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analysis: Cycles - Breadth - P&F and Fibonacci 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
Very Long-term trend - Down! The very-long-term cycles are down and if they make their lows when expected, the bear market which started in October 2007 should continue until 2014. Long-term - Up! We are in a medium-term bull market, which is a corrective move within a long term bear market. This bull market should last until 2011 SPX: Intermediate trend. It is more than likely than the index has made a top of intermediate nature. Unless it can hold above the 1044 level, the downtrend will probably continue until the Fall. 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 discusses the course of longer market trends.
What happened to the stock market last week was not a glitch. It is representative of the current automated trading environment. Unless some curbs are implemented, more catastrophic corrections of this sort lie ahead.
From its last interim low of 1044.50 the SPX had risen to its projected level, give or take 10 points, and was vulnerable to a correction. A moderate decline started from the 1220 level, and by Tuesday of last week, it had found brief support at the 20-DMA. It broke that support on Wednesday and on Thursday, a massive computer sell program was activated which took the index down 100 points for the day followed by a rebound of 70 points all, literally, in a matter of minutes. At one point, the DJIA was down nearly 1000 points. Some really weird things happened during this drop: a 40-dollar stock went to 1cent, and another apparently rose to $100,000.
Although one could argue that there was justification for a correction of that magnitude based on the technical condition of the market, the speed at which it happened is the issue. If unrestricted computer trading is allowed to continue, the stock market is going to become a gambling casino which, because of the risk involved, will lose its investor base.
What has this lightning correction done to the market trend? Probably, it has started an intermediate decline which was not "supposed" to begin until the end of May, according to some top analysts. And, since most market indicators are short-term oversold, but not in a position to start a rally, there is risk of further decline before a counter-rally develops.
From a pure technical standpoint, an intermediate decline will not be confirmed until the SPX trades below its last interim low of 1044.50. Although sentiment has become extremely bullish for the market after last week, the indicators will have to move back into a buy position before we can rally. This will be accomplished through a series of short advances and declines (at least one each) which create a pattern of deceleration showing that the selling is abating and that buyers are ready to take over. That's the way it normally works, but are we operating in a new norm? More likely, the market's basic structural frame work has not been impaired, and neither have the cycles been affected.
The rapid drop in prices may have vindicated the Elliot Wave Theory which was predicting such a decline -- although the anticipated timing left something to be desired. If this is a "wave 3 of primary nature", we should see a wave 4 rally followed by a wave 5 to new lows. There is an alternate count which would make this a "B" wave.
Chart Pattern and Momentum
Let's see what damage was done to the long-term charts. On the Monthly Chart (left), the index stopped rising where expected (at the dotted line), and is beginning to follow the anticipated future pattern based on cycles. There is still nothing to suggest that we have a long-term reversal. In question is whether or not the reversal of the 4-year cycle in the Fall can propel the market to new highs before the final precipitous drop into 2014.
The Weekly Chart (right) has given a sell signal which, based on the cycles which lie ahead, is probably of intermediate nature. The 3 indicators gave a sell signal along with the price index. Technically, however, until the last low of 1044.50 has been penetrated to the downside, the SPX remains in an intermediate uptrend.
The bottom indicator clearly shows the weakness of the third and last leg. The decline was not a matter of if, but when and how. Both turned out to be a bit of a surprise, especially the "how".
We'll now take a look at the Daily Chart. The short-term up-channel from early February was represented by the brown channel. The steep decline came right after prices moved out of it. In the process, they also broke through the blue channel which encompasses the price parameter from the March 2009 low. The index is now resting on the 200-DMA. In order to confirm the downtrend as intermediate, all they have to do is break below it, and subsequently penetrate the former low at 1044. That may not happen right away because the index is very oversold and should experience a rally before moving lower.
The indicators are at the lows of their range, but still not in a position to start a meaningful rally. There is neither deceleration nor divergence showing. A rally followed by another decline is needed to improve their profile.
One, and perhaps two cycles bottomed on Thursday and Friday. It's possible that the 20-wk cycle was partly responsible for last week's decline. It's not unusual for this cycle to be one or two weeks off its regular phase. If it has bottomed, it will be instrumental in causing a rally.
The Hourly Chart clearly shows that the index has not yet recovered from its weakness. There are still a greater number of sellers than buyers. A lot of trading has taken place at this level since last Thursday's decline. This shows up best on a one-point reversal P&F chart which, as of Friday, already measured 111 points across. Everything considered, it looks more like a large base is being formed, but it could also be distribution to be followed by another down move. We should know which it is by next week.
