BK Ends Sub-Wave (3) with Bull Flag

Bank of New York Mellon (NYSE: BK) rode the Financial Sector's post-election wave to a new high on November 15, surging to 47.96 on high volume.  In what has become a very familiar pattern in the week following the US Presidential Elections, a strong flagpole pattern emerged.  As with other stocks that we've reviewed this week, the subsequent trading sessions consolidated into a well-defined flag pattern.

BK Daily Chart

 The major uptrend for this financial sector giant started on February 11th, and it has traced a very distinctive Elliott Wave impulse pattern ever since.  Notice that Wave 1 encompassed a 5 sub-wave impulse that ended in June, 2016.  Wave 2 was a complex corrective wave, and retraced about 61.8% of Wave 1.  That corrective wave lasted for almost 4 1/2 months before Wave 3 kicked off on October 13. 

Based on our Elliott Wave analysis, Wave 3 has not yet completed.  Thus far, we've traced three complete sub-waves and are in the midst of sub-wave (iv).  There's still one more upward move coming in Wave 3, and that's the wave we hope to catch. 

Two price targets come into play to the upside.  First, we have a flag pattern that's been in play for over a week, and that target is 50.36 on an upward breakout.  (One caution to note, however, is that the time-duration of the flag is becoming troubling.  The proportion of flag to pole is very close to invalidating the pattern.  Keep an eye on this if it goes on much longer.)

The second pattern to consider is the Elliott Wave price target.  Thus far, Wave 3 has not yet reached the full length of Wave 1.  Typically, Wave 3 is the longest of the three impulse waves of the five wave set, although it doesn't have to be by rule.  The actual rule states that Wave 3 cannot be the shortest of waves 1, 3, and 5, but it doesn't have to be the longest of the three.  Based on that, we set our initial target to the actual length of Wave 1, recognizing that it's possible for Wave 3 to fall short of that without violating the rule.  For our flagpole target to be valid, in that case, we need wave 3 to rise 11.85 from the height of Wave 2.  A rise of only 10.45 is needed to satisfy that requirement.

Now, our current sub-wave is a bit of a problem since Wave (iii) falls just short of Wave (i).  That means that Wave (v) must be shorter than Wave (iii.)  Fortunately, the flagpole target is a full 2 points below that level, so a truncated Wave (v) will still be able to hit our price target.  Thus far, the pattern we're seeing appears valid on multiple counts.

Let's take a look at some other aspects of the chart to see what they're telling us.  Look, for instance, at the bullish channel that formed at through each of the waves as drawn in tan dotted lines.  The upper channel line, when extended out to the right, now intersects our flag pattern precisely where we're trading today.  That line may well form a support line if the stock breaks to the upside. 

The other interesting characteristics we see are the two spinning top candles that formed yesterday and today.  (We'll ignore the doji that formed on the day after Thanksgiving since it was a short, low volume trading day.)  The spinning tops indicate indecision in this context, meaning this stock can break in either direction. Volume has been consistent throughout the flag pattern, however.  We'll have to wait to see which direction the market decides to take this one, although the overall chart increases the probability of an upside break.

Here's how we're playing this one.

• If it breaks to the upside - meaning, it has closed above the flag pattern with confirming volume - we will go long, setting a price target of 50.36.  Our stop will initially be below the pattern low.
• We will trail our stop to reduce and then to eliminate risk.
• If the stock breaks to the downside, we will stay on the sidelines.  The pattern in general suggests high risk associated with a downside break, so we won't be looking to play a short on this one.

As always, watch the volume signature on a break to either side.  If volume does not confirm the pattern, wait for a pullback and a second break.  With all the attention the financial sector is receiving in the post election cycle, this stock has a high potential for false breakouts in either direction as the market makers attempt to shake loose the weaker hands.  Always watch for confirmation before entering the trade.

Happy Trading.

NTRS Forms Bullish Pennant On High Volume Flagpole

Northern Trust Corporation (NASDAQ: NTRS), a Chicago based financial services holding company, formed a well-defined pennant after tracing a strong 4-bar flagpole on high volume.

NTRS Daily Chart

In addition to the classic pennant formation, the current uptrend completed three waves and is currently in the fourth.  Note that, for a short term price analysis, we're looking at the last of the impulse patterns starting on July 6th, not the major impulse that started at the low on February 11th.  The longer term wave is certainly a valid one, however the time horizon for the next wave in that analysis is longer than our preferred holding period.  So, for now, we'll focus only on the shorter wave analysis.

Starting with the flagpole, we will use 76.4% of the height of our pole as the measure for our price target.  Using this standard, the target for our pennant in an upward breakout is 88.71.  If, however, the pattern fails and breaks out to the downside, we will use the first major support line at 75.84 as our target.  Remember, at this point we don't know which way this pattern will break, although the volume signature at present is pointing us towards an upside breakout.

Our Elliott Wave analysis also points towards a fifth wave upward breakout with a target of 90.29.  Now, that target would take about two months to play out and would likely be a five sub-wave pattern itself, so while we're using it to confirm the potential strength of an upward breakout, the time horizon is too long for our preferred holding period of under a week.  Rather, we'll stick to the pennant targets since we can anticipate a swift short-term spike towards either of our targets.

Looking at key dates for this stock, we can ignore earnings within our holding period.  They next report on January 18th and we'll be out of any position long before then.  The other key date, however, does impact the analysis, however.  NTRS goes ex-dividend tomorrow (November 30th) with a $0.38 dividend.  For you dividend players, that means you need to own the stock at the close today, and the pay-date for this dividend is January 1, 2017.  It's important to factor in that dividend in our chart analysis, however, since those 38 cents will be taken off the stock price tomorrow at the open.

Here's how we're playing this stock:

• On a break to the upside, we will go long, setting a price target of 88.71.  Our stop will be just below the low of the pattern.
• On a break to the downside, we will go short, setting a price target of 75.84.  Our stop will be just above the high of the pattern.
• In both cases, "a break" indicates a close either above or below the pattern with volume that confirms the move.
• Also in both cases, we will trail our stops seeking first to reduce and then to eliminate risk.

It's important to watch the volume signature on this breakout.  The flag and pennant patterns are extremely popular, and they are therefore prime targets for market makers seeking to take out entry stops, thus trapping the trader on the wrong side of the intended direction for the stock.  We can see that this stock was marked up rapidly on very high volume over a period of four days.  Equally interesting and important, however, are the two down-days in the pennant. Notice the volume on both days.  (Ignore the volume on 11/25 - that was an early close on the day after Thanksgiving, so it tells us virtually nothing.)  The candles across the pennant have been very consistent in range, as has the volume signature.  Price is being held at this level by the market specialists, although it's too early to tell if this is in preparation for another accumulation phase or a setup for distribution.  We need the breakout to tell us that.  Watch the chart, study the volume, and ride on the coattails of the market makers when the breakout occurs.

Happy Trading.

OPEC Poised for Oil Production Cut on Wednesday

The 171st Meeting of the OPEC Conference is scheduled to meet this Wednesday, 30 November, in Vienna, Austria.  It's widely anticipated that OPEC (Organization of Petroleum Exporting Countries) will agree to cut oil production by at least 2.5% in their 10:00 AM EST announcement.  OPEC last cut oil production in August, 2008.

Until this afternoon, the largest wild-card in the equation was Iraq, however they announced today that the fourth largest oil exporter in the world will cooperate with OPEC and called for a 4.546 million barrels per day reduction in production.  Iran is similarly considering a cap on production, although they have yet to announce any projected levels.

Oil spiked on the news from Iraq, however it settled down before the close, today as the news was digested by commodity traders.  As of this writing, WTI Crude is trading at 46.92 and Brent Crude is trading at 48.02.

It's important to note that four of the top ten oil producers in the world - Russia, the US, China, and Canada - are not members of the OPEC cartel.  None have signaled either support or opposition to the OPEC plan, although all would benefit from a production cut accompanied by higher oil prices in 2017.

Ironically, the initial call for a cut in production came from Saudi Arabia, the world's largest producer.  Starting in 2014, Saudi Arabia increased production dramatically, driving oil prices from their $100 per bbl range down to as low as $26 per bbl.  Their intent at the time was to cripple the US shale market by driving price below a profitable level for the hydraulic fracturing wells used in the shale fields.  While the price cuts did initially cripple the shale industry, price eventually stabilized in the mid-40s, thus mitigating the impact.  Saudi wells could absorb the short-term impact on profitability, however as we head into the fourth year of abnormally low prices, the impact is now being felt across the Saudi Arabian economy.

Analyst expect at least a 2.5% production cut on Wednesday.  This will likely cause significant volatility in the oil market for the short term, and we can expect to see an overreaction to the upside until the actual impact of the cut is determined.  With refining currently at or near capacity, it's likely that the cuts will have little end-user impact over the long term, and we can expect oil to stabilize in the low to mid 50s in 2017.  That's still lower than it should be, however it's far better for the economy as a whole than the excessively low range we saw in 2015 and parts of 2016.

