A 3-dimensional approach to technical analysis
Cycles - Structure - 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
Although this newsletter has been published every two weeks since the first of the year, the recent market action warrants an interim edition.
A Review of the Past Week
Last week's newsletter started with this paragraph: The decline which began on 3/07 has come to an end -- at least temporarily -- for all indices except for the transportation index which made a new low on Friday. All other indices are trying to get back into an up trend. Friday's weakness is not significant unless it intensifies this coming week and threatens the 1168 low of the SPX. Well, things got worse, much worse! Not only was the SPX 1168 penetrated, but by week's end, the index closed on its low at 1142. In the What's Next section, I also stated: By stopping at 1164, the SPX has only retraced .382 of the up trend which began last August. A 50% pull-back is considered a normal correction and we could still see the decline extend to 1144 later on. At the close on Friday, even that level was penetrated and it very much looks as if we could go all the way to 1124 before the short-term trend can be reversed.
I'll cover this in greater detail later on.
According to Yahoo Finance's Market Update, "The Dow recorded its first third consecutive triple-digit loss in over two years". All the other indices joined in and some of the marginal positive signs that existed were wiped out, but others actually improved.
Most of the decline occurred during the past three days, with the advance/decline averaging about -1600 per day, and the NH/NL index also showing weakness, but not proportional to either the price decline or the A/D figures.
Gold is trying to stabilize, but oil continued its decline as the May contract touched $50, over 8 points since its recent top.
Current Position of the Market.
SPX: Long-Term Trend - The long-term trend turned up in October 2002 in conjunction with the 12-year cycle. It is now reinforced by the 10-year cycle which turned up in the Fall of 2004. A top is likely in late 2005 or early 2006, although the recent weakness in the stock market may be a warning sign. This will be discussed below.
SPX: Intermediate Trend - The intermediate trend which started in August 2004 is undergoing a correction and is probably going to find support, at least temporarily, after a .618 retracement of the up trend which started in August '04.
SPX: Short-term Trend - The short-term trend could not move above the critical 1191 price level before wholesale selling took over. It is still down but may reverse at 1125 for the reasons given below.
Because of market volatility, the short-term trend is better analyzed on a daily basis with the help of hourly charts. This is done in our daily market updates and Closing Comments. What follows is the kind of information which is dispensed in the daily comments:
Thursday 4/14/05 Morning Comment
By refusing to go past 1193, dropping down to 1171, and having an abortive rally back to 1190, the SPX has erased all the marginal positive technical readings that were building up. It is now highly probable that it will make new lows, although new lows will almost certainly result in even stronger positive divergence patterns in the McClellan oscillator and in the daily momentum and buying/selling pressure indices.
The move from 1163.69 to 1191.75 resulted in a retracement of slightly better than .382 of the drop from 1229. This is typical of a weak counter-move if it does not extend further. Until yesterday, especially with the strong rally of the day before, there was still a chance that we could make it to at least 1197 which was the 50% retracement level. But with Wednesday's action, it's fairly obvious that any chance of this happening is gone.
The drop to 1171 and the sharp rally, was most likely the bottoming and immediate failure of the 12-week cycle. If we break below 1171 and then 1168,1164 will not be expected to hold.
Structurally, the move from 1229.11 down to 1163.69 probably represents the first wave or "a" wave of a corrective pattern, with the rally to 1191.75 being the second or "b" wave. We have now entered the "c" wave which can extend at least to 1158. However, there are two other valid Fibonacci projections. One, based on the "b" wave retracement gives us a potential zone of 1145-1155. The other, based on .618 of the "a" wave, projects the low at 1151. Since there are Point and Figure counts which support both projections, these are the levels where we should look for a completion of this phase of the correction. Of course, price targets will come into effect only if we break below 1164.
This will give you an idea of what to expect during the next week or so. I will expand on this analysis in the next Week-end report. If, by some miracle, the 1164 is going to hold, then we should have an advance warning as we approach it.
In order to clarify the technical picture, it is probably best to dissect the various technical components of the market and comment on each individually.
Cycles: The 120-week cycle and the 72-week rhythm are combining to make a low in late June. The intermediate correction is likely to last until that time, but there will be intermittent rallies, and there is an outside chance that late June will be a higher low than the low that is about to occur. Much of this depends on the structure which is currently forming. The short-term structure very much looks like we are about to complete a wave 3 of the decline which started at 1191. Decennial pattern and long-term cycles: There are some good reasons why I am still not convinced that we have just witnessed a long-term top in the markets.
One is that the 12-year cycle and the 10-year cycle are still early in their up-phase and should mitigate serious price weakness at this time.
Another is that the decennial pattern has been extremely reliable for the past century and it calls for the 5th year to make a new market high. Since this pattern is the result of the 10-year cycle action, and this cycle is only 6-months old, it is extremely unlikely that it would fail this early, especially since it is supported by the 12-year cycle which is only 3 years along in its up phase. This does not mean that this pattern is forever, and even if it survives this year, it may not in the next decade because of the long-term cycles which are due to bottom toward 2014.
A third, is that the current weakness is caused by the bottoming process of the 120-week cycle whose top waited until week 104 (CA) to form instead of week 60. This is known as "right translation", and is a sign of long-term strength (the influence of the 12-year and 10-year cycles). I doubt that the next low of the of the 120-week cycle will carry the same bullish impact that it did in March 2003, because then it was greatly influenced by the 12-year low which had just taken place 5 months earlier. But it should still carry a strong bullish impact on prices when it bottoms in June.
