Stock market internals strength waning as resistance tested: Charts review

Happy first trading week of 2012! But get extra cautious because negative divergence has increased, so our Year 2012 Overview thesis of a decline into the middle of this month is looking more ripe now. Many equity indices and stocks saw their high on Monday and struggled with up and down swings the rest of the week. Behind the scene, we see deterioration in strength of market internals data. We won't know until February whether the stock market can ascend to higher highs in early March. First we have to brace for a decline that has the potential to retest the November lows around 1170's $SPX. We'll look at various charts of this, as well as a couple of my sentiment charts ($VIX).

First, the McClellan Oscillator which tracks the internal strength of the stock market basically dropped through the week; and its level remains well below that of October-November. In the lower indicator window, the McClellan Summation Index is testing its 50-day moving average, indicating that the longer-term outlook may be in doubt as well.

It's also noteworthy that Tom McClellan and his team are showing negative divergence in the McClellan Price Oscillator for the Dow Jones Industrial Index, their "Chart in Focus" this weekend at McClellan Financial, http://www.mcoscillator.com/learning_center/weekly_chart/.

Last weekend the McClellan folks showed negative divergence involving copper prices. Today, I looked at the Baltic Dry Index and see something equally concerning. This $BDI index of shipping rates fell sharply in recent days:

Resistance is illustrated in several charts. I'll start with charts showing how many of index stocks are above their key moving averages. The number of Nasdaq stocks above their 50-day moving average is itself testing up to its own 50-day moving average. And the number of New York Stock Exchange (NYSE or $NYA) stock above their 200-day moving average is testing up to its own 200-day moving average!

In both cycles theories, and good old-fashioned Dow Theory, the fact that not all indices made highs above last year's October-November highs remains a potentially bearish sign. Also, the Dow Industrials are tickling up to an upper price channel. As for the monthly - I've got an old chart with a bearish downtrend fork, and price remains confined within it. Testing it, even - so we'll see!

Finally, the volatility index while declining is both stretched, and nearing potential support. Sure, down is down until it isn't, but the $VIX remains well above the 2011 lows. It's below the October-November lows which looks bullish, but being so far above the early 2011 lows isn't so bullish necessarily. The $VIX is also nearing potential trendline support levels on my daily and weekly charts. These trendlines are a little roughly drawn but you get the idea:

Based on the VIX's overstretched condition, once it rises over the prior day high it can be a stock-index sell signal that lasts longer than the last one. And all in all with the negative divergences and price resistance shown above, the upcoming dip may be a significant one. We'll want to buy that dip when it completes, but we don't want to lose money on long positions while the dip takes shape.

Will Hallowe'en make a nightmare, or just comic relief, before Santa rally?

The idea of a Santa rally is a rise from lows - like October lows - then up into December. We thought we'd see that this year. But Fibonacci and technicals have me questioning that (i.e., can the market make a higher high). Fibonacci time (1.618 time extension of the slide off October 2007) suggests that June-July might have been the highs of the move up from March 2009. Fibonacci price retracements raise this possibility too, as I've marked on my daily S&P 500 chart (courtesy of Stockcharts.com). Going into this "scary" Hallowe'en weekend, this stock index reached a Fibonacci retrace level (61.8% to 70.7%) consistent with a wave 2 pullback. The scary thought is, this could be all we get from the rally, even though we thought the rally might continue into December (after a pullback we'd expect over the next few days). I might not be the only person seeing that there's a potential downtrend channel marked by parallel lines incorporating this week's rise, as I marked on that chart.

We can let the markets tell us. For example, collect on the rally, then either re-enter if it goes higher, or re-enter after a pullback maybe by the end of next week or mid-November with a tight stop in case it's more than a pullback. So this could be a KI$$ approach. Can the market break above the bearish downtrend channels? Sure! - but we can wait to see if it does, or not.

Below are charts of the S&P 500 daily, the Baltic Dry Index, and the SPX monthly. I've included some markings, plus there are technical indicators that support what I'm pointing out. Daily basis the technicals still look positive (though the McClellan Oscillator does have some negative divergence, plus VIX as I pointed out last night is testing support); but the BDI has turned down, and the SPX monthly indicators show merely a backtesting that hasn't turned the indicators actually positive. The BDI is thought to point the way for stocks, because it's a measure of shipping activity and therefore economic conditions.

PS - Fibonacci fans, the 1.382 time extension of the 17-month drop from October 2007 was March of this year, which certainly was a wild time in the stock market. And the 1.786 time extension was August of this year - so a low, from the high crest at the 1.618 time extension. The next time that may echo (and possibly the last of much significance, we'll see) will be the 2.0 time extension in January. I've had to correct this note, because it's January (not December as I originally posted). It actually adds to reasons to look for a significant low (or maybe high) in January (and we'll see if that's a drop from a higher high than already reached). There are also reasons to look for a relative high in March - we'll see.

