideas behind Elliott Wave analysis is that the market struggles when moving against the larger trend.

The Philadelphia Bank Index continues to lag.  So far, this isn't doing much to sell me on this rally as anything that will have legs for SPX.

Even if this rally is going to become an impulse and make a new all-time-high, it looks like it's very close to being a complete structure.  As I've noted previously, the main bullish hopes would lie in the idea that when this five-wave fractal completes, it will make up wave (i) of a still larger five-wave fractal.  Given NYA and BKX, I currently have to view that bullish option as lower probability.

In conclusion, I do not presently believe this is the start of a nosebleed rally -- to the contrary (while I think it's entirely possible SPX will push on to another high), I still believe the market is in a topping phase.  Trade safe. 

No Fed Chairman? Must be Bullish

Futures are indicating a big gap up come Monday morning, so it looks like the market could blow through my 1695-1700 target.  This market somewhat reminds me of the reverse of the 2008-2009 bear market.  In 2008-2009, the market would bounce for a little while and get bulls hoping the bottom was finally in -- then it would collapse again to new lows.  The market didn't form a long-term bottom until bulls had all but given up entirely.  I recall in March 2009, investor sentiment was over 70% bears.

We may need to see that shoe on the other foot now, and I wonder if we aren't awfully close to the point where bears capitulate.  The ongoing challenge of speculating as if we were working within a "normal" market framework is that we have continued Fed money pumping -- and as the saying goes, "You can't keep a good printing press down."

Speaking of, the big news over the weekend was the voluntary withdrawal of Larry Summers from consideration as next Fed Chairman.  Summers notified Obama on Sunday first via phone call, then sent a letter soon after (the title I really wanted to use today was: "Summers Falls as Winter Approaches").  In response to Summers' withdrawal, Obama issued the following press statement via teleprompter:

"Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression [APPEAR CONCERNED], and it was in no small part because of his expertise, wisdom, and leadership that we wrestled the economy back to growth [GESTURE WILDLY AND FORCEFULLY, AS IF WRESTLING] and made the kind of progress we are seeing today [PAUSE FOR LAUGHTER]."

Many are speculating that Federal Reserve Vice Chair Janet Yellen is now the front-runner for the Fed Chairman position, since, among other things, her qualifications include having a last name that sounds like "yelling."  Yelling is considered an important skill for a Fed Chairman, because it's the only way they can be heard above the constant roar of the printing press.  (And now that I've brought that segue full circle, I can move on in good conscience.)

Anyway, I'm wondering if this bull market will just keep running, until we reach the point where everyone reflexively buys every dip and bears have completely capitulated.  If it behaves as the inverse of 2009, then when the real top comes, everyone will naturally assume it's just another pause.

Technically, the bear count won't be invalidated until the S&P 500 (SPX) trades back above the all-time high.  The market has shown the 1710 area as resistance, and it's tough to get too bullish near resistance (or too bearish near support).  Keep in mind that the market often likes to run just a bit farther than a key level to grab stops before reversing, and my original (but since abandoned) preferred count target for SPX was the mid-1700's.  Certain indices like the NYSE Composite (NYA) have been suggesting that a fifth wave up was still needed -- I noted those signals weeks ago; in hindsight, I probably should have given them more weight than I did.

NYA "should" make a new high here; and it will be interesting to see how SPX behaves after the opening gap. 

SPX suggests similar.  If the rally is developing into a five-wave impulsive structure, it will need to unwind at least a couple more fourth and fifth wave sequences:

Even if 1710 is claimed, in the bigger picture, we aren't presently talking about a blow-out rally.  Bulls will have to keep their fingers crossed that the pending potential impulse wave is only wave 1 of the larger red v.

In conclusion, the bearish wave count may be reset this week, but presently that doesn't put the bears out of the running.  If 1710 is broken, then we'll have to see the form of the next decline to help anticipate if this wave is indeed going to mark all of red v and lead to a protracted decline, or if it's only going to mark wave 1 of red v.  And if mere mention of a protracted decline makes you feel hopelessly frustrated, then we may actually be getting close.  Trade safe.