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July 17, 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 top of the 4-year cycle bull market is now confirmed.

SPX: Intermediate Trend - The secondary reaction which started from the 1220 level came to an end at 1280 and the long term decline has resumed.

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 ambiguity which existed about the near term trend of the stock market disappeared last week in a spectacular reversal which sent indices tumbling several percentage points. Mike Burk, who writes "The Technical Market Report" on Safehaven shows the performance of the major indices over the past 8 trading days in terms of percentages:

Dow Jones Industrial Average 4.4%
S&P 500 (SPX) 3.4%
NASDAQ composite (OTC) 7.0%
S&P Mid cap 5.6%
Russell 2000 (R2K) 6.8%
Wilshire 5000 4.0%

In my last newsletter, the SUMMARY read:

The SPX has found support at the bottom of its longer term uptrend channel, from which it has rallied. If it fails to move back into the upper half of this channel fairly quickly, it will become vulnerable to another downward reversal which should take it below the channel line and confirm that the 4-year cycle top has been made.

As you can see on the next chart, after crossing the entire width of its long term up channel which goes back to August 2004, the SPX had found temporary support on the bottom trend line and rebounded within the channel. It made a brief attempt at resuming its uptrend, but could not overcome the overhead resistance and last week broke to the downside, thereby signaling that the downtrend had resumed.

In my opinion, the best leading indicator is the relative performance of the SPX to the NDX. In my last newsletter I showed a chart of these two indices which warned that the next move for the SPX was likely to be down and not up. In this updated chart, you can see that the relative weakness of the NDX has worsened, suggesting that more decline is probably in store for the SPX.

Is there a way to predict how far this decline will go? For the short-term, yes! Let's look at a 30-minute chart of the SPX. But before discussing projections, I want to show why there was so much uncertainty about the direction of the market just prior to the decline. Look at the similarity of the two consolidation patterns. They are almost identical. This type of formation is generally bullish and resolves itself to the upside. This set up expectations that a fifth and final wave from the 1220 low would be needed to complete the move, and it was reinforced by the preferred interpretation of the larger Elliott Wave pattern which also called for one more up wave! So much for expectations!

Now, note that I have drawn pink lines on the chart. The horizontal line represents the distribution area of the top formation. When converted into a point & figure projection, it can be estimated that the decline should continue to a minimum of 1225. If the small shelf on the left of the top is included, the count is extended to 1216. This is an "iffy" count because it includes distribution to the left of the top. However, since there are also Fibonacci projections which extend down to that level, it may be valid.

The decline should reach the projected target on about 7/21. The ideal date for the bottom of the 3-week cycle is 7/18, but there is an important CIT point on 7/21, and this might extend the low by a couple of days. After that, the SPX should be ready for a rally, but the longer term trend of the market is likely to remain down until the 4-year cycle makes its low some time around October.

It is easy to see the worsening geopolitical condition in the Middle East as the trigger for the current market weakness. It has also affected the price of oil which, as you can see on the next chart is moving toward its potential target of $82 dollars. What is interesting is that oil seemed to be anticipating that something like this was going to happen. After reaching $75, the price of oil made a sideways consolidation, just waiting for the next development which could send it higher. The good news is that after it gets there, it will have completed a 5-wave pattern from $56 and should go into a more protracted reversal of trend. Does this imply that the flare up in the Middle East will only be temporary and things will soon settle down?

The stock market may also reflect concern about the future of the U.S. economy. In his latest newsletter, John Mauldin expresses the view that stagflation and a potential recession lie ahead. If he is right, we may be starting a decline which goes even beyond the projected 4-year cycle low and extends well into 2007, and perhaps 2008. There is a 7-year cycle low due in 2008, the same cycle which caused the steep declines in 1987 and 2001. Naturally, there is no guarantee that its next impact in will be as dramatic.

It is important to watch market breadth for clues about what lies ahead, even though it has become extremely volatile since the advance/decline figures have been decimalized. Until last week, the McClellan oscillator was showing a lot of strength, which is one of the reasons why an extension of the rally was anticipated. Now, it has once again gone negative and this has turned the summation index back down at a time when it was trying to rebound from a deeply oversold level.

The new highs new lows index chart which comes right after the advance/decline chart looks even more negative. This index did not begin to rally until late June, and now it is already making new lows. The Nasdaq data is particularly weak, which should be no surprise considering the performance of the index.

Finally, I want post a chart of other leading indices to show how they have been affected by the recent decline. It looks as if the DJIA and the Russell 2000 could easily make new lows during the remainder of the decline, but the NYSE and OEX may not.

SUMMARY:

Last week's decline is a confirmation that the May high was the top of the 4-year bull market and that the downtrend has resumed. A rally should take place after the short-term projections are met, but it should only be a temporary halt to a longer term decline into about October.

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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