Complexities Abound in Trade Deficit Discussion

The US Census Bureau released advanced October trade deficit numbers on Friday, signaling a 9.6% increase in the International Trade imbalance.  Similarly, both wholesale and retail inventories declined by 0.4% month over month. (Seeking Alpha: International Trade.)

Historically, a trade deficit is not necessarily a problem, and economists have split over the years on the actual impact of a trade imbalance either way.  Traditionally, countries with strong, growing economies achieve a trade deficit as compared to countries with stagnant or declining economies. We see this today when we compare the trade deficits between the US and Japan, for example.  This makes sense in the context of healthy economies placing higher demand for goods and services than can be satisfied internally, thus the imbalance on imports.  Similarly, a country in recession cannot afford to import, thus their imbalance on the side of exports.

The other positive aspect of the trade imbalance comes in the form of investment.  Typically, the nation with the trade deficit has the healthier economy and thus enjoys an influx of investments from foreign sources.  These investments boost the Treasury bond markets, corporate and municipal bonds, equities, and Forex. It's most obvious when there is negative news overseas and the US markets experience a surge in Treasury bond and Utilities Sector investments as foreign traders seek a flight to safety.

Beginning in the mid-1980s, however, there was a subtle but not insignificant shift in the causes and impacts of the trade deficit as viewed from the US side of the ledger.  With the relaxation of trade restrictions with China, Russia, and other Eastern Bloc nations came a wave of technology exports that, initially, were extremely beneficial to numerous US industrial sectors.  This was followed by a slew of increasingly permissive free trade agreements intended to further lubricate the flow of goods and services in both directions.

What the latter actually created, however, was a means by which entire industries could circumvent US labor, environmental, and safety laws.  The results were goods that could be produced in third world countries at a fraction of the cost of that same production in the US since those third world countries bore none of the financial burdens imposed by US regulations and US labor requirements.  Little has changed in that regard, today.

With the restrictions on technology trade lifted, these same third world countries were able to improve the quality of the product they produced to the point where they were either en par or surpassed the quality of the same product produced in the US.  No longer was "Made in Japan" a symbol of "junk" but rather it became a symbol of high quality as evidenced by the dominance in the 1990s of brand names such as Sony or Toyota.  We see the same surge coming out of the Korean peninsula today with the rise of Samsung (current problems notwithstanding) and Hyundai.

The situation on the service side is equally grim.  US customer service and call centers now abound in the Philippines, Costa Rica, and India. The reason is simple: labor costs.  High paid technology resources - resources that would command a $150,000 per year salary (plus another 30% in benefits) in the US - are now outsourced to companies in India, Bangladesh, Costa Rica, the Philippines, and a host of former Soviet Bloc nations simply because they can be paid less than 1/3 that salary and not receive benefits.  In many companies the mantra is clear - if it can be off-shored, then it will be off-shored.

The regulatory imbalances and the labor law imbalances remain, however.  The developed world is effectively turning a blind eye towards sweatshop labor and environmental disaster, provided the third world continues to ship inexpensive yet high quality products.  This is coming at a severe economic cost.

On top of this loss of critical jobs to overseas subsidiaries, there is also the rapid march towards automation.  Self-service checkout lines, unattended gas stations, self-service airline check-in, and even the full automation of large warehouses such as those run by Amazon are all adding to significant job loss across the nation.  (Bloomberg: How Amazon Triggered a Robot Arms Race.)

The October 2016 Labor Force Participation Rate as reported by the U.S. Bureau of Labor Statistics was 62.8%.  This rate measures the number of people that have jobs in the US aged 16 to 65 that are not students, disabled, in the military, or officially retired, and, in my view, is the truest measure of the employment situation we have.  What this shows is that 37.2% of the population eligible to work is not working.  That's 95 million Americans that should be working but do not have jobs.  This doesn't factor in all those that are underemployed, having part-time jobs where they want full time, or having lower skilled jobs due to jobs in their areas of proficiency being unavailable.

This is the hidden dynamic behind the trade deficit put into context in the 21st century. While we don't recommend an immediate repeal of international trade deals - the impact of that would be economically catastrophic - we do need to increase the profitability of bringing service, technology, and manufacturing jobs back into the US.  This doesn't mean the imposition of tariffs.  All trade tariffs are immediately passed on to the consumer, so a trade tariff is simply another sales tax that the consumer will ultimately pay.  Rather, the objective - and it's a very long term objective for it to be achievable - is to raise the labor standards and environmental standards in third world countries.  For US companies with overseas facilities, we can certainly consider the delta between US costs and their overseas costs to be taxable income.  The objective must be to incrementally raise the costs of the overseas holdings to the point where it's more economical to return those services to the US.  That cannot be achieved in the short term, however, and requires the cooperation of other industrial nations, cooperation that will be difficult to achieve, at best.  Still, the path we are on right now is one that leads to a very lengthy economic decline and a resetting of the standard of living we've come to enjoy in this nation.  That may still be a generation or two away, but without taking action on securing our own industrial and service viability, that destination is inevitable.

LHO Completes Double Bottom - Poised For Next Move

LaSalle Hotel Properties (NYSE: LHO), a real estate investment trust (REIT) that specializes in upscale luxury hotel properties in prime markets around the US, completed a classic double bottom pattern on November 17.  Dubbed a "Big W" pattern for obvious reasons when you look at the chart, the double bottom itself is a very reliable trading opportunity.  Now that the pattern has completed, however, we'll look at our options for setting up the next play with this stock.

LHO Daily Chart

The double bottom started at Point A on the chart, with the first leg completing at point B.  The bound back up to "C" completes the retrace leg, and we quickly return to the second bottom at point "D".  Stock pattern guru Thomas Bulkowski would classify this as an Eve & Adam double bottom due to the rounding effect at point B.  That does matter, since the potential rise is influenced by the shape of the bottoms.

If we measure the length of leg A-B, take 76.4% of that leg, and add it to point D, we come up with a price target around 27.70.  That target was met on November 17th, so we can consider the double bottom pattern complete.

It's important to note the candle that appears on November 17th as that target is reach.  The long upper wick on the candle, accompanied by higher than average volume suggests climactic activity where supply has now overtaken demand.  The likelihood of this stock climbing higher in this pattern is greatly diminished.  Indeed, we see the stock amble sideways for the next week.

Look closely at the activity on November 22nd.  We have very high volume on a day where the stock opened up, drove higher, and then plunged to its lows before closing below the open.  Similar behavior on much lower volume was seen the day before.  The range for the day was small, at least as compared to the candles that made up the entire prior leg up, yet our volume was very high.  From a Volume Price Analysis perspective (VPA,) this should be shooting warning flares all over your charts.  Remember that only the large institutions can really drive volume to that level.  Retail traders simply don't have the capital to do it.  Large institutions traded a lot of shares that day, but the price basically went nowhere.  Now, whether they were holding price down to accumulate large quantities or they were holding price down to unload large quantities, we don't yet know.  It's a sign, however, that the next move for this stock should be a fast, explosive move in either direction.

With that in mind, here's how we'll play this stock:

• The final leg of the "W" formed a flagpole, and the pattern for the past week was a clear bullish flag.  If we close above the flagpole, then we will take a long position, setting our price target at 31.11.  That's 76.4% of the flagpole height added to the current top of the flag.  Our stop in this case will be the mid-point of the flag on breakout day.
• If, however, the breakout is to the downside, signaled by a close below the bottom of the flag, then we will take a short position, setting our price target at 23.06, the low of the double bottom.  Once again, our stop will be the mid-point of the flag on breakout day.

We expect the move in either direction to be swift, matching the slope of that final leg in the "W".  If the stock meanders or doesn't move with the velocity we anticipate, then we'll exit the trade.  Lackluster movement would invalidate our interpretation of the behavior over the past week.

Once in the trade, we need to be cautious of overhead resistance on the long side, as well as a level of support on the downside.  There's really only one area of resistance of concern, and that's the dashed line at the top of the "W" pattern.  Other than that, there's not much constraining price movement.  On the downside, however, there's an extremely strong support level around 25.20 were a solid support line coincides with the 38.2% retracement level of the entire double bottom pattern.  The potential for a bit of consolidation at that level is significant.  If we're short, we'll tolerate that for a day or two, but after that we'll exit the trade.  Since we pay interest on short positions, each day it meanders sideways is another day that interest takes away from our potential profits.  When I'm short, I want the stock to move, not sit there in neutral.

As always, manage your trade to reduce and then to eliminate risk.  Take your profits at the first indication that the trade is no longer playing out as planned.  Always remember that risk management and money management are the keys to profit, and as always, know your exit strategy before you enter the trade.

Happy Trading.

CE Drawing Bull Flag Pattern On Daily Chart

Hot on the heels of an Acetic Acid price increase in China, Celanese Corporation (NYSE: CE) is drawing a distinctive bullish flag pattern on the daily chart.

