BOND ETF HITS RESISTANCE - DOLLAR CONTINUES ITS RISE - LESSONS FROM PRIOR BEAR MARKET - A QUICK TOP ON 2001 - A DRAWN OUT TOP IN 2002 - TECHNICAL ANALYSIS IS FRACTAL - S&P 500 HITS IMPORTANT RESISTANCE ZONE

BOND ETF HITS RESISTANCE... Link for todays video. After a pretty good rally in January, the 20+ Year Treasury ETF (TLT) hit resistance last week and fell back over the last three days. Chart 1 shows TLT breaking support the 91.5-93 support zone with a sharp decline in December. TLT rebounded in January, but this broken support zone turned into a resistance zone. Also notice resistance coming in from the October trendline. Chart 2 shows a weekly candlestick chart with the Aroon Oscillator in negative territory. TLT has been trending lower since breaking wedge support. The next big support zone is in the low-mid 80s. The bond market is gearing up for Fridays employment report. Todays weakness was brought on by a better-than-expected ADP Employment report. Initial Claims will be reported on Thursday before the open. Bonds are sensitive to employment statistics because the Fed is hardly likely to raise interest rates as long as non-farm payrolls decline. Any strength in non-farm payrolls would likely cause bonds to drop and interest rates to rise. Friday will be an important day for the bond market.

Chart 1

Chart 2

DOLLAR CONTINUES ITS RISE... The Dollar is catching another bid today on positive economic news. First, the ADP Employment report was better-than-expected. Second, the ISM Services Index moved above 50 in January. Anything above 50 favors economic expansion, while anything below 50 favors contraction. An improving economy would put upward pressure on interest rates, which in turn makes Dollar denominated bonds more attractive. The Dollar is also benefiting from weakness in the Euro, which remains under pressure on concerns with Portuguese debt burdens. Chart 3 shows the Euro ETF (FXE) nearing potential support from the June-July lows. The ETF has been in a freefall since breaking flag support and the 200-day moving average in mid December. Chart 4 shows the DB Dollar Bullish ETF (UUP) moving higher on Wednesday. While the Euro ETF is near its June-July lows, UUP still has a ways to go before reaching its June-July highs.

Chart 3

Chart 4

LESSONS FROM PRIOR BEAR MARKET... Technical analysis is all about studying past price patterns to predict future price movements. With that in mind, I went back to the prior bear market to analyze retracements and trend reversals in 2001 and 2002. Chart 5 captures the prior bear market from March 2000 to October 2002. There were three big declines and three normal retracements that ranged from 44% to 60%**. The first peak near 1300 retraced around 50% and formed over a relatively short period. The second peak around 1150 retraced around 60% retracement and was more extended. The third peak retraced 44% and reversed rather quickly.

Chart 5

A QUICK TOP ON 2001... Chart 6 focuses on the first decline, 50% retracement and peak. Rather than delve into indicators, I am just going to focus on basic price action via the price chart. The S&P 500 peaked around 1300 in mid-late May and declined to support around 1250 (red arrow). SPX bounced off 1250 to affirm support, but the bounce was short-lived as SPX broke support with a sharp decline in mid June. Support in the 1240-1250 area was clearly defined. The index clearly reversed the trend with a support break and lower low. Once reversed, the index moved to a new low.

Chart 6

A DRAWN OUT TOP... Chart 7 focuses on the second decline, 60% retracement and peak. The S&P 500 first peaked around 1175 in early December (red arrow). After a support test around 1125 in mid December, the index bounced back to resistance near 1175. It is important to note that the 1125 area was a support zone. The S&P 500 consists of, well, 500 stocks. As an index driven by many different components, support and resistance levels are difficult to pinpoint. For indices, it is often better to rely on zones for support or resistance. Even after a clear break below the 1125 support zone, the S&P 500 made another run to 1175. Talk about frustrating the bears! Resistance held again as the index moved to new lows in late April and May. This top was a lot more extended than the prior top. Consider it a long distribution period as the S&P 500 traded around the 1125 area from November 2001 until April 2002 (six months).

Chart 7

TECHNICAL ANALYSIS IS FRACTAL... Before moving on to the current S&P 500 chart, just a reminder that technical analysis is fractal in nature. This means we can apply analysis techniques across different timeframes. Charts can be split into parts (different timeframes) and these parts have similar characteristics. Without labels on the X-axis and Y-axis, a 10-minute chart looks the same as a monthly chart. We can use the same indicators, chart patterns and techniques for either chart. One chart below is a 10-minute chart, the other is a weekly chart. Some of you may be able to spot the difference. I cant. Some of you may even recognize these charts. The answer is at the end of this commentary.

Chart 8

Chart 9

S&P 500 STALLS IN RETRACEMENT CLUSTER... The previous charts were based on daily bars, but chart 10 shows weekly bars for the S&P 500. Considering the fractals, I am going to apply some of the lessons learned from the prior peaks to the current situation. There are many reasons to believe the S&P 500 has hit a major resistance level. First, we can see that the S&P 500 hit resistance in a retracement cluster around 1150. There is always debate on drawing the Fibonacci Retracements Tool so I just decided to draw this indicator from both highs. First, there is a retracement cluster marked by two retracements. 1150 marks a 62% retracement of the Oct-07 to Mar-09 decline and 1125 marks a 50% retracement of the May-08 to Mar-09 decline (yellow area). Second, there is potential resistance in this area from the October 2007 trendline. Third, weekly MACD moved below its signal line for the first time since March 2009. With the MACD cross, retracement cluster and trendline resistance, there is a good argument for resistance in the 1150 area. We can also add overextended conditions as the index advanced some 70% (666 to 1150) in 10 months without a pullback greater than 10%.

Chart 10

Despite evidence for resistance, I have yet to see an actual reversal of the uptrend that has been in place since March. The 2001 and 2002 trend reversals were confirmed with a break below support from a reaction low. For the current advance, chart 11 shows the last two reaction lows in the 1020-1030 area. Even though this support zone seems far from the current high around 1150, it makes technical sense from a trend identification standpoint. A downtrend starts with a lower low. This means the S&P 500 needs to break its prior reaction low to fully reverse the uptrend. Should the index rally back to the 1150 area, I would then raise reaction low support. This methodology will not predict a top. Instead, it is designed to identify the trend and follow until proven otherwise.

Chart 11

ANSWER TO THE CHART QUIZ... Chart 12 is a weekly bar chart of the Dow Industrials from February 2000 to December 2003. Chart 13 is a 10-minute bar chart of the Dow Industrials from January 26th to February 2nd (2010).

Chart 12

Chart 13