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The Probability Favors A Large Pullback
I don't usually write a title for my updates but this time I do write one:
THE PROBABILITY FAVORS A LARGE PULLBACK
If in the last two weeks you have been reading my daily SPX updates you must be aware that I am confident that price is on the verge of concluding an Ending Diagonal. This Ending Diagonal will bring to an end the up leg off the November 16 low and it will open the door to a significant retracement without endangering the intermediate up trend, since if my long term count is correct there is still one more pending up leg that should be in charge of completing the wave (X) off the 2009 lows.
In addition to the potential ending pattern sentiment, breadth and momentum indicators are providing the necessary components for an overdue pause
So lets review some breadth and momentum indicators:
In the breadth front:
- Summation Index: During the second week of February it has issued a sell signal by crossing its 10dma. Despite price has kept grinding higher the sell signal remains in play. This long- term gauge of the momentum of market breadth is raising a yellow flag, as the pace of the declining stocks is greater than the advancing ones. This is a troubling sign for the bulls; since if/when the McClellan Oscillator turns negative it will bring the Summation Index down.
- The weekly stochastic of the Summation Index during the last week of January it has issued a sell signal. This sell signal also remains on. Usually when the weekly stochastic is overbought and triggers a sell signal it opens the door to a multi-week pullback. The next buy signal should occur when the stochastic drops to the oversold zone.
- The McClellan Oscillator has been clearly diverging from price since the beginning of January, while SPX has been advancing to new highs the Oscillator has declined from its January's peak. On Friday it broke the short-term trend line support and it has dipped once again below the zero line. Next week if the SPX Ending Diagonal is almost done (It needs the last wave up) then the McClellan Oscillator should establish a lower high below 5.61 On the other hand if the Oscillator breaks to the upside above 5.61 then the Ending Diagonal option will be jeopardized.
Lets now see that not only we have a potential sell signal but we also have negative divergences:
- The NYSE % of stocks > 50 dma has been falling since its January peak.
- The NYSE ratio of New Highs/New Lows is also in a downtrend since the January's peak.
- The NYSE 10dma Adv-Dec Volume is also in a clear down trend (This is a sign of distribution).
Regarding the momentum, the picture also favours the bears:
- RSI has a negative divergence since its January's peak. If price is going to embark in a multi-week correction I expect the RSI to drop towards the 50 line.
- The bearish cross issued by the Stochastic on February 13 remains in place. Here a meaningful retracement should carry the Stochastic into the oversold zone (Below the 20 line).
- The MACD bearish cross issued on February 4 remains on.
Breadth and momentum indicators are suggesting that the up trend from the November lows is in in its late stages. Naturally the stock market can keep rallying with a waning breadth/momentum but the odds are clearly favouring a retracement.
Lets move on to the charts.
First a reminder of my preferred long-term count: With an Ending Diagonal which is assumed to begin at the June 2012 low price could complete the Double Zig Zag wave (X) off the November 2008 lows establishing a major top. Once the wave (X) is in place, EW wise, odds are very large that a downward wave (A) could move back towards the October 2002 / November 2008 lows.
1530 = September 2000 peak is the next immediate resistance.
In the next weekly chart I show you the Ending Diagonal project.
The current wave (III) could extend up to 1551.12, but lets suppose that in the area of 1530 it establishes the top. If this were the case the next directional move would be to the down side with a potential target for the wave (IV) in the range 1463 (Horizontal support) - 1442 (20 wma). Therefore the correction could last into the end of March before price should attempt the next and probably the last rally.
Next in the SPX weekly chart below we can see that bulls have achieved 7 consecutive weekly higher highs. The last one has formed a potential bearish Spinning Top at the trend line resistance that connects the April - September peaks. If next week bulls achieve another higher high we have two potential reversal areas: 1530 and the upper BB = 1534.
I can raise the pivot support at 1513.61, when/if it is broken it should kick off a correction towards 1474-1442 (If the Ending Diagonal is the correct pattern price has to break through 1474). A mean reversion to the 20 wma = 1442 is not a preposterously target.
Next in the SPX daily chart we can see the potential ending pattern, which should still need the last wave up, but we cannot rule out a Double Top. Above last Wednesday's high we have the upper BB at 1528.
Below the pivot support we have all the major critical support obstacles that bears will have to reclaim. The most important one is at 1474.51, which will have to be breached if the Ending Diagonal option is the correct pattern.
Once/if we have the top of the November up leg we will have the Fibonacci #, in the mean time if the meaningful correction is in the cards lets establish two potential targets for the assumed wave (IV):
- Rising 50 dma (It is rising) = 1467
- Range 1451- 1442
Lets now move to the shorter time frame where I show the Ending Diagonal project.
Friday's down leg is corrective hence, in my opinion the probability of a Top is slim, instead in my opinion from the top of the wave (III) price has unfolded a Double ZZ (Flat) wave (IV), hence there is still a pending wave (V) up. Technically the pending wave (V) can extend up to 1540.63 (I doubt it). As discussed above the range 1528-1534 could be the candidate for the pending top, but here there is no rule, sometimes the perfect wave never comes hence I remain open minded as even a marginal higher high or a Double Top can occur.
I have the greatest interest in looking for a short set up in NDX. The reason is based upon the scenario of a potential Triangle that I discussed in the weekly update posted on January 27. If by any chance the Triangle pans out then the November up leg could be almost fully retraced with the wave (E).
I am not sure if NDX is also involved in an Ending Diagonal which would imply a top with only a marginal higher high, but I will monitor closely next Wednesday if the pattern pans out, in which case I will go long SQQQ.
Next week bears need fear and a flow into bonds (Risk Off).
Regarding VIX, despite Friday's marginal lower low the Double Bottom pattern is still valid but Friday's Doji candlestick (I would have preferred a Hammer) means indecision, in addition despite being oversold the stochastic has not issued yet a bullish cross. Hence there is no assurance that VIX has established a bottom.
But if VXX is on the verge of concluding a downward thrust out of a triangle with a bullish falling wedge, which would be aligned with the pending wave (V) up of the SPX's Ending Diagonal then an upward thrust would be guaranteed.
This pattern can offer a swing long set up either at the lower trend line of the assumed wedge (riskier) or once price breaks above 22.47.
Regarding the other risk off trade and using TLT as a proxy for the bond market, here we have an interesting set up that auspicate a "large" (Depending upon the intensity of the equity pullback) wave (B) rebound.
If the count that I am working with is correct, price should have completed last Wednesday a Double Zig Zag wave (A) with two exhaustion gaps out of a Triangle. In addition we have a Double Bottom reversal pattern if price breaks above 117.59.
The DB has a target at the 50 dma in conjunction with a gap at 119.67, but I would not rule out an attempt to fill the January 2 gap down (Fiscal Cliff "kicking the can" announcement).
Here I will analyse the entry point for a long set up with TMV.