Structure: If the first wave down from the SPX top at 1229 is a 5-wave pattern which was followed by a flat consolidation, and if the current decline is going to end up being another 5-wave pattern, which is very probable, then the overall decline will most likely end up being a zig-zag. On the other hand, if it turns out to be an impulse wave, and that the current down trend is a 3rd wave, followed by another consolidation and a lower low into June, then we may have seen the long term top of the market. It is too early to predict this since there are still too many possible patterns that can develop between now and late June.
Correction: I have been of the opinion that we were correcting the up trend from August 2004 but instead, we may be correcting the move from March 2003. I will leave it up the EW experts to decide if my interpretation of the long term structure shown on the weekly chart below is valid. Much depends on whether June turns out to be a higher or lower low that the one which lies directly ahead and, if a new low, what the structure into that time frame spells out.
Indicators: In spite of last week's weakness, the McClellan oscillator is setting up for positive divergence. At the low of the first phase, it made a low -370 (this calculation may vary depending on the data provider) and in spite of the severe weakness of the past 3 days, the current reading is only -180. Since our first rally is probably due in the next couple of trading days, the reading will improve and make it less likely that we will get anywhere close to the lows of the first down phase.
My daily Up/Down Ratio (new name for the Buying/Selling pressure -- whose abbreviation turned out to be B/S, a not very desirable term) indicator is also making a very bullish divergent pattern by retracing less than half of its up move from its recent low point, in spite of the current market weakness. The same indicator, but on an hourly basis, closed on Friday with its highest reading in 2 days, suggesting that a short-term low is very near. There was a solid projection at 1145 which could have been only temporarily overrun.
The daily stochastic oscillator is oversold indicating that a rally can happen anytime. This is confirmed by the hourly stochastic, which is also oversold. However, the daily and weekly oscillators do not indicate a final low in the decline.
Both the daily and hourly RSI are at a level from which rallies normally take place, although both are neutral with the market, and do not now show positive divergence, which also suggests that even if we rally, we have not seen the final lows.
Projections: The deepest projection for the end of what is now clearly a wave 3 from 1191 was 1144. This was slightly surpassed on Friday but could still be a valid approximate target low for a wave 4 rally which should develop in earnest as early as Monday. 1144 also represented a 50% retracement of the up trend which started in August 2004.
As a result of the current weakness, more valid Fibonacci projections can now be made to the 1124/25 level. This also represents a .618 retracement from the August 2004 low.
If we are currently correcting the entire move from March 2003, then a .382 retracement could take prices all the way down to 1060 by late June.
Leading indicators: The XBD is currently stronger than the SPX, having retraced only .382 of its up trend since last July. It made its low in July 2004, approximately a month before the SPX, and topped out in early January 2005, making a double top when the SPX moved higher to 1229. If the action of the next few weeks is constructive, the XBD will signal an end to the decline in the averages by reversing first, as it has in the past.
The BKX is also less weak than the SPX and carries the same implication as the XBD.
The SMH has a pattern which is very similar to the XBD, and this also is bullish for the market if it continues.
GE made its low in January, did not confirm the SPX high when it moved to 1229, and has yet to break its January low.
Fundamentals: Although I normally stay away from this area, there are some fundamental areas which can greatly influence market action in the future. One is that, as a result of the current market weakness, including that of commodities, the Federal Reserve may decide to stop raising short term interest rates much sooner than is generally expected.
The other, is that the ECRI leading indicator is calling for stronger economic growth in the second half of the year. Since it has an excellent forecasting record, it seems to be saying that the current concern about economic weakness will be short-lived.
Crude oil, gold and the dollar: Oil peaked at 58, justifying our projected target for a top. It has been declining ever since, as have other commodities.
Gold, has also continued its decline and strongly suggests that the 8/9 year cycle has peaked, although this will only be confirmed with time. But the fact that commercial traders have again increased their short position as of the last report (4/12), it is clear that they are expecting lower bullion prices ahead.
The dollar, conversely, has continued to rally, which is normal since it has an inverse relationship to commodities, including gold.
An update of the SPX is provided below. The channel and trend lines on the weekly and the first daily chart are drawn according to Andrews pitchfork methodology. It signaled the end of the intermediate up trend which started in August 2004 and tells us that the correction is still in progress. It may also indicate that the up move from March 2003 is being corrected. I have labeled the wave patterns according to my interpretation of the current structure. The vertical lines show the position of the indicators vis-à-vis the price. Notice that there were pronounced divergences on both the daily and weekly chart at each important turning point.
The second daily SPX chart also shows the position of the various indicators discussed above, but the up/down ratio indicator discussed last week has been added. Note the strong positive divergence in this indicator which I have studied going back to the 2000 market top and which showed a little ambiguity only once in the past 4 ½ years. Also note that the RSI on the second chart, which is calculated slightly differently than that of the first daily chart, is neutral with price while the RSI on the first chart shows positive divergence. This chart also shows the various Fibonacci retracement points and the time and potential retracement level of the June low. If the 1060 level is not broken by then, it will be the first confirmation that the long term trend is intact.
Finally, there is a chart of GE which clearly shows its leading index properties. Look at how it preceded the strength in the SPX by about 6 months. It is also evident that GE is not showing the kind of weakness that is currently prevailing in the SPX.
The correction of the intermediate term trend which began in August 2004 is well under way and could continue into mid-year in conjunction with the 120-week cycle low and the 72-week pattern.
It is too soon to say if the current correction is that of the up trend from August 2004, or if it is that of the trend which started in March 2003.
The short term decline looks ready to complete its 3rd down wave by Tuesday of next week at the latest, with a 4th and 5th wave to go.
Completion of the 5th wave at the projected .618 retracement of 1125 shown on the chart above, would also make the move from 1191 equivalent to 100% of the first down wave from 1229 to 1164, and would enhance the interpretation of this correction, scheduled to end within two weeks, as a zig-zag pattern.