The trend has steepened dramatically since the sell-off. In order to rally, the index will have to break through its down trend line. The indicators, which are already in an uptrend favor such a rally; but it will find resistance at the former rally top (red line) and, if it moves higher, at the bottom of its former channel (heavy brown lines). If such a rally develops, it could be considered normal back-testing of the former blue channel.
It is very likely that this overhead resistance will set it back, but if the pull-back is not too severe, and it resumes its uptrend and manages to get back inside its former channels (blue and brown) it would be a sign of strength. If the index has formed a base, there is enough count in the Point and Figure chart to do just that, and even more.
If the 20-wk cycle did make its low on Thursday and the 26-day cycle bottomed on Friday, considering the deeply oversold market state and very favorable sentiment, the two combined should produce a decent rally. This would fulfill our previous expectation that 5/20 would either produce new high, or a re-test of the high.
The market will have a limited time window during which to rally, as dominant cycles -- the 17-wk and the 2-yr cycles are not very far ahead. And then, of course, they will be followed by the 4-year and 9-month cycles bottoming in the Fall.
As mentioned earlier, The Point & Figure chart has already built what appears to be a substantial base which is divided into distinct phases. If that base is complete and we start to rally on Monday, these are the projections derived from each phase:
1st phase: absolute minimum, 1143. Moderate count, 1149. Maximum, 1152.
2nd phase: minimum, 1167. Maximum, 1175.
3rd phase: minimum, 1195. Total base count: 1217
Each one of these targets is capable of bringing about a reversal which could be either interim or final. The technical background at the time the projection is reached will determine which it is.
If there is a re-test of the lows before we start up, it will invalidate the given counts as the base will be expanded.
If the "accumulation" turns out to be distribution instead, that phase is not yet complete and we have to wait for a rally to complete it. If this happens to be the case, we will re-visit the projections in the future.
I mentioned in the last newsletter that the QQQQ had a potential projection to 51.50. It appears that it satisfied itself with a move to 50.65 before giving up. Just a little shy of the potential target.
The creation of an intermediate A/D indicator for the weekly chart showed the vulnerability of the third leg of the rally from March 2009.
The NYSE Summation index displayed below (courtesy of StockCharts.com) did not as clearly display the vulnerability of the market. At the top, it was overbought and although it displayed long-term divergence with its September 2009 peak, it did not show any near-term negative divergence with the shorter-term peak of January 2010. Normally, it requires a move below zero before confirming that the uptrend is over.
In fact, just as the SPX has to break below 1044 to confirm an intermediate downtrend, this indicator will have to go lower than its February low to suggest that such a downtrend has started.
Just like our daily indicators, the RSI has become oversold, but probably needs a little more work before starting to rise again.
Market Leaders and Sentiment
The graph of the NDX/SPX relative strength (provided courtesy of StockCharts.com) shows a mild divergence, but nothing serious. The chart shows only a short-term corrective downtrend, but the MACD suggest that it is not yet ready to turn. At this stage, it does not seem to be a significant threat to the SPX's intermediate trend.
The Sentiment Reader (courtesy of same) is even more glaring in its suggestion that we could be near an important low. But we should keep in mind that this is not a specific timing indicator.
The VIX chart (below) agrees with the NDX/SPX graph, in that it shows no immediate sign of topping.
The dollar index is still an important gauge of market direction as it continues to move in a distinctly opposite direction to the equity market.
The above chart of its ETF (UUP) shows that it is breaking out of a major downtrend with the indicators confirming this as a valid break-out. The dollar P&F chart -- presently at 85 -- tells us that it could reach 92. However, the indicators are overbought and could soon develop negative divergence and cause a pull-back from a slightly higher level. Break-outs have a tendency to back-test the trend lines which they have just broken.
The weight of evidence suggests that the SPX made an important top at 1220 and that it is probably not yet ready to reverse its short-term downtrend until more work has been done to put the daily indicators in a better position. This could come in the form of a sideways move or a re-testing of the lows, and not necessary in a new low for the index.
What is less clear, is whether or not this will develop into an intermediate top. The index would have to drop more than 70 points to confirm that it has and it may not be ready to do that before a substantial rally to retest the high takes place. If this is the case, the time window for such a rally is very limited, as dominant bottoming cycles should soon exert downward pressure on prices which may keep the SPX in a downtrend until the Fall.
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Thanks for all your help. You have done a superb job in what is obviously a difficult market to gauge. J.D.
Unbelievable call. U nailed it, and never backed off. C.S.
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