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April 24, 2006

Turning Points
by Andre Gratian

A 3-dimensional approach to technical analysis
Cycles - Structure - Price projections

"By the Law of Periodical Repetition, everything which has happened once must happen again, and again, and again -- and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ... The same Nature which delights in periodical repetition in the sky is the Nature which orders the affairs of the earth. Let us not underrate the value of that hint." -- Mark Twain

Current Position of the Market.

SPX: Long-Term Trend - The SPX inched its way to a new bull market high last week but its long term uptrend may be challenged next month.

SPX: Intermediate Trend - The uptrend which began in October should come to an end in the early part of next month.

Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which determines the course of longer market trends.

Daily market analysis of the short term trend is reserved for subscribers. If you would like to sign up for a FREE 6-week trial period of daily comments, please let me know at ajg@cybertrails.com.

What's Next?

The combined 12-year and 10-year cycles are still driving equity indices higher and led them to record new highs last week, with the notable exception of the NASDAQ 100 which made its high in January, and has not been able to exceed it.

The next chart shows the weekly trend of four of the major indices and the progress that they have made since the bottom of the 10-year cycle in August 2004. On the right, the NYSE composite and the Russell 2000 are still the two strongest and continue to trade at record levels.

On the left, the Dow Jones Industrials has been playing catch up since October and is now less than 400 points from its all-time high. But the Nasdaq 100 made its high in January 2006, and has now traded sideways for 3 ½ months.

I have discussed before the negative implications of the underperformance of the Nasdaq 100. Historically, it has nearly always signaled a market reversal. This divergence can be seen best on the following chart of the NDX /SPX relationship for the past three years. You can plainly see the similarity between the current pattern and those that started on January ‘04 and ‘05. These accurately predicted the beginning of the two most important corrections of the bull market, and it is another indication that the bull market may be close to reaching its top.

Let's now analyze a chart of the daily SPX to see exactly where we are in the process of topping out. This chart also represents the market action since the bottoming of the 10-year cycle in August 2004. I have pointed out before that the index continues to trade in a narrow range in the upper half of its up channel, and that it has not been able to break out of that tight range which started in December.

The first sign that the bull market is coming to an end is when it drops into the lower half of the channel. Is there any evidence that it is about to do this? There are signs that it is going to try as early as next month. But in order to observe these signs more clearly, we need to see a close up of the same chart. Here, there are several negatives to consider, all suggesting that at the very least the move which started in October is coming to an end.

(1) Note the increasing negative divergence on the A/D oscillator, below. Starting with the end of wave IV, there have been 3 rallies. In the second rally, the oscillator easily surpassed the peak of the former wave, while this was also the case with price. But now, even though the SPX has made a new high, the A/D oscillator line -- which had gone deeply negative and remained there longer than at the previous low -- has finally managed to get positive again, but just barely, while the slower component, (the heavy red line) is still below the "0" line. Perhaps this will improve but probably not much, for the reason given in (2).

(2) Looking at the structure, the move is currently in the terminal stages of wave 5 of V. A normal fifth wave is where the loss of momentum occurs. It is the aging and "tired" part of the move. This is usually reflected in both the price pattern and in the A/D. This is why, although it is still trading in the upper portion of its up channel, the SPX has been confined to a narrow trading range, and this is also why the A/D oscillator is beginning to show negative divergence. It is likely that this pattern will continue in the same vein until the market has completed its final wave structure and is ready for a reversal.

(3) I have outlined the channel of wave V with blue lines. The mid-point of that channel is defined by a dashed line. Structurally, we have started the 5th and final wave of that pattern. Since wave 4 was caused by a couple of cycles which just made their low, wave 5 could take a little while to complete, perhaps extending into May. When prices drop decisively below the center line, it is likely that wave 5 -- as well as V -- will have completed and that a reversal will be on the way. The final confirmation will come when the lower blue trend line is penetrated and prices close below it.

(4) Our leading indicator, the NDX has already begun to show weakness by refusing to make a new high last week. When it begins to sell off, the SPX and other indices will be likely to follow.

(5) Cycles! There were two cycles (*) which were instrumental in causing wave 4. There are two more cycles coming up which will play an even greater role in the coming reversal. A short-term cycle bottoming in early May could start the decline, or cause the last small up wave of 5. The larger cycle which makes its low about 5/20 is the one which will put an end to the October move. It should be all the more effective because it coincides with an important Bradley turn date.

The conclusion drawn from the analysis of the daily SPX chart is that the end of the move which began in October is near and that we are about to have the most extensive decline in several months. But it is too soon to make a projection, because there are still several days before the reversal takes place, and the amount of distribution which occurs during that time is what will determine the extent of the decline. So you will have to wait until the next newsletter for a price target.

Here is another, more comprehensive view of the breadth/ price relationship:

Of all the indicators available, I still believe that the performance of the advance/decline gives the most accurate warning of the approach of significant reversals in the market. I don't think that one can ignore the above chart.

Will this also constitute the top of the bull market? It could be for some indices and not for others. I am still of the opinion that the Nasdaq 100 has already made its bull market high, but there is still a lot of strength in the overall market, and the coming decline should at least be followed by a test of the highs and quite possibly by another rally to new highs. It's too soon to tell. To break the back of the bull market uptrend, the decline would need to break out of the long term channel which started back in August '04, and that is not likely to happen in just 2 or 3 weeks. We'll have to see what kind of action takes place after 5/20.

The last newsletter was written just at the start of the wave 4 decline and as I was trying to assess how much of a decline we might have, I wrote the following:

An argument that this may only be a short term decline is that the divergence between the Nasdaq 100 and the SPX no longer exists. In the past two weeks, the NDX has had a good rally and is now on an even par with the SPX. By rallying it also pulled away from the trend line and support level which it threatened to break less than a month ago. This resurgence of strength may only be temporary, but it is another reason to think that we are not quite ready for an immediate and sustained decline.

Now, the situation has reversed once again and the NDX is once more saying "watch out!". Better heed it!

Gold appears to be at an intermediate top and could have a significant retracement from here. The XAU is not confirming the last advance in gold, and that normally signals the end of a move. Also, the XAU had a P&F to 158 projection which has been filled.

The US Dollar has not done much of late, but it needs to hold its current level or it could be in danger of resuming its long-term downtrend.

OIL is stretched out, short-term, and may be ready to pull-back, however there is no hint of a serious top developing at these levels.

SUMMARY: There are ample warnings that the intermediate trend which began in October is finally coming to an end. How much of a decline will ensue is not determinable at this time. Nor is it clear at this time if this top will also constitute a bull market top.

Andre Gratian
MarketTurningPoints.com

The above comments about the financial markets are based purely on what I consider to be sound technical analysis principles uncompromised by fundamental considerations. They represent my own opinion and are not meant to be construed as trading or investment advice, but are offered as an analytical point of view which might be of interest to those who follow stock market cycles and technical analysis.

I encourage your questions and comments. Please contact me at: ajg@cybertrails.com.

Copyright © 2004-2008 Andre Gratian

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