A 3-dimensional approach to technical analysis
Cycles - Breadth - 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.
Long-term trend - The Dow Jones Industrials are deviating from their typical decennial pattern in an election year. Important cycles going into the Fall could be the reason for this, but one also has to consider the possibility that the downward pressure from the 120-yr cycle, which is due to make its low in 2012-2014 has began to take effect and that October 2007 was the top of the bull market. This is not yet confirmed.
SPX: Intermediate trend - The initial phase of the intermediate correction came to an end on 3/17 at 1257. After a tentative uptrend to 1440, the index is now in the process of testing its March low and expanding its base.
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.
Overview
By trading below its January low last week, the Dow Jones Industrials are deviating from their normal Decennial pattern in an election year. The Dow Financials and the S&P100 have also broken to new lows. This could be a cause for concern, and one has to consider the possibility that October 2007 was a major top instead of intermediate. However, the fact that the other indices have not joined in and some have remained relatively quite strong should prevent us from jumping to that conclusion too soon, especially with the current correction probably due to come to an end by early next week.
The strongest indices continue to be the Dow Jones Transportation Index, the Nasdaq 100, and the Russell 2000. The Dow Transportation alone should raise some caution about calling for a bull market top; it made a new high in May of this year which was unconfirmed by the Industrials but, according to the Dow Theory, by staying well above its January low in this correction, it is not confirming the start of a bear market . Since we cannot decide at this time whether or not we are in a long-term downtrend, let's concentrate on the intermediate term.
The decline currently underway is most likely within a day or two from making a low and reversing. Short-term cycles along with a large cycle are causing this weakness. The shortterm cycles are ready to reverse in a couple of days, and only the type of rally we get from here will tell if the longer cycle has bottomed as well. Most of the time, it makes its low later in July and this would be a little early.
As we will see later on, breadth and sentiment are also telling us that we are near the end of a decline, but not necessarily near the end of the correction which started last year. It could go into the Fall.
There is no question that a good part of the market decline is directly correlated with the rising price of crude oil. We had a small proof of this on Friday when, after crude made a new high and the SPX a new low, a small drop in the oil futures caused a 12-point rally in the S&P. If we are near an important reversal in the stock market, it would be logical to expect oil futures to be heading in the opposite direction.
What's ahead?
Chart pattern and momentum:
From the last newsletter: The fractal similarity of the patterns underscored by a heavy light blue line on the daily SPX chart below continues and is now becoming more and more apparent. There is a good chance that it will last to the very end, since the current decline is anticipated to persist into the end of the month.
The patterns are not exact, but they are certainly very similar, and if we get a reversal at the anticipated time, one will have to wonder if they will continue with a strong rally, followed by another decline. The odds are pretty good considering the cyclic configuration, not only short term, but into the Fall as well. Let's not get into a mind set that the forthcoming rally and decline will be both of similar intensity as the ones which took place late last year. It will be interesting to see if this similarity of patterns continues, but we are not going to base the crux of our analysis on it.
We'll analyze the cycles a little later on to show that it is unclear whether we are only making a short-term low or putting an end to the intermediate trend at this time, but we are at or near some sort of low.
The chart pattern of the SPX makes this ambiguous, as well. Note that since the secondary high at 1440, the decline began at an angle of descent which became steeper as it went along. This created two distinct channels. The red channel contained the price for a while, until it started dropping into the steeper blue channel. The coming rally will probably take the price pattern out of the blue channel, but not necessarily out of the red channel. If we fail to break out of it, this decline could be extended.
The imminence of a rally is signaled on this chart by the position of the two indicators. The MSO is oversold and beginning to show some positive divergence to price as it crowds its downtrend line. The divergence in the A/D indicator is even more pronounced. To signal a reversal, both indicators will have to break out of their trend lines and start an uptrend along with the index. The strength of the rally will be determined by the ability of the SPX to break out of both its blue and red channels.
If the index does not trade outside of its red channel, it may signify that the larger cycle has not yet made its low.
Cycles
There is a cluster of 4 short-term cycles bottoming over the next couple of days. Since they are unlikely to make their lows exactly at the same time, we may have a little bit of base building in this time frame and around this price level before starting a rally. They have been driving prices down with the help of a larger cycle behind them -- the 2-year cycle -- which may or may not bottom at the same time. Since it would be more typical for this cycle to make its low 3 or 4 weeks from now, it could mean that this is only a short-term low to be followed by another later on.
The weakness which has resulted from this decline makes it improbable that we will be ending the intermediate market correction at this time. With the 6-yr cycle bottoming in the Fall, there is a good chance that it will continue until then before a potential resumption of the bull market.
Projections:
The price projections given for the SPX in this letter continue to be accurate. Two weeks ago, when the index was at 1360, I wrote the following:
After the decline resumes, the projection for the new low will be somewhat dependent on how far up this rally goes. Right now, about 1300 looks likely, but if there is a climactic bottom, 1278 or a little lower could be reached.
In the last Week-end Report to subscribers, I re-iterated this forecast:
The red horizontal dashed trend line represents an important support level. It was slightly violated on Friday and, if the index rallies strongly right away, it will probably be a false break. If, however, we go down to about 1304 before rallying, it will represent a more serious violation of that level, and if the 2-yr low comes at the end of the month, it will have triggered a projection zone for that low ranging from 1254 to 1278 with a preferred target of 1263 (horizontal line).
Last Friday, after reaching a low of 1272, the S&P 500 closed at 1278.38, and the target range has been slightly adjusted to 1252-1277. Since the final low may not come until Tuesday, we could dip farther into the projection zone before making a reversal.
Breadth
The McClellan Summation Index has continued to correct and is approaching its former lows. Since the McClellan oscillator is diverging from the price and will probably become positive before long, it is unlikely to go much lower. The RSI also confirms that it is oversold. This is consistent with our expectation of a market reversal early next week.
On Friday, some positive divergence developed in the hourly A/D indicator, signaling a possible reversal to continue on Monday. If it occurs, it is likely to be only a bounce since the favored time for a low is on Tuesday.
Market Leaders and Sentiment
GE is following the financial index which is very weak. There is no sign that either the stock or the index is ready to start an uptrend of consequence at any time soon. Can we continue the bull market without the participation of the financial and banking stocks???
On the other hand, the Nasdaq 100 is still one of the strongest indices, along with the Russel 2000. As long as these two indices remain healthy, I think that we are safe in thinking that this is only a selective intermediate decline and not a bear market. If they should begin to show real weakness, watch out!
There are several sentiment indicators which are calling for a low: The 4-wk moving average of the AAII Bull Ratio has dropped back into bullish territory, as has the Investors Intelligence index. My interpretation of the VIX also calls for an imminent low.
Summary
The decline from 1440 should come to an end within a couple of weeks and make another important low which will probably turn out to be a successful test of the March bottom.
The above was written a couple of weeks ago, and we have arrived at what should be at least a short-term low in this time frame. However, the weakness in the Dow Industrials and the financial sector makes it likely that the correction will extend into the Fall.
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