CE Daily Chart

The announcement came on November 23, and signals a strengthening of economic conditions for the chemical giant in the Asian markets.  As the daily chart shows, the news came as no surprise to market insiders who had been pushing demand since the 11th.  That demand forms a distinctive 7-point flagpole on stronger than average volume.

More telling is the volume accompanying the flag itself.  Notice the lack of supply accompanying the minor declines in price into the 23.6% retracement level.  That level may serve as support for the flag, although there's a better support level hovering at the 61.8% retracement level.  From an Elliott wave perspective, there are two potential wave counts from the current pattern.  In the first situation, it's possible that a 5-wave impulse has completed and we're now into an "A" wave retracement, although the shallowness of the retracement currently rules out that interpretation. If it is, however,  then a 61.8% retracement would be the norm.  On the other hand, this could be an extended wave "1" formation, in which case we're in sub-wave "iv" of that impulse.  If that's the case, then a shallower retracement to 38.2% is more likely, and it's the one currently supported by the last week's candles.

Which count is correct, once the stock resumes an upward move, is irrelevant from the swing trade perspective.  Either way, the next wave will be an upward wave, and that's the wave on which we intend to capitalize.  What does matter, however, is the potential profit, and our initial analysis is focused on that bull flag.  The pole length is 7.15, and we'll use the 76.4% value (5.46) to estimate our profit from the breakout point.  Currently, that would be 84.06, although the longer the flag takes to break, the lower that target will be.  No matter, the profit potential remains the same.

Now, everything's not rosy on the daily chart.  Look at the last three major upthrusts on this chart.  All three of them have traced pretty much the same length, and all three have pretty much the same slope.  The prior two ended with a consolidation period that looks suspiciously like the consolidation we've seen in the last week.  Now, the reason we have cause to believe that this one may be different and may be the start of a new major bullish impulse is that the flagpole started with a breakout over a major resistance level formed by three separate peaks and a horizontal channel.  The pole also did so on very high volume, so there was a lot of institutional support for this surge.  The volume pattern implies this one is different.

The weekly chart, however, also urges caution.  Let's look at it.

CE Weekly Chart

The weekly chart completed a perfect A-B-C wave pattern in July 2012 before starting a slow but steady channel-bound rise to where we are today.  The cyclical nature of this stock is evident when you look at the overall pattern, and that's where we must exercise some caution. 

The base of the channel is clearly defined, and that represents the lowest level of support for long-term investors.  The upper bounds of the channel, however, are a bit more ambiguous.  The uppermost line connects the two highest spikes, and if our daily scenario plays out, that will likely be the upper resistance level that will constrain our trades.  The middle line represents the initial upper boundaries of the channel, and you can see that a breach of that boundary is quickly followed by a retreat.

Therein rests the concern.  We penetrated that boundary three weeks ago, and have remained above it - barely - for two weeks.  This warrants scrutiny.  If we are truly in the start of a new bullish impulse, then that line will become support.  If, however, the price retreats and stays below that line, then our play will be a short through to the bottom of the channel.

The weekly chart provides a long-term view of the trend, and also provides insight into strong support and resistance lines that will impact the daily chart.  In this case, the breakout above the three peaks that formed through 2015 and early 2016 is significant.  What has yet been seen, however, is if that breakout is a bull trap, if there will be a pullback to test that line, or if we're heading north without pause. 

So here's how we intend to play this:

• If we close above the bull flag on higher than average volume, then we will go long.  Our stop will be just below the low of the flag and we will adjust that stop daily to first reduce risk and then to eliminate it.  Our price target will be 5.46 above the flag top, wherever that happens to be when it's breached.
• If we close below the bull flag on higher than average volume, and the middle channel line on the weekly chart is breached, then we will go short.  Our stop will be just above the high of the flag, and our price target will be the bottom of the flagpole at 71.94.  Depending on volume patterns, we'll consider taking partial profits at the support line of 72.96.

Let the market decide which way it wants to run, and follow it.  As one famous options player puts it, "Don't anticipate; participate."

Happy Trading.

GE Posts Bullish Pennant Break

Disclaimer: This article is not a buy or sell recommendation.  You must do your own analysis and consider your own risk, money management, and trading strategy before placing any trades.
 
GE showed up on my radar a bit late, so a potential good trade opportunity was missed.  Despite that, it still provides a good lesson in items to watch when analyzing a chart for a short term swing trade.

GE Daily Chart

The trading opportunity came about as GE broke out from a bull pennant pattern on Tuesday.  The flagpole was well defined although the pennant waved in the direction of pole, which is less than desirable.  The breakout occurred Tuesday, and using 76.4% of the height of the flag as our target, we come up with a potential price target of 32.88.  But let's examine the rest of the story.

For openers, we can see that there has been a considerable amount of overlap in trend patterns on this chart going back to the beginning of the year.  By definition, when there's overlap of multiple waves, then we are in a consolidation pattern, not an impulse pattern.  So let's keep that in mind.

We can see that the pattern leading down to the flagpole was a 5-wave pattern. Now, a case could certainly be argued that the two waves prior to that could have been an "A" and "B" wave, which would make the prior wave a "C".  This means we are now in one of three possible waves - an "X", a new "A", or the start of a new impulse wave, making this Wave (1).  For the moment, it's irrelevant since all three of those tend to be 5-subwave patterns.  For the purposes of this analysis, we can treat them equally.

An area of concern on the chart coincides with where our stock is trading right now.  Look at that month-long consolidation period, and look at the strength of the Volume at Price indicator at that level.  We can anticipate a period of consolidation here before the stock decides to either continue its upward climb or retrace back to the start of the flagpole.

Another warning sign comes on the breakout itself.  Volume was extremely light, so there wasn't a lot of enthusiasm for the upward push.  The day after the breakout, there was a very narrow bar, again on light volume.  I'm not seeing a lot of demand driving the price upward.

Thus far, GE has retraced 61.8% of the prior wave, which again forms a natural resistance zone, and there is also horizontal resistance waiting for us at the 76.4% level.  That level corresponds to a failed retest of the prior day's high on April 1, 2016.

Our price target lines up very well with the 52-week high that actually precipitated the stock's decline on July 20th.  That increases our confidence that our target is a good level to either exit the stock completely, or to at least take partial profits and tighten the stops.

So here's how we're watching this stock and potentially playing it.  Today is an early close, and volume will be extremely light.  I won't be entering any position today.  My normal trading window is from about 10:15 to 15:30 Eastern Time.  This avoids the extreme volatility of the open and the close and helps prevent entry at a time where market makers are gunning for stops and limits.  It also allows us to see where the market makers are positioning themselves since we want to be on the same side of the trade as they are.  So with a 13:00 close today, I'm sitting this one out.

I'll be watching that resistance line carefully.  If we see penetration of that line with some gusto, then we'll hop into a long position.  Stops, however, will be extremely tight since I expect at least one more retest of that resistance line before we head north towards the price target. 

A play to watch is for consolidation at the 76.4% level followed by a retest of the resistance line.  If the stock shows a bullish candle pattern on that retest, then that would be the perfect opportunity to jump in, setting a stop just below the low of that resistance pattern.  But we need a bit of patience, since it may take another week or so for that pattern to play out.

The dotted horizontal lines are the Fibonacci Time Zones.  Zone 0-1 marks the time it took for the flagpole to complete.  We're using that as a reference to see just how much enthusiasm there is for an upward thrust, and we're also using it to gauge the width of any subsequent consolidation periods.

There are no earnings announcements on the horizon, nor is a dividend imminent.  We have time to watch this stock play out and to see which pattern ultimately comes into focus.  For now, the play is long, however a failure to break through that resistance line could rapidly change that perspective.  Keep an eye on this one and see which way it breaks.

Happy Trading.

Solanezumab Failure has Eli Lilly Down But Not Out

Disclaimer: This article is not a buy or sell recommendation.  You must do your own analysis and consider your own risk, money management, and trading strategy before placing any trades.

Pharmaceutical giant Eli Lilly and Company (NYSE: LLY) suffered a serious blow, yesterday, with the announcement that their premier Alzheimer's drug Solanezumab failed Phase III testing.  The latest study failed to demonstrate a statistically significant improvement in the slowing of cognitive decline as compared to a placebo.  Shares of LLY plummeted over 11% at the open.  As a result of the study, Eli Lilly is also taking a step back to assess the status and progress of other Alzheimer treatments they currently have in their development pipeline.

The tale-of-the-tape, however, shows some serious potential for traders in all time frames.  Let's examine the weekly, daily, and hourly charts for LLY to see what information we can glean.

LLY Weekly Chart

 Let's start with the weekly chart.  A selling climax in September of 2012 ended the prior consolidation period for this stock and started the bullish impulse wave that continues through today.  The weekly pattern has thus far traced three well-defined Elliott Waves (marked (1), (2), (3) respectively,) and is currently in Wave (4). 

