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
A Review of the Past Two Weeks
Equity indices have been in a rally mode for five to six weeks now, depending on the index. Last week saw further appreciation for some, but it was not uniform. The NASDAQ and Russell 2000 had good gains, but the Dow industrials went sideways, and GE, one of my favorite leading indicators has now been declining for 9 days. This tells me that a correction is near. I had expected a reversal to take place by the end of last month, so, from my point of view, it is slightly overdue.
The breadth indicators have remained strong but, although it has shown no weakness so far, the McClellan oscillator has not been able to surpass the top that it made 3 weeks ago. On the other hand, the new highs/new lows index is at an eleven week high.
NYSE volume has remained light at about 1.6 billion shares per day during both up and down days.
The dollar was a strong performer and benefited from the recent weakness in the Euro, trading at a five-month high ,while gold went in the opposite direction, retracing to about $414 before bouncing back in the middle of last week. This was predictable since the commercial traders have been reducing their short positions for several weeks.
Crude oil also found its footing after a 10 point decline from its $58 peak and by Thursday had rebounded to $55.
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 was reinforced by the 10-year cycle which turned up in the Fall of 2004. Unless significant weakness develops between now and the end of June -- a prospect which does not seem likely -- I have to assume that the bull market highs are still ahead of us.
SPX: Intermediate Trend - The intermediate trend which started in August 2004 is undergoing a correction which may have ended in April when prices found support after slightly more than 50% retracement. Structurally, there are several possibilities, but whatever the wave pattern turns out to be, a pull-back into late-June to early July is expected. It's only a question of whether or not some of the indices will make new lows for the year.
SPX: Short-Term Trend - The short-term trend has gone a little longer than I had expected, but a top could be made by next week.
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.
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What's Next?
Some analysts are calling for the market to continue moving up and to make a final bull market high in the middle of the year. While this is a possibility, a better scenario would be for a decline with a final correction taking place into late June, early July. This is fully justified by the current cyclic configuration, with important cycles bottoming around the end of this month and ongoing to mid-July. The same cycles, after they have made their low, should provide a final rally for all indices with an excellent chance that most, if not all, will make new bull market highs.
It is noteworthy that while the NASDAQ and SPX have exceeded their March high in this rally, the Dow Industrial, NYSE Index and Russell 2000 have not.
Structurally, I do not know how to label the move which started in mid-April, but I am fairly certain that it is not an impulse wave and it may have to be analyzed as a component of a larger pattern which began with the January high. It will undoubtedly clarify itself after a few more weeks have passed.
The breadth indicators still continue to perform well, and if they do not show too much weakness in the coming retracement, they will provide additional evidence that new market highs lie ahead.
The daily momentum indicators are very overbought and should begin to correct, and the daily up/down ratio (buying/selling pressure) index is showing a pronounced decrease of momentum (see chart below). The hourly RSI of all indices peaked two weeks ago and has been in a down trend ever since. This is negative divergence indicative of an imminent top.
The most significant warning that a long term top is in the making will be given by the weekly RSI, which is currently trying to regain its upside momentum. How it performs during the next few weeks of correction and especially afterwards should give us an indication of how much time is left in the bull market which began in October 2002.
Projections: The 1198 projection for the SPX has been exceeded, but not by much. However, this triggered a new projection to 1207 or slightly beyond. The first two trading days of next week will determine how much higher this rally will extend. If the A/D is not strongly positive and prices reverse by Tuesday or even Wednesday, this will be an indication that the top has been made. Confirmation will come if there is an hourly close below 1190 on the SPX and 37.90 on the QQQQ, preferably after a one or two-day rally.
The performance of the leading indicators has been mixed. The semiconductor index has done well and accounts for the strength in the NASDAQ. The XBD (Securities Broker Dealer Index) has also been in synch with the stronger indices. But the BKX (Banking Index) has under-performed the market since March and, along with GE, has shown a loss of upside momentum for the past two weeks.
Gold and the Dollar: Commercial traders have reduced their short positions in bullion to a level that has not been seen since February. At that time, this led to a 36 point rally in gold. With the performance of bullion in the past week, it is likely that a new intermediate trend has started. Gold has a well-defined 15 to17-week cycle and last week marked week #16 since the last cycle low.
The US Dollar also appears to have a 16-18 week intermediate-term cycle, which is offset from the gold cycle of the same length by half a span. One could therefore conclude that the dollar has seen a temporary high, and that its action of the past week was a short term "blow-off" which coincided with the weakness in the Euro.
Oil is priced in dollars, and it is possible that the current rally in crude has been in anticipation of dollar weakness, although I have not been able to find a cycle in oil which corresponds to the intermediate cycle in gold and the dollar. It is unlikely that the current strength will lead to a new high, but this could be a test of the highs with its price reaching $57 in the next few weeks before declining once again.
Charts
Since the stock market is made up of fractal patterns, one can obtain a better perspective by comparing the action of weekly, daily and hourly charts. I have included three charts of the SPX based on these time frames, and a daily chart of GE.
Beginning with the hourly chart, note how prices have traded in a tight, shallow channel for the past two weeks. This indicates a fairly severe loss of upside momentum and is confirmed by the RSI which has been in a declining pattern for the same period of time.
The lower indicator -- which cannot be synchronized exactly with the chart above and has been broken into two sections -- shows that there was continued buying into the end of the month, but it started to decline one day before the market made its high. This is a leading indicator. The current pattern makes it probable that a slightly new high will be made by the SPX in the early part of next week. This is reinforced by the breadth indicators which are still showing a good deal of strength. Also, note that the STO is oversold and should rise for at least one or two days to relieve this condition.
Finally, late Friday or early Monday will mark the low of a short-short-term cycle which should provide some lift to prices after it has bottomed. If it turns down by Wednesday -- at the latest -- it will be an indication that the longer term cycles have began to take control of the market.
The second chart is a daily chart, and it gives us a longer term look at the market action. Here, the RSI has stalled just below its overbought level and has gone flat for the past two weeks. This is also an indication of a loss of upward momentum which is made even more significant by the two indicators below. The STO has been overbought also, for the past two weeks and, just like the RSI, appears ready to break below its rising trend line.
But the most telling indicator is the lowest one. It always leads price action by at least a couple of weeks, as shown by its behavior prior to the dashed vertical lines that indicate short term reversals. It has been diverging from the price action for the past two and a half weeks.
The third chart -- the weekly chart -- shows a pattern for the past year and a half which is similar to the one that has developed in the hourly chart recently. It carries the same implication, indicating a long term loss of upside momentum and the probability that within a few months the lower channel will be penetrated and bring the bull market which started in October 2002 to an end.
The last chart is a daily chart of GE. The stock has performed better than the market during the correction which began in late December when it made a top ahead of the market, thereby giving warning of a market decline. Last month it finally broke out of its trading range, but has been losing momentum for the past two weeks while most indices were making new recovery highs from their April lows. This is short-term negative divergence and it is an indication that a short-term top is near.
The performance of this stock over the next few weeks should give us an early warning that the top of the bull market is about to take place.
SUMMARY:
Every trading day brings us closer to the top of the short-term up trend which began in mid-April, and the beginning of the end of the intermediate-term correction.
It is not clear if some (or none) of the indices will make new lows for the year, but this possibility has severely diminished as the result of recent market strength.
The next short-term low is expected at the end of June, early July, and it should usher in the final leg of the bull market which began in October 2002.
