Markets Look to be heading for Lower Levels

We began last week with a near-term bullish view of the markets. However action late last week has forced us to sweep our bullishness aside, for now at least, and concentrate on what we believe to be a bearish scenario developing.

The Dow Industrials saw a shaky week and a much needed correction from its recent impressive runup, declining by more than 5% for the week. Clearly, the market has been extremely overbought and was in desperate need of a correction. It is no surprise that it has been significant, and we should be prepared for the possibility of even further declines. We surmised that the tremendous amount of money on the sidelines until now awaiting a Dow correction will not come pouring into the market providing ever more liquidity and propelling the Dow closer to higher levels. This may indeed turn out to be the case. But it is beginning to look like a sucker play.

The single indicator that has us nervous is the Dow's daily candlestick futures chart, which shows a very bearish pattern that developed last Wednesday, Thursday and Friday. It is known in Japanese candlestick parlance as an "identical three crows" pattern and is labelled on the accompanying chart. This pattern generally presages intermediate- to major-term bearishness ahead in the market. There is no way to measure amplitude with this pattern, but it almost always means significant declines ahead. Further strengthening this interpretation was the unusually high trading volume in the Dow Industrials futures index on Thursday, the day of its last posted down day. It exceeded the volume seen in this index for months, even while volume for the cash Dow index was considerably less (comparatively speaking). What it all boils down to is this—be safe and either enter short positions or stay in money markets until this blows over. We have a feeling the coming days could get nasty.

We don't like to reference extraneous news events in our analysis of the market as possible influences, but Brazil's near-meltdown as well as the apparent resumption of meltdown in Russia do not bode well for the U.S. markets in the long run, and probably not in the short run either.

Other technical indicators speak to the waning momentum in the Dow's long-term rise. Breadth has been horrendous throughout, although we conveniently ignored it the past few weeks because it doesn't much matter in an all-out market bubble. But in a weakening market on the verge of a major downtrend it does. The ratio of new highs to new lows on the NYSE has also been unimpressive throughout the Dow's rise from September—averaging less than 100 new highs versus the nearly 300 new highs it was averaging back in July. Now it has shrunk to below 50 and sometimes not even that. Apparently, the chiefs have abdicated and the Indians have followed suit.

Other technical indicators do not even bear mention because of their unreliability throughout the Dow's three-month rise—CBOE put/call figures have been extremely overbought throughout but what else is new? Now maybe the market will wake up to reality and correct its previous errors, meaning of course a major decline. ARMS index readings have also been ridiculously overbought as well.

Last Wednesday's high-volume decline had us perplexed but not worried—such high volume declines normally presage the beginning of either major or intermediate downturns and we argued in our e-mail market update that was not the case. But we now believe we were wrong and have accordingly adjusted our market stance to accommodate the obvious bearishness developing in the markets.

For now, the critical support level to keep an eye on is 9100 in the Dow Industrials, which represents Thursday's penetration of trendline support and our new target sell signal. For traders who like to stay long the market until the last possible minute, once this level is reached we advise exiting all long positions. Conservative traders should already be out of long positions in the U.S. equities market in anticipation of a coming decline. This week will be a crucial day in our opinion as far as determining the near-term trend in the U.S. market.

Elliott Wave practitioners will note the clearly-defined five wave decline in the Dow's hourly chart through this week which points to at least an a-b-c upward correction, which began Friday. In fact, this could be nothing more than the start of the bearishness we have mentioned in this commentary, in which case we will still want to exit and stay on the sidelines until it is complete. Again, 8924 holds the key, but conservative investors will want to exit even before that—like now. The Dow's daily bar chart shows what is known in Japanese Candlestick parlance as a "tweezers top" that developed last week. This is when two consecutive days share the exact same intraday high. It almost always points to a correction—sometimes minor, sometimes of intermediate degree. It doesn't always portend a major correction, but it can, and this may be the case presently. The last time a tweezers top developed was in late-November, which saw a correction of 600 points. Another one developed in early November and presaged a Dow decline of 200 points.

The Dow Jones Transportations fell below Fibonacci support of 3100—not a positive sign—but we gave some leeway to this index on Thursday evening and the Transports bounced back to near the 3150 area on Friday. It now is faced with Fibonacci 62% resistance. If the Transports cannot overcome the 3150 area level, it will send a Dow Theory signal that we have entered the early stages of another bear market.

It is important to emphasize that there is no guaranty that any of the technical patterns we have mentioned as basing our interpretations on are 100% reliable. Maybe the Dow will not turn down but will instead soar to greater heights. But a good trader always plays it safe, and when technical analysis warns of possible danger in the market we must heed its call.