As of yesterday, we've retraced 61.8% of Wave (3).  The alternation rule is satisfied since Wave two was short and relatively flat - only about a 38% retracement of Wave (1).  Given the weekly pattern, we can expect a resumption of the bullish impulse into a Wave (5).  Since Wave (3) is longer than Wave (1), there are no restrictions on the height Wave (5) will travel, although it will typically run between 68.2% and 100% of the length of Wave (1).  If yesterday marked the end of Wave (4) - and to be clear, we do not know that, yet - then we have a minimum price target range of 79.25 to 88.77.  Note the caution sign, however.  There is very heavy resistance around 71.00, so once the uptrend resumes, we can expect a bit of a pause and consolidation at that level.  What this chart does tell us, though, is that there should be another bullish impulse coming, and there's potential for price movement between $15 and $24 to the upside.  Since we're looking at a weekly chart, however, do consider that the time-frame for the full Wave (5) move is approximately 20-months.  Playing all of Wave (5) is not a short-term strategy.

LLY Daily Chart

Now let's turn our attention to the daily chart.  This is the chart we use both to assess potential trades and to plan exit strategies.  The methodology we follow uses three charts - the daily for the overall setup and strategy, the weekly for the long-term trend of the stock or market, and the hourly for the entry strategy.  So what is the weekly telling us?

First, it tells us that the bad news really came as no surprise.  Look at that nice double top pattern that developed in August and October, and look at the swift and steady decline that followed the failure to retest those August highs.  Sure, we had a bounce in November - the entire market had a bounce in November, but the volume on the bounce was very lackluster.  It doesn't come close to the volume we saw in late June when the stock covered essentially the same ground on its way to the August high.  What can we conclude from this?  The smart money had an inclination that bad news was on the horizon and they gradually turned shares over in preparation for it.  Their long-term plan suddenly comes into focus when we look at the hourly chart, but more on that later.

The gap up last week was on better than average volume, but as we saw the next day, it was unsustainable.  A test of that high failed, and the stock meandered downward in a lackluster fashion for the next week.  The behavior and pattern strongly suggests that the stock would close the gap before much longer.

Notice, however, that red line I've drawn on the chart.  Prior to yesterday, we'd have expected that line to represent a very strong support line, and we would have played a long position on a test of that line.  That line represents the 38.2% retrace of the entire Impulse, the 50% retrace of Wave (3), and the 50% retrace of yesterday's gap.  With traders in all time-frames spotting significance at that level, we can expect a period of consolidation and testing as price approaches and attempts to penetrate that line.  Of course, following yesterday's gap, that's no longer a major support line but is now a major resistance line.  Either way, we can play it.

LLY Hourly Chart

Finally, let's look at the hourly chart.  In this case, it not only helps us plan an entry strategy, but it also gives us insight into what the smart money - i.e. large institutions and market makers - are doing.  Remember, the market maker is almost always on the opposite side of the retail trader, but if we want to profit, we need to be following, not opposing, that market maker.

So what did the smart money do, yesterday?  The went bargain hunting and bought a tremendous quantity of LLY throughout the day.  The navy blue line represents yesterday's open.  Now, normally, I ignore volume on an hourly chart, but yesterday's can't be dismissed.  Look at the candle and the volume in that first hour.  There was so much demand at that point that the stock moved over 2 points upward in the first hour.  That trend continued through lunch before the bars narrowed and price settled into a narrow range.

Going into the last hour, the stock had gained almost 4-points from the open.  The last 15-30 minutes of trading normally sees extremely high volatility as day traders close their positions.  You can glean a lot of information in that period.  Wednesday's close was particularly significant since the market is closed today for Thanksgiving and tomorrow has a 1:00 PM close.  Many traders turn it into a 4-day weekend, and volume will be extremely light tomorrow.  As a result, short-term traders - both day traders and swing traders alike - do not like to carry risk through the close on the Wednesday before Thanksgiving.  Too much can happen before the market opens on Monday.

Did we see the smart money unload their shares yesterday afternoon?  Not even close.  Oh, it was slightly down in the last hour, but you'd expect that.  The range, however, was extremely narrow, and the volume was en par with midday.  The smart money not only held onto their shares, but they also kept price in a very narrow range.

So, how are we going to play this stock?  There are numerous potential strategies that could play out: 

1.  A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with a downward breakout.  If that happens, then we'll be looking to play a short when the flag or pennant is violated.  Our price target in that case would be 53.75. (I normally set the target at 76.4% of the height of the flagpole, either adding it to or subtracting it from the violation price depending on direction.)
2. A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with an upward breakout.  If that happens, then we'll play a long position when the flag or pennant is violated.  Our price target would be 78.84, although we would expect that to be a five sub-wave impulse that we'll likely play separately.  
3. Without a flag or pennant pattern developing, we'll look to play a sustained break of yesterday's high with a long position, setting the target at 70.75, just below that major resistance level.  
4. Once price is playing around that resistance level, we will watch for two things.  If there is a second failed test of that resistance level, then we'll play a short back down to yesterday's low.  If, however, a second test succeeds and it's penetrated, then we will wait for the stock to drop back down to that resistance line in a retest.  At that point, we'll look to go long  with a target back to around 76.50.  (Notice the resistance lines forming at that level.)

You'll notice that we're not looking to play a short if yesterday's low is taken out unless that happens following a flag or pennant.  Due to yesterday's decline, there's a 4-day short-sale restriction in effect, so we have plenty of time to assess  any plays to the downside.  Until mid-next week, the only plays are up, and that's just fine for now.  Once that short-sale restriction is lifted, however, be cautious of a downside surge that could produce a price trap.

However you chose to play this, be sure to determine your exit strategy in advance.  One of the primary rules of swing-trading is to know how you will exit the trade before you ever enter the trade.

Happy Thanksgiving!

Is the Dow Rally a New Impulse Wave or a Bull Trap?

The Dow Industrials average has been on a tear since November 7th, rising over 990 points in two-weeks.  The question we have to ask, though, is if we're seeing the start of a new bullish impulse wave or if this represents an end-of-year bull trap.  Let's look at the daily chart:

Dow Industrials Daily Chart

A short but very productive impulse wave started on February 11, 2016, and that wave pushed the market to a high on April 20th.  If we consider that Wave 1, then Wave 2 ran pretty much through the remainder of 2016.  It was a fairly flat consolidation that culminated with a very tight two-month congestion leading up to the US presidential elections.

The current impulse wave - which may very well be Wave 3 - started November 7, the day before the election.  From there, the market surged skyward, gaining 990 points in a week.  This flagpole formed the foundation for a classic pennant pattern that we appear to have broken yesterday.

Now, the rosy interpretation of this chart places a price target at 19,920 for that flagpole pattern, and it should be obtained relatively quickly - no more than a week or two.  Similarly, the target for Elliott Wave 3 is 20,500, and that lines up rather well if the flagpole target ends at a sub-wave consolidation before continuing to the peak. 

All of this is plausible, especially as we head into a period traditionally marked by a Santa Claus Rally.  That's when this could get a bit ugly, though.  The alternation rule states that Wave 2 and Wave 4 must differ in form and time.  Wave 2 was long and relatively flat.  Therefore, Wave 4 must be short and deep.  Expect a very sharp correction that takes out anywhere from 50% to 61.8% of the Wave 3 gains, and expect it to happen very quickly.  That's as much as a 1650 point drop before Wave 5 commences.


Are there other warning signs on the horizon?  Certainly.  The Dow just achieved an all-time high, but it did so on relatively low volume and with two consecutive narrow range bars.  This implies there really wasn't a lot of enthusiasm pushing the rally, and we may shortly see some climactic action as the large investment houses wind down for the holidays.  This rally would have been much more convincing if accompanied by high volume.

There are also a couple of major events on the horizon that could easily turn this rally into a bull trap.  First, it's a near certainty that FOMC will raise interest rates when they meet on December 14.  In fact, the futures market has priced in a 98.2% chance of a rate increase.  Fed Chair Janet Yellen has also signaled an intent to raise rates twice more in 2017 (data permitting, of course.)  So that would likely mean a June and December hike, and that's precisely what you see if you look at the futures market.

In the midst of this slight tightening of US monetary policy, the UK will be moving towards an Article 50 invocation.  Prime Minister May has targeted the end of March for that major milestone, although the UK courts have added a measure of doubt to the timetable.  Whenever it's done, however, it will certainly have a sobering impact on the EU and British markets.  The combination of Brexit and US interest rate hikes will certainly send shock waves through the world markets. 

So, what does all this mean for us as traders?  Well, that we are in a bullish impulse at the moment cannot be doubted.  We're going to continue playing the long side as long as that impulse remains in effect.  Now, Friday's an early close and will be ultra-low volume, so I'll be sitting that one out.  But once the market opens on Monday, my bias will be to the long side.  The closer we get to 19,500 and then 19,900, however, the tighter my stops will be, and the more I'll be watching for sub-wave 4.  That sub-wave and then the actual Wave 4 will be two that we will want to catch to the short side.  Both will be deep, but both will be short, so remain vigilant.  There won't be much of an opportunity to hop into those waves once they are in full swing.

For now, have a Happy Thanksgiving here in the States, enjoy a nice 4-day stretch away from trading, and let's see where the market decides to take us next week.

