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 - It is not possible to determine with any degree of certainty if the top of the 4-year cycle bull market has been made.
SPX: Intermediate Trend - The intermediate trend may have begun a sideways pattern with a slight upward bias which could last for several weeks or even months.
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 firstname.lastname@example.org.
It is obvious that the stock market, for the time being at least, does not want to go down. But that does not mean that it is getting ready for a big move up either! We may have entered a period of several weeks -- and perhaps months -- which is likely to frustrate both the bulls and the bears.
The SPX made a low at 1220 on June 14. After rising to 1280 in early July, the SPX retraced only to 1225 thereby making a successful test of the low The most likely analysis using Elliott Wave terminology, is that the entire move from June 14 to the present is a flat and that it will be completed in the next few days. A non-Elliott interpretation is that the SPX has made a double bottom and, when it breaks above 1280, this will confirm that it is back in an uptrend.
A flat is a corrective pattern, meaning that it is only a pause in the primary trend. This might signify that the mini bear trend which started at 1326 is about to resume to the downside! But not necessarily, or at least, not right away. Corrective patterns can come in a series of twos or threes. Perhaps this is what is happening here. When this flat pattern is complete, it should be followed by a retracement. If this fails to bring about new lows before the uptrend resumes, then we could make another corrective pattern. This process can continue for several more weeks and perhaps months, resulting in a broad ranging lateral move. After it's done, then the long term decline can resume. Corrective patterns in the form of twos or threes are fairly common and it could very well be what is beginning to take place here.
In the last newsletter, I mentioned that John Mauldin was concerned that stagflation and a recession were in store for the economy. In this week's newsletter, he makes an even stronger case for it. He believes that the stock market got all excited by the lower than expected GDP figures and that investors concluded that this would lead to a halt in the Fed's steady increase in interest rates. He thinks that they may be disappointed, and that even if the Fed does pause at the August meeting, it will be only briefly as it becomes apparent that inflation is still a problem.
I seldom discuss "fundamentals", but the scenario which he envisages is so perfect for what I see happening in the market, that I had to mention it. The optimism of the investing crowd may be based on false expectations about both the Fed and the economy. When investors come to the realization that the Fed is not finished, and that the economy continues to weaken, then the market will be able to resume its long term downtrend, extending the decline into 2007.
It is also noticeable that the day-to-day activity of the stock market is influenced by developments in the Middle East. Another trip to the region by secretary Rice this week-end has set up expectations that a negotiated end to the violence may take place. This expectation could have played a part in Friday's rally. But this may prove to be a difficult task, and if nothing is accomplished over the week-end, these hopes will be dashed and the shortterm trend will soon reverse.
Where is the 4-year cycle in all this? Perhaps it caused the SPX and some other indices (NYSE, OEX, DJIA) to make an early low in June, or it could still take place later on this Fall. The 4-year cycle low could even be delayed until next year. Even a cycle which has been as regular as the 4-year cycle can occasionally miss a beat and the analyst has to give first consideration to what the market is doing and not have rigid expectations based on a cycle's past history. In any case, the possibility of an extended corrective period before the resumption of the long term decline is very real and bears considering until the market reveals its intentions more clearly Actually, the entire move from August 2005 has been a series of corrective waves, and this would simply be a continuation of that pattern.
Now, let's look at a few charts. The first one is the long-term weekly chart of the SPX which seems to bear out my last statement. The up-channel is drawn with Andrews pitchfork and it has contained prices perfectly for the past 2 years. Market activity has simply moved from the top of the channel to the bottom. The red line represents the mid-point of the channel and it acts as a support line when prices trade above it, and as resistance when they are below. There is no reason to expect this to change, and even if the 1280 level is penetrated over the next few days, prices will quickly encounter the mid-line resistance.
Let's now scale down to a daily chart. Here, we see that if it keeps moving up, the SPX will soon run into resistance from two other sources: 1) The parallel to the lows drawn across the top, and 2) A line which is parallel to the mid-channel line drawn across some previous lows. This line acted as support on three occasions during the period of July to September of 2005, and as resistance to the move up from the June 14 low. I think that this proves its validity. The fact that it converges with (1) just above the current price level signifies that the index is going to have only a limited advance from this point on.
This is borne out by the two indicators below the chart. The top one is a momentum indicatorwhich is now well into the overbought area, as well as at the very top of a rising channel. The lower indicator is even more revealing; this is an A/D oscillator, and it is clearly exhibiting negative divergence.
Note also that the 10-week cycle is ideally scheduled to make its low in the next 1-2 weeks, and the 6-week cycle should also bottom during the same time frame.
Finally, scaling down one more time, let's consider the hourly chart. First, I am going to post the index chart, and below it, a chart of the hourly A/D.
The chart spans the entire time period from the June 14 low to the present. There seems to be little doubt that it is a flat which is in the last stages of completion. We are clearly in a 5-wave diagonal pattern since the early July low and about to complete the 5th wave of "C". Only a powerful thrust upward next week could negate this pattern.
The momentum indicator below has made several trips in and out of the overbought area, and is overbought once again, but has not yet given a sell signal.
Now let's look at the hourly A/D chart. I am a firm believer that any price trend must be confirmed by the A/D to be valid, and that the hourly A/D is one of the best indicators to signal an imminent short-term reversal. Note how the July top was predicted by negative divergence on the raw data as well as the two indicators below. Also, positive divergence occurred on 7/18. Right now, the bottom oscillator is beginning to flatten at a lower high, but the raw data at the top was still in a strong uptrend on Friday and needs to show some negative divergence. I interpret this to mean that a short-term top is likely to occur in the next few days. When the decline begins, all the uptrend lines will have to be penetrated to the downside if the move is to be of any significance, and a down channel will start forming. In fact, it is already forming at the top of the raw data and in the lower oscillator.
There is also data from at least two other modalities which support my belief that a short-term top will be made next week.
The market as a whole is fragmented. The various indices are at different stages in their downtrends and some still appear to be in the process of making their 4-year cycle low, while others may already have done so. This is obvious in the next two sets of charts.
Please notice that, for the short term, the NDX may have halted its decline and may have begun to keep up with the SPX. In fact my point & figure chart of the QQQQ suggests that the 36 level is probably as low as it will get for a while, although 35 is still a possibility. This corresponds roughly to the 1450 level of the NDX. While still lower levels are indicated, they may not come for quite a while.
Also, the Russell 2000 appears to have begun to diverge from the SPX. We will know better when the next pullback occurs. I would not be surprised if that index made a new low. The RUT is another indicator which tends to lead the SPX, so it bears watching.
Finally, take a look at what happened to the Transportation index in the last couple of weeks. This has created a tremendous disparity of trends between that index and the Industrials which will undoubtedly have some significance in the future. But for now, it does not seem to have had much of an effect on either the Dow or the overall market.
The market as a whole is fragmented and it appears that individual indexes are reacting individually to the bottoming action of the 4-year cycle.
The SPX and some others appear to be completing a corrective pattern that started at the June 14 low. What happens in the next couple of weeks will determine whether or not this is only a short pause in the resumption of the bear market downtrend.