SHORT-TERM MARKET IMPROVEMENT CONTINUES AS LENDING RATES AND VIX DROP -- DAILY EMA LINES STRENGTHEN, BUT WEEKLY AND MONTHLIES STILL POINT DOWN -- COMMODITIES BOUNCE WITH STOCKS AS DOLLAR AND YEN PULL BACK

LIBOR AND VIX CONTINUE TO DROP ... Short-term market conditions continue to improve. One reflection of that is the continuing drop in the LIBOR lending rate (London Interbank Offered Rate). Chart 1 shows the three-month LIBOR dropping another 15 basis points today to 2.71% which is the lowest level since June 9. That puts it below the level in mid-September when the latest crisis began. The one-month LIBOR has fallen to the lowest level in four years. Those moves have helped restore some confidence in financial markets. So has the drop in the VIX.

Chart 1

DROP IN VIX BOOSTS STOCKS ... Last Tuesday, I wrote about the CBOE Volatility (VIX) Index showing signs of weakness which signaled a short-term rally attempt in stocks. The daily bars in Chart 2 show the VIX dropping to the lowest level in nearly a month. The VIX has already lost more than half of its gain from August to October and is nearing a test of potential support around the 45 level. What it does from there should help determine how far stocks can rally.

Chart 2

OVERHEAD RESISTANCE BARRIERS... I wrote last Thursday (using the ADX indicator) that I suspected that the market was entering a trading range as opposed to a big rally. The short-term trading range could last until the end of the year. There are any number of ways to determine the upper limits of that trading range. One way to do that is to plot Fibonacci retracement levels from the September peak to the October bottom as shown in Chart 3 for the S&P 500. The first overhead barrier is the mid-October intra-day peak at 1044 which is just beyond the 38% retracement point. If that is exceeded, a further rally retracing 50% to 62% is possible. That would also bring the S&P back to its 50-day moving average. I'd be surprised if the market got much further than that. Things could start to worsen again after the normal yearend bounce.

Chart 3

DOWNTREND LOOKS INCOMPLETE ... Some of our readers have asked for an update on Elliott Waves. Chart 4 is my interpretation of where they stand. Since the May peak, the market appears to have dropped in three waves. Trends in the direction of the major trend (which is down) usually form five waves. There's good and bad news in that view. The good news is that a fourth wave rally (or consolidation) appears to be starting which could retrace 50% to 62% of wave 2 as shown in the previous chart. Fourth waves are often trading ranges. Once the fourth wave is complete, however, another downleg is likely. That could take place sometime in the new year if seasonal trends follow their normal pattern. That expected downleg could test the 2002/2003 lows in the S&P 500.

Chart 4

MONTHLY EMAS ARE STILL DOWN ... Part of my pessimism on the market's long-term trend stems from the next chart. On Friday, I wrote about the 13-34 week exponential moving average combination. Chart 5 uses the "monthly" version of that combination. It shows that the monthly EMAs recently turned bearish for the first time since 2001 (see red circle). Earlier in the year I pointed out that the crossing of the monthly lines was too slow an indicator to use for timing purposes. I suggested using the difference between the two lines which is plotted below the chart (MACD line with 13,34,1 values). That line turned down at the end of the last year (see arrow) and is still dropping. I'd need to see some improvement in that line before turning more positive on the market's major trend.

Chart 5

TRADING EMA SPREAD ... One of our readers asked if it was possible to trade turns in the spread between the EMA lines. The answer is yes, but only for short-term trading purposes. Chart 7 overlays the 13-34 daily EMA spread over the S&P 500. The chart shows that turns in the daily 13,34,1 MACD line coincide with short-term turns in the S&P 500. The last two downturns in mid-May and early September coincided with market drops. The rebound in the MACD line in mid-July led to a modest rebound. At the moment, the black line is rising which also suggests a market rebound. Keep the major trend in mind however. The major trend of the black line is bearish as long as it remains below zero. Until that changes, don't expect the market to rebound too far. That's especially true when the weekly EMA spread is still dropping as shown in Chart 7.

Chart 6

Chart 7

WEEKLY EMAS ARE STILL DROPPING ... Chart 7 applies the same logic to the spread between the "weekly" EMA lines. Chart 7 shows that the last three crossings above and below the 13-34 week MACD zero line signaled major market turning points (compare circles and lines). Actual turns in the spread line itself can provide earlier signs of a market turn. At the moment, however, the weekly EMA spread is still dropping. That should limit the upside in any rally attempt.

COMMODITIES BOUNCE AS DOLLAR AND YEN PULL BACK... Another sign of short-term market improvement is the drop in the Japanese yen and the U.S. Dollar. Money poured into the yen and the dollar during the recent crisis. Both are now entering a downside correction as global stocks stabilize. Chart 8 shows the yen dropping over the past week. Chart 9 shows an overbought PowerShares US Dollar Bullish ETF starting a pullback as well. The combination of a weaker dollar and rising stocks is causing oversold commodities to bounce. Chart 10 shows the DB Commodities Tracking ETF starting to rebound. There's no convincing evidence, however, to suggest that these recent signs of improvement are long-term in nature. They look more like short-term retracements to longer-term trends. Much like the rally in the stock market.

Chart 8

Chart 9

Chart 10