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 may be 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 begun to take effect and that October 2007 was the top of the bull market. This is not yet confirmed and remains only a possibility.
SPX: Intermediate trend - Last week's action suggests that the intermediate trend correction has not yet run its course.
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:
The weak counter-trend rally which started in mid-July came to an end last week just ahead of the release of a not very encouraging jobs report. On Friday, the NYSE Composite made a new low for the entire decline since the bull market high of October 2007. Also notable was the weakness of the Nasdaq 100 over the past two weeks. This index tends to be a market leader and had been one of the strongest in this market correction. If it does not stabilize soon, we will have to be concerned that we are dealing with something more than an intermediate correction. On the other hand, another market leader, the Russell 2000, is faring much better and continues to be stronger than the general market.
Also offsetting the general market weakness, the financial and banking indices were the strongest, last week. This is undoubtedly due to advanced knowledge of the rescue plan for Fanny Mae and Freddy Mac which was announced over the week-end, and which caused indices to surge after hours on Friday, on top of an excellent recovery from the selling which took place in the morning. After being down 18 points, The SPX recovered all of its losses and closed up over 5 points. In after-hours trading, the SPY was up the equivalent of another 20 S&P points.
While the performance of the NDX has been disappointing lately and adds a bearish tinge to the stock market picture, if the financial stocks show that they have bottomed and begin an uptrend, this would have an opposite effect. I have pointed out in the past that the stock market was disjointed, and it looks as if we have more of the same.
Oil continues to weaken and some oil analysts are now projecting that crude could decline to about $80.00 a barrel, which should be its fair market value based on supply and demand.
What's ahead?
Chart pattern and momentum:
The rally from 1201 in mid-July came to an end last Thursday when the SPX broke below 1260. This would presume that the index is now on its way to test its low, or make a new one. However, we will need to see a little more market activity to make a decision about what is actually taking place. It's almost certain that Monday will have a strong opening. Will it follow through? What about the rest of the week?
There is no question that a short-term sell signal was given by the momentum indicator (top), but it has not been confirmed by the breadth indicator which is showing positive divergence. After the price break, the index now has strong overhead supply starting at 1260, and if its rally stops there and the decline resumes, there is a very good chance that we will see new lows or, at least, an expansion of the base which started at 1201 -- depending on how much weakness materializes in the ensuing days.
Cycles
From the beginning of the year, I have cautioned that the market correction would probably extend into the Fall. This was based on the assumption that this is when the 6-year cycle would make its low. More recently, I mentioned that we were probably also in the bottoming phase of a 7-year cycle. The market behavior over the next few weeks will depend on whether these two cycles make their lows simultaneously or if they are separated by a number of weeks. Based on past performance, the odds favor that the 7-year cycle will make its low in September, and the 6-year in October. If this is the case and the 7-year bottoms soon, it will act as a buffer against the weakness that might be caused by the other cycle, and the resulting market action would probably build a large base instead of a potential selling climax. Let's see how September goes!
The 6-wk cycle should bottom about 9/10, in conjunction with another minor cycle. The 20- week cycle is due in early October.
Projections:
On Friday, the SPX had a target of 1229 or, if surpassed, of 1220. It made its low at 1217.23 before reversing.
A close below 1234 would have triggered a lower projection, but with the strong rally and the close at 1243, it was nullified. We now need to wait for what transpires over the next few days before making a projection for the next phase down.
With the resumption of the decline, we should also remember that there is an unfilled projection zone or 1145-1180. If we break below the current SPX low of 1201, it would trigger a confirming overlapping projection of 1130-1155.
On the upside, if (as expected) 1245 is surpassed on Monday, the rally could expand to 1255- 60.
Breadth
The Summation Index (courtesy of StockCharts) has made a good recovery from its recent low, but it is still within the confines of a corrective channel and still negative. Furthermore, the RSI index shows that it is now overbought and could begin to reverse at anytime.
This confirms the market position which essentially says the same thing: The correction is not over, and the short-term trend, after completing a counter-trend rally, should resume its downward path.
If you look at the MACD of the A/D in the daily chart above (bottom oscillator), you will see that it remained much stronger than the momentum indicator in last week's decline. This means that the SPX may not be ready to resume its decline immediately and will either consolidate before moving lower, or attempt to resume its uptrend (beyond Monday's anticipated extension of the rally).
Market Leaders and Sentiment
In the last letter, I wrote the following:
The underlying market weakness is best exemplified by the NYSE Composite. Where is the rally? Mostly in the momentum indicator which is still overbought! As it corrects, is there any doubt that this index will make new lows?
The new low came on Thursday. Will the other indices follow? As I stated above, the NDX has had a rather serious spate of weakness over the last 2 weeks which has taken it slightly below its mid-July low where most indices bottomed, but it remains above its March low. If it should continue to weaken at the same rate, it would bring some concern that the decline from October 2007 is more than an intermediate correction.
This is a weekly chart of the QQQQ from its October 2002 low. After resisting breaking out of its long-term channel, it now seems ready to do so.
Short and intermediate-term sentiment indicators are moderately bullish.
Summary
From the last newsletter: "The 6-yr and 7-yr cycles are now very close to making their lows. Until they do, we cannot have a sustained uptrend, and signs are already appearing which suggest that the current rally is on borrowed time. This is illustrated by the momentum indicators of all the indices. They are overbought and are beginning to roll over."
Last week, the indicators gave a sell signal. The decline will remain in effect until the indicators are in a position to give a buy signal.
Since important cycles are in the process of bottoming, we cannot predict ahead of time how much price weakness lies ahead. The risk of a potentially significant decline will continue to exist until the end of October.
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