PPS - the 3.0 time extension will be in June 2013 (note, even the base 17 months is intriguing because it's twice 8.6 which has its own Fibonacci-type characteristics). So June 2013 could be a time projection for a major low, if we get a high-low-high-low-low sequence (10/07, 3/09, 8/10, 1/12, 6/13). Perhaps also interesting, a h&s target if the SPX made a neckline around 1075 that it'll go below, would be about 775. But a 70.7% retracement of the move 667 to 1370 would be roughly 880; which also interestingly, would be about 61.8% of the retrace from the 2010 highs back toward 667. That price range would touch around the midline of the downtrending fork on my monthly chart, around May 2013. I'm not saying this is ironclad, or even my primary point of view. Just charting out possibilities in case the SPX is going to work out a deep second-wave retrace by the May 2013 time frame.

Some market indicators aren't as bearish as you might think: Chart review

I'd like to share various charts below, to demonstrate that things aren't as bearish as you might think - at least through the end of this year. First, our year 2011 forecast in general is currently showing that, once we get past October (whatever turbulence it may bring), the markets should be up for a "Santa rally" into November and December, maybe beyond. Second, look at the Baltic Dry Index ($BDI) chart below - it made a huge move up recently (kinda reminds me of how Google ($GOOG) has powered up recently! The $BDI has gotten overbought but that doesn't mean it'll crest immediately, or that it won't rebound for a first retest from a pullback.

Below that are daily and monthly charts of the Dow Transports index ($TRAN). Along with the $BDI, these tend to track economic activity, and it's positive they've been rising to challenge the 2007 highs. They've dropped back, but notice now the daily chart's volume-by-price indicator (horizontal bars) show an "air pocket" above the current price, although heavier resistance by this year's highs. Even if the Transports can't move above the monthly chart's double top, there's room to rally up more for another effort.

Last, I've added the McClellan Oscillator chart for the Nasdaq (with its summation index in a lower indicator window), and the $TRIN Arms index. The McClellan Oacillator shows the market's near-term frothy, but can do a first retest after a pullback, and the longer-term indication from the rising summation index clues us in that the market has room to move higher when it's ready. Finally, the $TRIN similarly shows that the market is overbought, but the $TRIN's moving averages are high enough that they show the market has room on the upside before it finishes working off the bigger-picture oversold condition.

It's true that other breadth indicators (like the Nasdaq advance-decline data, shown in a long-term chart at bottom) show that market isn't running strong. But once we get past possible turbulence into later this month, the new-month new money plus seasonal influences are likely to afford swing and KI$$ traders a decent rally to ride, at least into the end of this year.

Resistance tested in Nasdaq 100 & Baltic Dry Index in opex time zone

Investors and traders (including KI$$ swing traders), beware. We're testing resistance going into this Friday's options expiration "fun and games" so don't adopt a longer-term bullish view unless this resistance crumbles under continued positive movement next week. The Baltic Dry Index ($BDI) chart below shows that after an initial rise, followed by a triangular range, $BDI spiked up in recent weeks, but testing approximately 50% retracement back to the prior peak. Meanwhile, the Nasdaq McClellan Oscillator ($NAMO) is testing its own retracement spike with a lower high (and flagging CCI) as the Nasdaq 100 index ($NDX is the symbol for this index, which traders often trade using the QQQ as their ETF) makes a higher high now retracing about 50 to 61.8% back to its high of this year (plus its 200-day moving average) It's looking like negative divergence between $NDX price and the $NAMO as these key price retracement levels are being tested.

Opex can allow for more extended moves as trades unwind, and we must also see whether or not these resistance levels will cause reversal patterns sending prices back down. After all, it's possible that resistance may crumble and a new bullish wave could theoretically move not only higher, but perhaps even to new highs for the year. But I'm thinking we're more likely to see another topping out in the next few trading days, so I'm getting poised for that.

The $TRIN indicator chart at bottom shows that the market is generally oversold, which can extend for a long time in downtrends, yet is getting overbought short-term. This doesn't guarantee whether or not the resistance levels will be overcome. Objective traders - including "Keep It $imple $wings" (KI$$, my term) - should be prepared for a possible swing top over the next few days, and to position for another swing downward to possible new lows, unless the stock market can continue above this week's high after Monday (time) and/or this resistance area around the 200-dma (price). That's my best take on all this - happy market navigating, all!