Trading Outlook for the Week of August 15-19

Markets are still showing strength as we head into mid-August.  The Nasdaq shows amazing strength, riding its 7-day moving average as a very strong support line.  The Nasdaq composite has not closed below it's 7-day since June 28th, and has only dipped below it intraday four times in that period.

Surprisingly, given the strength of the Nasdaq, the Technology sector has rotated into neutral territory.  The leaders last week were Energy, Consumer Staples, and Consumer Discretionary.  Utilities rotated up to neutral, and that coincides with a slight drop in the 10-year Treasury yield. 

The probability of an interest rate hike on September 21 has declined to just 9%.  A December 14 rate hike, however, is still at 40.6%.  With the CPI being announced Tuesday, however, those probabilities could change dramatically.  The current consensus is for CPI to be unchanged for July.  That would be the weakest result in 3-years, and it's the primary reason expectations for a September hike are near zero.  Excluding food and energy, the index is expected to rise 0.2%, which is a healthy rate, however it's likely not enough to move the Fed.

All market capitalizations are still indicating long positions, so that's the way we'll play it this week.  Earnings season is winding down, and we only have Home Depot and Deere on our watch list for this week.  We'll also be paying attention to Wednesday's release of the FOMC minutes.  That release does have a tendency to move the market, however please keep in mind that it's month old data.  Market reactions to the minutes tend to be short lived.  Still, for those of us that swing trade, it's important to be aware of the potential for movement Wednesday afternoon.

Finally, this is Options Expiration week, so watch for some volatility on high volume this Friday.

Here's a summary of the week ahead.

Trading Bias 

Large Caps - Long
Mid Caps - Long
Small Caps - Long
Nasdaq - Long

Sectors

Showing strength
XLE - Energy
XLP - Consumer Staples
XLY - Consumer Discretionary

Showing weakness
XLB - Materials
XLF - Financials
XLV - Health Care

Neutral
XLK - Technology
XLU - Utilities
XLI -  Industrials

Economic Reports of Significance (all times are EDT - GMT-4)

Monday, 8/15/16

• 08:30 - Empire State Manufacturing Survey
• 10:00 - Housing Market Index
• 16:00 - Treasury International Capital
  

Tuesday, 8/16/16

• 08:30 - Consumer Price Index
• 08:30 - Housing Starts
• 09:15 - Industrial Production

Wednesday, 8/17/16

• 10:30 - EIA Petroleum Status Report
• 14:00 - FOMC Minutes

Thursday, 8/18/16

• 08:30 - Jobless Claims
• 08:30 - Philadelphia Fed Business Outlook

Friday, 8/19/16

• 16:00  - August Monthly Options Expiration

Earnings Reports Watched for Sector or Market Significance

Tuesday, 8/16/16

• Before Market Open - Home Depot (NYSE:HD)

Friday, 8/19/16

•  Before Market Open - Deer (NYSE:DE)

Summary

Our bias remains long, and we will pay closer attention to Nasdaq stocks.  I'm still wary of Energy, however if there's a promising setup with a short-term (1-3 day) projected move, I'll take it.  Given the volatility of that sector over the last 18-months, though, I'm reluctant to play anything with a longer forecast.  Watch for continued signs of consolidation in the Tech sector, and watch sector rotation carefully for some hidden gems that may be on the upswing.  Sectors across the board are staying firmly above their 7-day moving averages, and the Slow Stochastic indicator remains above 50 in all capitalizations, so we are only considering long positions at this time.

As always, trade the market you see, not the market you want.  Remain nimble, stick to your trading plan, and always know your exit strategy before entering the trade.

Happy Trading.

Trading Outlook for the Week of August 8-12

A jobs report that far exceeded expectations saved what had promised to be a down week in all indexes.  Instead, all sectors except Utilities finished higher, with technology leading an extremely robust surge.  The flight from utilities matched a similar flight from the 10-Year Treasury which saw a 5.3% increase in yield on Friday.  Both of these moves signal a renewed confidence in the health of the US economy, although it's prudent to remember that nothing is more whimsical than the confidence level of the average equities trader.

The Technologies sector - and with it, the Nasdaq - continues to shine.  A note of caution is in order there, since it is now trading well above its 20-day moving average.  Be aware that a consolidation will likely follow such a strong upward charge that is now over 6-weeks running.

We're seeing some healthy sector rotation playing out with Financials joining Technology at the head of the class while Health Care and Industrials have slid into neutral territory.  We'll keep an eye on Consumer Staples late in the week since the all-important Retail Sales number will be released on Friday.  Energy, of course, continues to show weakness in the face of continued depressed oil prices.

Thursday and Friday are the big days when it comes to economic news.  We'll be especially interested in the Import/Export numbers in light of the growing strength of the dollar against the British Pound and the Euro.  The Retail Sales and Consumer Confidence numbers will shape our strategy heading into the weekend.

Here's a summary of the week ahead.

Trading Bias 

Large Caps - Long
Mid Caps - Long
Small Caps - Long
Nasdaq - Long

Sectors

Showing strength
XLK - Technology
XLF - Financials

Showing weakness
XLE - Energy
XLP - Consumer Staples
XLU - Utilities

Neutral

XLV - Health Care
XLI -  Industrials

Economic Reports of Significance (all times are EDT - GMT-4)

Monday, 8/8/16

• No reports of market significance
  

Tuesday, 8/9/16

• 08:30 - Productivity and Costs

Wednesday, 8/10/16

• 10:00 - JOLTS
• 10:30 - EIA Petroleum Status Report
• 14:00 - Treasury Budget

Thursday, 8/11/16

• 08:30 - Jobless Claims
• 08:30 - Import and Export Prices

Friday, 8/12/16

• 08:30 - Retail Sales
• 08:30 - PPI-FD
• 10:00 - Business Inventories 
• 10:00 - Consumer Sentiment

Earnings Reports Watched for Sector or Market Significance

Tuesday, 8/9/16

• After Market Close - Disney (NYSE:DIS)

Summary

Our bias remains long, and we will pay closer attention to Nasdaq stocks and Financial stocks.  With the sector strengthening, there may be some good dividend plays that also show short-term growth.  Watch for signs of consolidation in the Tech sector, and watch sector rotation carefully for some hidden gems that may be on the upswing.  Sectors across the board are staying firmly above their 7-day moving averages, and the Slow Stochastic indicator remains above 50 in all capitalizations, so we are only considering long positions at this time.

As always, trade the market you see, not the market you want.  Remain nimble, stick to your trading plan, and always know your exit strategy before entering the trade.

Happy Trading.

BoE Cuts Rates, Adds to QE

The UK's Monetary Policy Committee today announced their first interest rate cut in seven years, lowering the benchmark rate to a record low of 0.25%.  The rate cut came as no surprise to markets worldwide, and the MPC vote was 9-0 in favor of the cuts.  What did surprise some, however, was a £170 Billion stimulus that will be introduced via the purchase of Gilts (UK government backed bonds similar to US Treasury Bonds), the purchase of corporate bonds, and a new bank lending program.  That portion of the stimulus package was not expected to coincide with the interest rate cuts.

The FTSE responded positively to the news, finishing the day up 1.56% although the Pound dropped 1.5% versus the US Dollar and 1.3% versus the Euro.  US markets responded with a yawn, finishing the day flat.  The US 10-Year Treasury Yield, however, dropped 2.58% to 1.51.

BoE Governor Mark Carney sounded a pessimistic note in his presentation, stating, “We took these steps because the economic outlook has changed markedly.  Indicators have all fallen sharply, in most cases to levels last seen in the financial crisis, and in some cases to all-time lows."  That's a bit troubling, given the lengthy duration anticipated for the actual Brexit events to unfold.  With the benchmark rate now down to an extreme low, there is very little additional room for the BoE to maneuver should the British economy slow further.

Surprisingly, the MPC signaled the potential for a further rate cut, although Carney assured reporters that the central bank had no intention of bringing rates into negative territory.  That they would consider - and even signal - that rates could drop to near zero, however, indicates the level of concern the committee has over the economic prospects during the Brexit transition.

The fallout from the Brexit vote has manifested more slowly than critics had forecast, but - at least in the UK - it is starting to be felt.  Consumer Confidence is dropping dramatically, and the industrial outlook is starting to decline as well.  The forecast for the UK GDP is now down to 0.8% for 2017, and the Central Bank foresees a strong decline in corporate investment and in the housing markets.  The Pound's weakness is certainly hurting UK imports, and that is having a marked effect on growth potential over the next 18 months.  That import price pressure is expected to have an impact on inflation in 2017, with the central bank forecasting inflation to hit their 2% target in the fourth quarter of 2017 and exceed it throughout 2018.

What all this signals is a period of weakness, uncertainty, and potential market instability in the UK that will likely last through 2018.  With the ECB taking a bit of a "wait and see" attitude mingled with a healthy dose of skepticism a couple of weeks ago, the likelihood of continental fallout is extremely high.  US 10-Year Treasury yields have declined steadily since December, 2015, and are now sitting at the lows last seen in August, 2012.  That represents a significant flight to safety, and with US equities sitting near all-time highs, it's reasonable to conclude that the heavy demand on US treasury bonds is coming from overseas.

