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What Cycles Say About a Break in Equities

Originally published August 15, 2012

Since early June, we have said we thought equities were in the process of turning downward, and we continue to see evidence for that in several places. Our newsletter this week reviews some of the evidence for this view and suggests ways bearish developments in equities are likely to affect currencies, bond markets, and precious metals.

This week, for SafeHaven readers, we want to highlight a few of the methods we are using to assess strength in equities markets -- an examination of cycles, cycle/price divergence, and the commodity channel index.


NYSE Composite approaches resistance

With the chart of the NYSE Composite Index, below, one of the first things that stands out is that there has been a series of lower highs since last year. Next, the decline from the high of earlier this year appears to be a five-wave sequence, followed by an upward correction that is approaching the 76.4% Fibonacci retrace level at 8,070, as well as a trendline that is likely to provide resistance.

NYSE Composite Index (NYA), weekly bars
NYSE Composite Index (NYA), weekly bars
Larger Image

Perhaps the most interesting thing to pay attention to with the NYSE is the way it is behaving with respect to its approximately 15-month cycle, the indicator for which is shown by the oscillating dashed line at the bottom of the chart. In a bullish market, price peaks generally extend later in time than the ideal cycle peak, as was the case until mid-2011. In a bearish market, price peaks typically arrive earlier than the cycle would predict, and that seems to have been the case with the price high that occurred last March. The current rally that began in June appears unlikely to challenge the March high on a timeframe that matches the cycle indicator.

With the NYSE, the 15-month cycle is now pointing downward. Another cycle (not shown) drawn from price data since 2007 would predict a high this month, also followed by a decline. In other words, both of the cycles that have been working recently with the NYSE say it is time for a downward turn.

Still more evidence for a weakening market can be seen in the Commodity Channel Index (CCI) oscillator at the bottom of the chart. Despite the sharp rally from June, the CCI has remained almost flat. Any drive for sustained higher prices is diminishing.

The Commodity Channel Index is a good tool for assessing the strength behind an observed price trend. It compares the magnitude of recent daily or weekly price changes against the average of price changes during a longer look-back period. While it usually is not precise enough to give "go long" or "go short" signals on its own, it can be one of several signals that a trader might watch to trigger a trade. In addition to divergence between the CCI and price, the CCI also provides a signal when it crosses above or below the zero line.


Russell looks even weaker

The Russell 2000 Index shows even more pronounced signs of weakness. As with the NYSE chart, there was an early price peak with respect to cycles, and the CCI is shows that upward pressure is faltering. Whereas the other major indexes are making retraces toward their spring highs, the Russell thus far has been unable even to beat its July high. A break of the lower channel line shown on the chart could lead the index to seek a much lower support. A weekly close beneath that line would be seen by many as a signal that support has broken.

Russell 2000 Index (RUT), weekly bars
NYSE Composite Index (NYA), weekly bars
Larger Image

For replicating this chart, the fork tool is handy, but it is not essential. The lower channel line on the Russell chart is the same as a trendline drawn to connect the two lows. The dotted line below that represents a doubling of the channel width, and it would be an additional place to watch for support.


Other markets

Other indices and futures markets we chart in this week's edition of the Market Outlook newsletter include the Global Dow, Nasdaq 100, 30-year treasury bonds, the U.S. Dollar, the British Pound, and gold. An introductory sample of the newsletter can be requested at our website.

 

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