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November 19, 2006

Turning Points
by Andre Gratian

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

Current Position of the Market.

SPX: Long-Term Trend - The 12-year and 10-year cycles are still in their up-phases and could continue to influence the long-term trend, but another substantial correction of the bull market which started in October 2002 is probably very near.

SPX: Intermediate Trend - The uptrend from June '06 is rapidly coming to an end, requiring only a few minor touches before beginning a significant reversal.

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.

What's Ahead?

The batteries of the Energizer Bunny bull market may soon need a recharge! But don't go mortgaging the house to buy puts just yet! They could have just a little bit more left in them. I'll go into that in a minute, but first, where did the recent strength come from?

Large market moves are caused by long-term cycles, pure and simple. Shorter-term cycles can be affected by a host of other conditions, but the long-term cycles are, themselves, the cause of economic, geopolitical, geophysical and weather patterns. That was the belief of Edward R. Dewey, President of the Foundation for the Study of Cycles, and there are many who agree with him.

I have frequently mentioned that the 2002 low and subsequent uptrend were caused by the bottoming of the 12-year cycle. In 2004, the 10-year cycle added its lift to the bull market. Both of these are still in their upphase and are influencing the long-term direction of prices. However, it is likely that before they get to their half-way mark, they will succumb to the downward pressure of much larger cycles which are moving nearer and nearer to their lows scheduled to occur around 2012-2014.

From May to June 2006, the bull's upward progress was temporarily halted by the bottoming of the 4-year cycle. Everyone, me included, expected this cycle to decline into the October-November time frame as it had done repeatedly over the years, but this time around it fooled a lot of analysts, and some are still waiting for it to bottom next year. Perhaps they will be right and only time will tell. But the strong and persistent uptrend which started in July could only come from a major cycle, and the 4-year cycle is the only contender to which this action can be attributed. With some notable differences, it is a small replica of what happened in 1994.

Back to the present. The end of the surge from the July low now appears to be in sight. This is particularly evident in the structure which calls for a few more minor rallies and declines before it is complete. This would suggest some sort of decelerating top pattern that could, with seasonality playing a part, extend into the end of the year. And then what? The most likely scenario would be a healthy correction to relieve the overbought condition, but probably not the beginning of another protracted bear market -- at least not right away. The next major cycle, the 7-year cycle, will not bottom until 2008, and only the 9-month cycle, scheduled to bottom about May could have a restraining cyclical influence on the market.

Let's look at some charts, beginning with the weekly SPX. The area in which the index is currently trading is an area of strong resistance because it is the juncture of two long-term Andrews pitchforks. As we can see, prices have risen above that level by a small margin, but this is probably not significant. In June and July there were minor and temporary penetrations of the bottom of the channel, after which prices reversed and continued in the opposite direction. Generally speaking, when the parameters of a channel are exceeded, it is regarded as signs of an overbought or oversold condition. In this case, if the preferred structural analysis is correct, it is more apt to signal the end of a move than the beginning of runaway prices.

The momentum oscillators at the bottom of the chart are just beginning to turn down from an overbought condition, a sign of deceleration, but not yet a sell signal.

The daily chart gives us much more detailed information. The uptrend channel is clearly outlined and as long as prices do not come out of it, the intermediate trend is intact. Within that channel, there is a green uptrend line. When that line is broken, it should cause the index to challenge the bottom of the channel, perhaps briefly pausing before breaking through.

The blue asterisks represent the lows of the 6-week cycle. The current one is responsible for providing the lift behind the latest short-term uptrend, but since it is now 1/3 of the way through its phase, it should soon begin to sputter and turn down with the next low expected in the second week of December. The level from which it started, 1361, probably represents the most critical level on this chart. If it is penetrated to the downside, it will be 99% certain that an important decline has begun.

Fibonacci projections have been marked on the chart. These are computed from the 1220/25 lows. The lowest one has already proven itself by temporarily stopping the move at 1393. The next one, at 1410 should also play a role in identifying another top (remember, we are expecting another 2 or 3 marginal moves higher to complete the structure). But these are not the only projections. Others taken from the 2002 low and from relevant points along the way also project to this general area, making it the likely level where a top should form. Earlier, I had mentioned 1400/1405 as potential prices where a reversal could occur. They should provide a temporary halt, but an extension of the move to 1420/30 would not be surprising. The value of valid projections is that they represent levels where market action needs to be observed carefully for a potential reversal, especially when they correspond with the completion of structural patterns.

Finally, let's look at the two indicators below the price chart. Notice how quickly the MSO (momentum) indicator turned down and dropped all the way to an oversold level as a result of the last correction. It is the first time this has taken place since the beginning of the move and it has now placed the oscillator in a position of negative divergence. Another downturn before reaching the top of the range should give a sell signal.

The A/D indicator below is slowly and reluctantly losing upside momentum. It is still spending most of its time in positive territory, but the thrusts are less and less pronounced. This oscillator will give a sell signal when it drops and remains below the zero line.

Next is a chart that I have not posted before. Because of its make-up, the Dow Jones Composite is one of the most important indices to track. The trend from the market lows has been so perfect that when prices break through its 3-point uptrend line, it will send a powerful signal that an important shift is taking place, especially if the recent low is penetrated. At a minimum, it will mean that we have entered a period of extended consolidation or correction. Note that here also, negative divergence is manifesting itself in the momentum indicators. This is a strong warning signal. But considering that this is a weekly chart, it would be illogical to expect both the trend line and the support level to be broken right away.

One final chart is necessary to demonstrate that we do not yet have the conditions for a final major top. As I have shown recently, several key leading indicators are lagging the SPX, but they are still in an uptrend. Furthermore, the most important one -- the NDX -- is still keeping pace. In last week's interim report I posted a chart which showed that this index had come to the juncture of two significant Fibonacci projections. This past week, it moved decisively beyond these projections. Note that this is where the NDX stopped in January, and therefore the projections which worked well then may now be "old news" and prices are seeking a new topping level. Because the NDX has historically lagged the SPX at market tops, we should be careful not to assume that it's going to be different this time. Look at the charts: no divergence!

I could post more charts, but they would send the same message: the advance is long in the tooth, the structure is almost complete, and projections suggest that we are just about there! The uninterrupted pattern of higher highs and higher lows of the SPX since 1225 and the well-defined trend and channel lines should make this one of the easiest reversals to forecast. The early bears who have tried to "guess" at the top have been severely punished time and time again. Because of the very long-term cycles that will be making their lows over the next 6 to 8 years, it is possible that when the stock market turns down it could start one of the worst and most prolonged slides in its history. But in the meantime, the trend is still up and all-time highs are being registered by some indexes almost on a daily basis. The market will let us know when it is ready to go in the other direction!

Summary:

The combined long-term cycles that have been driving this market higher have caused an overbought condition which needs to be corrected. But the topping process and eventual reversal may be labored. The SPX is reaching price levels and a time frame which make this a risky environment for the bulls. However, it is possible that the beginning of a short-term downtrend will not get underway until after the strong seasonal year-end period has past.

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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