There is a limit to how long the US can remain immune to economic weakness in the UK and the EU.  The strong US dollar is having a severe impact on US exports, and that, in turn has a serious impact on US companies that are heavily exposed to Europe.  This is evident in the behavior of the S&P 500 where demand has fallen off over the past few weeks, and the market has gone essentially flat since it reached a record high in mid-July.  With GDP growth down dramatically in Europe, the UK, and the US, prospects for a global recession are mounting as we transition from a tumultuous US presidential election to the uncertainty of a prolonged Brexit negotiation and execution.

Earnings season in the US is almost over, and there is not another FOMC announcement before September 21.  So now we turn our attention to tomorrow's jobs report.  The pattern in the market right now is not encouraging, so the key economic reports over the next few business days may well set the tone for the remainder of August. 

Happy Trading

Trading Outlook for the Week of August 1-5

The last week of trading in July saw continued strength in the Technology sector, and that carried through to the Nasdaq as a whole.  There's some signs of life coming back into the mid-cap stocks, however across the board the S&P large cap, mid cap, and small cap indexes continue to be flat.  A bit of demand came into the markets on Thursday and Friday, following the dovish Fed announcement that suggests interest rates will remain at their current level well into 2017.

We are still maintaining a long bias into the week ahead, however with the extremely tight range being experienced in all market capitalizations for the last two weeks, be aware that a breakout in either direction is possible.  Only the higher volume on the last two up-days suggests that the breakout could be to the upside.  In the meantime, we'll be keeping our stops close.

Here's a summary of the week ahead.

Trading Bias 

Large Caps - Long
Mid Caps - Long
Small Caps - Long
Nasdaq - Long

Sectors

Showing strength
XLK - Technology
XLV - Health Care

Showing weakness
XLE - Energy
XLI -  Industrials
XLP - Consumer Staples
XLU - Utilities

Neutral
XLF - Financials
XLY - Consumer Discretionary
XLB - Materials

Economic Reports of Significance (all times are EDT - GMT-4)

Monday, 8/1/16

• 09:45 - PMI Manufacturing Index
• 10:00 - ISM Manufacturing Index
• 10:00 - Construction Spending

Tuesday, 8/2/16

• 08:30 - Personal Income & Outlays

Wednesday, 8/3/16

• 08:15 - ADP Employment Report
• 10:00 - ISM Non-Manufacturing Index
• 10:30 - EIA Petroleum Status Report

Thursday, 8/4/16

• 08:30 - Jobless Claims
• 10:00 - Factory Orders

Friday, 8/5/16

• 08:30 - Employment Situation
• 08:30 - International Trade

Earnings Reports Watched for Sector or Market Significance

Tuesday, 8/2/16

• Before Market Open - Proctor & Gambel (NYSE:PG)

Wednesday, 8/3/16

•  Before Market Open - Avnet (NYSE:AVT)

Summary

Our bias remains long, and we will pay closer attention to Nasdaq stocks and Health Care stocks.  We'll keep our stops very close for several reasons:

• All three market capitalizations continue to show an extremely tight trading range.  Until we see the direction of the breakout, we'll need to remain cautious for a move to the downside.
• The 10-year yield is still trending down, indicating a continued flight to safety.  Weakness in the Utilities sector suggests this flight may be ending however we'd like to see confirmation in the treasury yield before reaching that conclusion.
• This is Employment Situation week, and that adds a measure of uncertainty to Friday's behavior. 
• The Bank of England has their announcement on August 4th, and there will be uncertainty leading into Thursday based on the view they will take regarding Brexit risks.

As always, trade the market you see, not the market you want.  Remain nimble, stick to your trading plan, and always know your exit strategy before entering the trade.

Happy Trading.

Showing Only 1.2% Growth, GDP Is Still Anemic

Is there truly an economic recovery in progress?  You'd never know it from the GDP which increased by a mere 1.2% in the quarter ending June 30th.  It continues a very sluggish trend that started in 2014 following what had looked to be a promising post-Great Recession recovery.

Quarterly GDP Growth 2012 to Present

Economists generally consider a range of 2.5% to 3.5% GDP growth to be healthy for the economy.  Lower than 2.5% and corporate profits suffer and with them, job growth also suffers.  Higher than 3.5% and the economy starts to experience inflationary pressures.  Now, that last point is significant in this case since we've been in an extended period of under-inflation.  The Fed mandate to maintain inflation at 2% needs a boost in GDP well above what we're currently experiencing before that target grows within reach.

Low inflation, in this case, translates to lower interest rates.  Following Friday's GDP report, the Fed Funds Futures market reacted sharply, reducing the probability of a September Fed interest rate hike to only 12%, and a December probability dropped to 30%.  As we discussed two days ago, interest rates will be depressed likely right through 2017.

Yesterday's announcement made mention of a slight increase in trade, saying it added about 0.2 percentage points to overall growth.  I've read some analysts point to that figure as evidence that the impact of the strong US dollar has stabilized, however I don't believe that to be the case.  Rather, what's driving the trade growth is a drop in US imports, not an increase in exports.  (Imports are subtracted from the figure, so if imports decline, it has a net positive effect on the trade number.)  Given the strength of the dollar, a reduction in imports is a very bearish signal, indicating a decrease in demand for materials and finished products.

Along those same lines, a major factor in yesterday's anemic announcement was continued reduction in inventory restocking by businesses in the US.  This is the fifth consecutive quarter in which inventory levels have dropped, and it's a further indication that there are strong downward pressures on consumer demand and on corporate sales.  Unlike analysts that are predicting a rapid end to that trend, I see just the opposite.  Until there is a healthy increase in the hourly wage statistics and a healthy increase in the Labor Force Participation Rate, I don't see any major driver for a change in inventory stocking behavior that would add anything of significance to the GDP.

When I consider the economic warnings hidden in the Schlumberger and Union Pacific earnings calls earlier this month, I begin to see a general underlying pattern of slowing growth, slowing demand for commodities and raw materials, and a potential crack in the expected rate of consumer spending over the second half of the year.  For that pattern to reverse, we need to see a weakening of the US Dollar, a dramatic reduction in the number of Americans that are out of work, and a return to a price of oil that provides healthy growth across a wide range of industries.  None of those appear to be on the short-term horizon, which leaves me pessimistic about future growth prospects in 2016 and into the first half of 2017.

FOMC Holds Rates Steady; Details Economic Progress

As expected yesterday, the US Federal Opens Market Committee (FOMC) held interest rates steady with the target range between 0.25% and 0.50%.  One sign of the weakening of the Fed's resolve at maintaining the status quo, however, came with Esther L. George's dissenting vote.  As noted in the formal announcement, the traditionally hawkish George preferred to increase the federal funds rate to 0.50% to 0.75%.  She was outvoted 9-1.

The language and tone of the announcement demonstrated a subtle shift towards a tightening policy, however. Respective to the Fed mandate of maintaining full employment, they said, "Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May."  

Given the very robust jobs report in June, that position is not surprising.  Indeed, the standard unemployment level has been sustained below 5% for several months, although it's equally important to note that over 94 million Americans are now unemployed - the highest number since the Labor Force Participation Rate has been maintained. 

If the job market were the only factor under consideration, there's little doubt that the Fed would be moving to raise interest rates.  The stumbling block continues to be inflation.  The all-items CPI for urban consumers is 1%.  The FOMC target, however, is 2%, and there's little indication that inflation will reach that target in the short term.  They acknowledged that yesterday, saying, "Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further." 

They did not define "medium term" in this context, however Janet Yellen defined it in 2009, saying, "From macroanalysis, I consider short term as referring to less than, say, a year or two, medium term as ranging from around two to six years, and long term as anything beyond around six."  Read into that what you will, since the ultimate question will be whether or not the Fed will raise interest rates before inflation reaches the 2% target.  If that target is not anticipated for at least another two years, then we've a long ways to go before we see any monetary tightening.

The June announcements were rife with caution, citing potentially permanent "headwinds" and some rather dire forecasts regarding the global economy. This month's announcement shows a complete reversal of those ominous undertones.  "Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments."

What they classified as "near-term risks" was not expounded upon, however it's reasonable to assume that they are referencing the unknown impacts of Brexit, a strong US dollar, and the prospect of recession in Europe.  While the Brexit impact is certainly moved out into the distant future - at least 2019 or beyond, even if the UK invokes Article 50 next year - and Europe appears to have inched ever so slightly away from recession, I find it hard to dismiss the impact the strong US dollar is having and will continue to have for the foreseeable future.  It's doubtful, however, that the dollar alone will be enough to stay the Fed's hand.

Interestingly, the markets appeared to treat the FOMC release with a yawn.  The Nasdaq Composite was up both yesterday and today, and the S&P 500, while down a hair yesterday, recovered it today to continue it's horizontal correction without giving or gaining any ground. 

