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Is the "Correction" Nearly Over, or Are We Beginning a More Serious Decline?

Words like "bull market, bear market, secular, cyclical, consolidation, correction, test of highs and lows, etc..." are frequently used to describe stock market behavior. That's fine! But they do not explain why this behavior occurs, and if we do not understand the underlying cause of this behavior, we will be prone to assess incorrectly what follows.

My basic premise is that stock market moves do not occur by whim or by chance, but are the result of a fundamental and orderly universal rhythm which we can observe but do not fully understand.

-- Stock market fluctuations, large and small, are the result of regular cycles of different periodicity.
-- Price progresses through Fibonacci relationships.

This observation is tremendously helpful in predicting stock market moves accurately. As an example, let's take where we are, how we got here, and, most importantly, what should come next.

Cycle analysis: The 12-year cycle -- of which the 4-year cycle is an important component -- bottomed in October 2002, causing a sharp decline into that period and a powerful rally after it had made its low. However, this low was shortly followed by the bottoming process of another powerful cycle, the 120-week cycle. Since prices held above the former lows, this was viewed by conventional analysts as "a successful test of the lows", and the combined action of these two powerful cycles produced the rally which has brought us to the present. This "mini-bull market" may not yet have run its course, but could extend into 2005! How the future unfolds depends on how much weakness is brought about by the action of the 10-year cycle which is scheduled to make its low in the next few months.

More recently, an important intermediate term cycle, the 9-month cycle finally topped out on 3/05 (SPX) and made its low on 3/24. This was followed by a powerful short-term rally. However, as stated in the last update, "Another potentially important cycle is due to make its low in about 4 weeks. I do not believe that this "correction" will see a new low by that date, but it may! After that, it will be clear sailing into the final top." (of this move)

The cycle referred to is the 60-week cycle (the half span of the 120-week cycle). Its ideal low is next week, exactly 60 weeks from the March bottom.

Caveat: Cycles routinely "fail" when they are overwhelmed by a longer-term, more powerful cycle which is moving in counter trend. This is why the 10-year cycle will play an important part in what lies ahead.

Fibonacci: Fibonacci ratios can provide important clues as to both the timing and extent of a move, in either direction. As stated in an earlier report, the current stock market high came very close to a .786 retracement of its former decline for the Dow, and a .486 (50%) retracement for the SPX. Also, the retracement from the top caused by the 9-month cycle stopped at .382 of the length of the second price wave which began in July 2003.

Besides retracement ratios, there are also ratios which apply to a move progression (new highs and new lows) which can be useful in determining the strength or weakness developing in a market.

And finally, besides Fibonacci price ratios, there are also Fibonacci time ratios, which can also be of help when used in conjunction with other technical considerations to identify turning points.

So, what conclusion can we draw from the above analysis?
1) The fact that the 9-month cycle topped out so late in its phase and provided so little price correction is in itself evidence that the long-term cycles (12-year and 4-year) are not weakening, as yet. At some point, the 10-year cycle, which is due to make its low in the next few months, will assert itself, but it is unclear if it is presently beginning to do so or if this will be at some time in the future.
2) More proof of strength is provided by the fact that the "correction" has only been able to achieve a .382 retracement of the second wave from the March low. Any technical analyst knows that the 50% retracement of a move is normal in a trend. Anything less or more than that is a sign of market strength or weakness.

So as of now, at least, there has not been any sign of significant weakness developing in the market trend, but only of a stop in the upward action caused by the two cycles mentioned above.

And when will the "correction" end? Turning to conventional technical analysis, as of the close of Friday, the hourly chart indicators are showing very strong positive divergence. Positive and negative divergences are always the precursor of a trend change, so we are probably very close to experiencing a very short term rally. Positive divergence is also beginning to appear in the new highs/new lows daily index, but not in the McClellan oscillator (Advance/decline) as yet, although this is not a necessary prerequisite for a rally. And the QQQ, which normally leads the SPX is still at best neutral with regards to the SPX. So the total picture suggests that a little more basing action may be required before the up trend can resume.

Stock market analysis is always a work in progress. It is analogous to a never-ending T.V. detective series in which previous episodes provide important clues concerning the unfolding of the plot. One must decipher the often misleading clues correctly in order to assess what will transpire in the following episodes. Where the stock market is concerned, cycle and Fibonacci analysis, supplemented by convention technical tools is, in my opinion, the best way to assess what lies ahead.

Gold: The commercial traders were, once again, correct in identifying an important top in gold. Now, having covered a sizeable portion of their short positions, they are suggesting that a rally in gold is imminent. This is also confirmed by the action of the dollar which has come very close to fulfilling its previously stated short term target of 92 and which may still reach it. A pull-back in the dollar would benefit gold. However, significant long-term damage has been done to the up trend in gold which will, at the very least, take time to repair, but more importantly suggests eventually more decline ahead. This would coincide with the dollar rally extending into an intermediate up trend, which is a real possibility.

Several reputable analysts are calling this action a major top in gold. I believe it is still a little too soon to make this kind of prediction.

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