Equally interesting, the Fed Fund Futures still show only an 18% chance of a rate hike in September, and the chance of a December hike dropped to 36.8%.  In fact, you have to go all the way out to June 2017 before the chance of an increase even reaches 40%.  Clearly, the market is factoring in very low interest rates for at least the next year.  The 10-year Treasury Yield is still declining, dropping to 1.52% today, which would be another possible indication that rates will continue low for some time.  (It's also a further indication of a flight to safety, which is a warning of potentially troubled times ahead in the equities markets.)

The Fed summed up a very dovish posture once again, stating, "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run."  That view, however, is not consistent with the "dot plot," an estimation of where FOMC members view interest rates over the next several years.  A solid base of participants forecast one additional rate hike in 2016, however the strongest dot concentration shows two rate hikes, presumably in September and December with the average rate falling between 0.75% and 1% by year end.

The next FOMC meeting is September 21st, so we have almost 8-weeks before the next rate decision is expected.  A lot can happen in 8-weeks, and there will be two more major economic data points available to the Fed before that decision is warranted.  What we as traders need to watch, however, is the potential for good economic news to become bad for the market.  A very strong jobs report, or a healthy uptick in inflation could signal that there is a greater potential for a September rate hike.  That would send stocks tumbling once again, hence the good news is bad phenomenon.  Exercise caution around major data releases since the reaction will be somewhat unpredictable for the time being.

With regards to monetary policy, we now turn our attention to the Bank of England and next Thursday's Monetary Policy Committee announcement.  Stay tuned.

Happy Trading.

Apple Beats on Earnings and Revenue, But Is It Enough?

Apple (Nasdaq: AAPL) posted their 3rd quarter earnings after the bell this afternoon, and on the surface, at least, the news sounded good.  They beat earnings by $0.04, and they also beat on revenue by $310 million.  In after-hours trading, shares of AAPL surged as high as 8% before settling back to $103.60.  They also held their quarterly dividend steady at $0.57 per share.

The underlying picture, though, is not quite so rosy.  Their sales were down 14.5% year over year, and their gross margin dropped to 38%.  In fact, their forward guidance for the next quarter includes a gross margin range of only 37.5% to 38%, and their forecast for revenue is up slightly from this quarter, but still well below last year.

International sales contributed to 63% of their revenue this quarter, but sales in China were down 33% from last year.  The Apple troubles in China continue, in fact, not only due to the slowing economy in Asia but also resulting from difficulties with Chinese regulators.  The iBooks and iTunes services were shut down by regulators last April, and in June the Chinese government ordered a halt to iPhone 6 sales due to a patent dispute.  (We'll skip the editorial about the hypocrisy of China arguing about a patent infringement.)  The point is, China was once seen as the major growth market for Apple, but at least for now that market has run dry.

The Services business, including iTunes and Apple Pay, were up 19% year over year, however on a quarter-to-quarter basis, it was essentially flat.  Despite Credit Suisse's forecast of the services business providing over 30% of Apple's revenue by 2020, the reality is that the current growth trends are not supporting that prediction.  With Google and Samsung both entering the payment market with comparable products, the competition faced by Apple Pay is becoming formidable. 

Demand for iPhones, iPads, and Macs appears to have peaked.  The iPhone market is already saturated, and the tablet and personal computer markets are crumbling, at least as far as the average consumer is concerned.  The iPad is still doing fairly well in certain business applications, but when it comes to the average consumer, the phablet is rapidly replacing them.  To that end, with the extremely popular Samsung Galaxy S7 and S7 edge out for 6 months, now, the iPhone 7 (with an expected larger screen offering) is a bit late to the dance.

The question that Apple must seriously entertain is whether or not a change at the top is in order.  CEO Tim Cook has yet to prove that he's capable of driving the innovation needed to keep Apple at the top of the industry.  I've seen an increasing number of analysts state that, in their view, Apple's best days are behind them, and thus far I've seen nothing to contradict that opinion.  There has certainly been no innovation coming from the company since the passing of Steve Jobs.  It may well be that the "next new thing" to come out of Apple will be a new CEO.

A Pause in the Rally Across All Capitalizations

For the entire month of July, we've been treated to extremely encouraging news in the face of the first major stock market rally we've experienced in well over a year.  For over a week, both the Dow Jones Industrials and the S&P 500 posted new all-time highs day after day.  Now that we're well into Q2 earnings season, however, the markets have turned flat and the exuberance is starting to subside.  Let's take a look at the anatomy of the rally separated by large-cap, mid-cap, and small-cap stocks.

Daily Chart of Small, Mid, Large Cap Indexes for July, 2016

These three charts show the month of July in the S&P 600 Small Cap Index ($SML), the S&P 400 Mid Cap Index ($MID), and the S&P 500 Large Cap Index ($SPX).  For those not familiar with the capitalizations, a Small Cap stock is considered one with under $2 Billion in market capitalization, a Mid Cap stock has between $2 Billion and $10 Billion in market capitalization, and a Large Cap stock has over $10 Billion in market capitalization.

At first glance, it appears that all three indexes benefited from the rally.  Each of them started their rally immediately following the Brexit sell-off in late June, and each of them have plateaued over the last two weeks.

From an Elliott Wave perspective, we have completed three very obvious waves in all three indexes.  Wave 1 lasted 4 days in each, Wave 2 lasted 2 days, and Wave 3 lasted 4 days in $SML, 5 days in $MID, and 6 days in $SPX.  From that point to the present, each index has traded flat.

Of the three indexes, though, in only $SML was Wave 3 longer than Wave 1.  Under Elliott Wave theory, we know that Wave 3 cannot be the shortest of the impulse waves.  This means that, assuming this is a true 5-wave impulse sequence, only the Small Cap stocks remain unconstrained to the upside.  Both the Mid Caps and Large Caps, however, are faced with a ceiling, which is the actual height of Wave 3 beginning at the bottom of Wave 4 when that wave completes.  As it stands now, the Large Caps have an upward limit of around 2250 and the Mid Caps around 1615.  We'll need to keep these potential limits in mind once the uptrend resumes and we plan exit strategies for long positions.

All this, of course, assumes that we are in a 5-wave impulse, and not a continuation of the correction that's been ongoing for over a year.  So far, the pattern has not violated any impulse rules.  In fact, it's conforming to them rather nicely.  Wave 2 retraced between 38.2% and 50% of Wave 1 in all 3 indexes, Wave 4 has not (yet) violated the territory of Wave 1, and we're experiencing well-defined alternation between Waves 2 and 4.  As long as Wave 5 doesn't exceed the length of Wave 3 in the Mid and Large Caps, the impulse pattern will be valid.

The caveat, of course, is that we're in the middle of earnings season, and anything can happen here.  We also have a presidential election coming up, and that should add a bit of volatility into the mix as the summer draws to a close.  What could easily invalidate the entire impulse pattern would be a price decline that creates overlap with prior waves, signalling a consolidation pattern, not an impulse pattern.  I would be very concerned if we dropped below the high set on June 8, causing overlap with the prior A-B-C corrective wave pattern, and I would consider the impulse pattern definitively invalidated if we drop below the high set on June 23, just prior to the Brexit vote.  Some purists may argue that the pattern's valid unless we dip into the Wave 1 high in the current sequence, however when analyzing Elliott Waves I find it important to consider the pattern or patterns that completed as we enter the current one.  Continuation patterns can be confusing since they can take so many different forms, and for those of us that change strategies based on whether or not a market is trending, knowing where we are in the cycle is extremely important.

As to the current situation, we have clearly been in a flat corrective pattern for the last two weeks, and the most obvious wave count structure would place this corrective pattern in Wave 4.  Take a look at it yourself, and plan your strategies accordingly.  Remember to include the weekly and hourly charts in your analysis if you're a short-term trader using the daily chart for your primary analysis.

Happy Trading.

GE Offers Promising Outlook for Aviation

General Electric (NYSE:GE) released earnings on Friday, beating EPS forecasts by $0.05 and revenue by $1.74 Billion.  That didn't prevent their stock from taking a 1.8% hit pre-market, however, due primarily to a 2% decline in orders and what they described as a "volatile and slow-growth economy."

The news, however, appears rather bright for the Aviation industries.  GE reported a strong first half of the year in that industry, and is forecasting the remainder of 2016 to remain strong as well.  There were a couple of items that bode well for the airlines, at least according to GE.  They saw commercial traffic growth of over 6% this year, down a bit from last year, but still experiencing a healthy growth pattern.  Additionally, the airplane load factor remains at 80% for the second year in a row, and GE reports over 2 million departures added in the past year.

GE reports, not surprisingly, that jet fuel continues to be deflationary, and is down over 50% over a three-year period.  When you combine the lower fuel costs, increased passenger demand, and a very strong load factor, it's reasonable to expect a healthy year for what has been an oddly depressed airline industry that has been in an Elliott Wave zig-zag and flat pair of corrective patterns for the past 18-months.  (Do keep in mind the Schlumberger warnings of an impending oil supply deficit, however.  If that manifests, it will put an end to depressed jet fuel costs.)

You can see the overall pattern for the airline index in this weekly chart:

Airline Index Weekly Chart

We can see on the chart that the index started a steep uptrend in October, 2011.  It then traced out a very distinctive 5-wave impulse pattern that completed in January, 2015.  Since then, however, it completed a classic A-B-C Zig-Zag pattern, retracing almost 50% of the prior impulse pattern, and it looks like it's starting a possible flat correction now.  This overall pattern appears to be Wave 2 of a larger overall 5-wave Impulse, so once this corrective pattern completes, we can look forward to a very healthy third wave impulse.  Long-term traders should enjoy a very nice 3 or 4 year bull trend in airlines once that wave kicks off.  The way this pattern is trending, though, that may not happen until 2017.

Returning to GE, there were some additional interesting comments related to defense spending.  They forecast it to be flat in 2017 here in the US.  Given the number of industries here dependent upon defense spending, that's a cautionary note that we'll have to carefully watch.  Now, this flat projection may well be due to the number of sizeable contracts that were awarded in 2015 and early '16, so a pause in new contracts is to be expected, but it will be important to watch other companies in the industry to see how this matches their own forecasts and revenue plans.

Interestingly, GE forecasts international defense spending to be up 4% globally (excluding the US.)  That comes at a time when Europe is teetering on recession and facing the unknown threat of Brexit, so that 4% value is likely depressed due to the state of the global economy.  Should the economy heat up, it's reasonable to expect a similar increase in global defense spending, especially at a time when the terror threat appears to be spreading to parts of Western Europe.

With US defense spending flat but international defense spending up, we'll need to watch for companies that have a strong global stake.  These would include Lockheed Martin (NYSE:LMT), Boeing (NYSE:BA), and Raytheon (NYSE:RTN).  Fire Support, a defense marketing website includes an excellent list of the top 100 global defense companies for 2015.  While the list is a year old, the major players in this space have not changed.  If you're looking for companies that will benefit from growth in international defense spending, this is an excellent place to start.

From a trading perspective, it looks like there will be some short-term potential plays in the airlines, but be aware that there should be at least one more downward wave in the correction.  Longer term players can look forward to growth of a bit over 200% in the airline index from 2017 to 2021 if the Elliott Wave pattern holds true. For defense contractors, look more for trades in companies servicing overseas orders.  Just be aware of the impact the strong US dollar will have on their exchange rate and earnings forecasts. 

Happy Trading.

Trading Outlook for the Week of July 25-29

We close out the month of July in the coming week, following four solid weeks of strong performance.  The week ahead sees the July FOMC meeting, the GDP report, and another week of key earnings reports.

We're starting to see a bit of a pause in the upward movement across all capitalizations, and from an Elliott Wave perspective, all but the Nasdaq Composite appear to be in a fourth-wave consolidation.  The strongest plays for the week appear to be in either the Nasdaq or in the Large Cap stocks.  Both Mid and Small Cap stocks remained in a horizontal consolidation pattern, so we'll avoid those until their trends resume.

The three strongest sectors closing out the week are Technology, Utilities, and Health Care, so for long trades we'll be looking primarily in those sectors.  That the Utilities sector surged on Thursday and Friday is an area of concern since that indicates a renewed flight to safety.  The 10-Year Treasury Yield declined 1.87% this week after a large spike up last week.  We'll keep an eye on this throughout the week as well, since a decline in yield will further support the concept of a flight to safety.

Here's a summary of the week ahead.

Trading Bias 

Large Caps - Long
Mid Caps - No Trades
Small Caps - No Trades
Nasdaq - Long

Sectors

Showing strength
XLK - Technology

XLU - Utilities
XLV - Health Care

Showing weakness
XLB - Materials
XLE - Energy
XLI -  Industrials
XLP - Consumer Staples

Neutral
XLF - FinancialsXLY - Consumer Discretionary

Economic Reports of Significance (all times are EDT - GMT-4)

Monday, 7/25/16

• 10:30 - Dallas Fed Manufacturing Survey

Tuesday, 7/26/16

• 09:00 - S&P Case-Shiller HPI
• 10:00 - New Home Sales
• 10:00 - Consumer Confidence

Wednesday, 7/27/16

• 08:30 - Durable Goods Orders
• 10:00 - Pending Home Sales Index
• 10:30 - EIA Petroleum Status Report
• 14:00 - FOMC Meeting Announcement

Thursday, 7/28/16

• 08:30 - International Trade in Goods
• 08:30 - Jobless Claims

Friday, 7/29/16

• 08:30 - GDP
• 08:30 - Employment Cost Index
• 09:45 - Chicago PMI
• 10:00 - Consumer Sentiment

Earnings Reports Watched for Sector or Market Significance

Tuesday, 7/26/16

• Before Market Open - Caterpillar (NYSE:CAT)
• Before Market Open - 3M (NYSE:MMM)
• Before Market Open - United Technologies (NYSE:UTX)

Wednesday, 7/27/16

•  Before Market Open - Boeing (NYSE:BA)

Thursday, 7/28/16

•  Before Market Open - Ford (NYSE:F)

Friday, 7/29/16

• Before Market Open - UPS (NYSE:UPS)

Summary

Our long positions this week will be limited to large caps and Nasdaq stocks, primarily in Technology, Utilities, and Health Care.  We'll keep our stops very close for several reasons:

• Both UNP and SLB provided strong evidence of potential problems in several key industries.  This may take the wind out of the strong bullish sails we've experienced for four weeks.
• Strength in the Utilities sector and a slight decline in the 10-year yield are showing signs of a renewed flight to safety.
• There are major companies reporting earnings throughout the week.  This will add a measure of unpredictability to the markets.
• FOMC reports on Wednesday.  While we don't anticipate any major announcements, just the tone and language of the announcement can generate unforeseen shifts in market behavior.
• Mid-caps and Small-caps are experiencing consolidation, and both Large-caps and Nasdaq are showing signs that they, too, will enter a similar phase.

As always, trade the market you see, not the market you want.  Remain nimble, stick to your trading plan, and always know your exit strategy before entering the trade.

Happy Trading.

Schlumberger Warns of Impending Severe Oil Supply Deficit

Schlumberger (NYSE:SLB) announced earnings after the bell yesterday, beating EPS estimates by $0.02 and revenue by $70 million.  That's the good news.  Everything else about the release points to a serious energy crisis looming in the not-too-distant future. 

Demand in the oil industry continues to grow at a steady and aggressive pace.  As the economies in the US, Europe, and China recover, that demand will increase.  The supply side, however, has taken a horrendous hit over the past two years.  CEO Paal Kibsgaard summed it up, "We are heading towards a significant global supply deficit as the E&P [exploration and production] spend rate now is down by more than 50%."

There has been a significant cost efficiency problem within the industry for some time, and that inefficiency in cash flow has been exacerbated by the dramatic plunge in oil prices worldwide over the past seven quarters.  Rig operators have reacted to this price crisis with a massive reduction in oil field activity.  Active rigs are now down to 25% of their original level, and the appetite to start new wells has reached a critical low.  This has caused a ripple effect through the entire oil supply-chain industry, and it's about to reach critical mass.

Non-OPEC production is set to drop an additional 900,000 barrels per day.  Similar weakness is being forecast in the non-Gulf OPEC nations, and as short-term high production activities run their course, the expectation is for an accelerated decline in overall oil production worldwide.

Kibsgaard went on to say, "The market is also underestimating the potential reaction from the supplier industry, which has temporarily accepted financially unviable contracts to support the operators and to keep their options open as the downturn has deepened and extended into uncharted territory."

Cash flow from the rig operators is becoming strained, and they are delaying payments to creditors in an attempt to improve that flow.  This, too, has a ripple effect through the supply-chain industry.  What the entire environment demonstrates, though, is that as the service industry pricing inevitably improves - supply and demand will naturally force it - much of the capital that would normally be spent on exploration and production will instead be spent on debt reduction.  That will put added pressure on the oil supply deficit, extending the duration of the pending crisis.

What all this means is that there will be continued negative pressure on the various industries that support all aspects of the oil business.  Expect the metals industries to take a hit as both repairs to existing rigs and the development of new rigs are put on hold or canceled outright.  Expect shipping to take a hit as the flow of supplies, raw materials, and energy resources to and from suppliers and operators continues to decline.  Expect the chemicals industries to take a hit as there is less demand for the materials that are used in drilling and refining.

This is not good news for the consumer, either.  We currently still have an oil glut, which, coupled with an uncharacteristically strong US dollar,  is holding prices down for the moment.  As that glut transitions to a supply shortfall over the coming year, however, we can anticipate a rapid rise in oil prices world-wide.  That will dramatically impact the price at the pump, likely forcing gas prices to record highs around the world. 

It will take some time for all of this to play out, but it does appear that the piper that played the tune of ridiculously low oil prices is poised to deliver the bill.  Paying that bill will be painful at best. 

Happy Trading.