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
If you have been reading past issues of this newsletter, you know that I have been expecting some important cycles to make their lows toward the end of June or in the first week of July. The following is an excerpt of an email addressed to subscribers on the evening of 7/7:
Today's market action had all the earmarks of a cycle bottom and this could be the low of the 72-week cycle. When a long cycle makes its low, it usually does so in climactic fashion which may or may not be associated with a negative event, beginning the day very weak, stabilizing, and closing higher for the day. This behavior is known as a key reversal. Today qualifies as a weak key reversal. The A/D finished positive, but only mildly so.
Just in case there is a follow-through tomorrow, what would it take to confirm the low?
-- Moving and closing above 1206 on hourly and closing A/D of 1500+, and with daily volume in excess of 2B.
If this is accomplished, the first projection would be 1212/1220.
If we move above 1220, it would trigger higher projections of 1229/1241.
Thursday 7/7/05 was in fact the low of a decline which began on June 30th. Since then, the Russell 2000 and the Wilshire 5000 have made historic highs, and the S&P500, the Semiconductor Sector Index (SOX) and the Securities Broker Dealers Index (XBD) made new 2005 and bull market highs. All the indices generally participated in the euphoria to some extent, but the Dow Jones Industrials and Transportation Indices were clearly laggards.
Volume never did expand significantly during the rally, and breadth was supportive only for the first couple of days, and has since ranged from mediocre to negative.
Gold and the dollar could not decide which way to trend, and oil may be building a top.
Current Position of the Market.
SPX: Long-Term Trend - The bull market which started in October 2002 is now nearly three years old and it would seem unreasonable to expect a dynamic new up trend to develop at this time with the 4-year cycle low expected in about 15 months. However, the Decennial pattern has an unblemished history for the past 125 years, and if history repeats itself, the Dow Jones industrials and the S&P 500 will be higher on December 31st, 2005 than they were on January 1st.
SPX: Intermediate Trend - The current rally does not look like the beginning of a new trend, but rather the extension of the one which began in May.
SPX: Short-Term Trend - After a brief correction, the short term trend turned up and had a 5-day rally which appeared to be running out of steam by Friday.
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.
Daily Market Analysis: If you would like to receive an explanation of how I arrive at buy and sell signals and sign up for a free 6-week trial period of daily comments, please let me know at email@example.com
The ambiguity which existed two weeks ago still prevails. In spite of all the apparent market strength, indicators are still giving mixed signals. Let's see if we can get some clarity by examining various aspects of the market:
Cycles: The anticipated low of the 120-week cycle seemingly took place 122 weeks from its March 2003 low. Close enough!
The 72-week fractal (360 trading days) which was illustrated on one of the charts two weeks ago, also came in within one week of its normal span. You'd think that two cycles of this magnitude bottoming precisely at the same time would create a lot of selling, but they did not! This should be seen as a sign of strength, because it represents extreme right translation. On the other hand, after the cycles made their lows, one would expect a sustained up trend to develop. Instead, by the end of the week things were beginning to look a little toppy. We will see later that there is an explanation for this.
Cycles make up the structural frame work of the stock market, but they do not tell us ahead of time how much strength or weakness will take place after they have reversed. This depends on other factors, and their influence on prices should be assessed through technical analysis. One of the best tools for this is the McClellan oscillator.
Breadth: Two cycles of this magnitude reversing at the same time should have caused strong positive breadth This did this not happen, and by the end of the week both the A/D and the NH/NL statistics looked rather bleak! The McClellan oscillator never did support the trend reversal and it suggests that more consolidation lies ahead.
The NH/NL did not fare much better, going from an 18-week recovery high of 472+ last Monday to a mere 98+ on Friday. This sudden loss of momentum is a red flag and, since it looks as if a short-term top is forming, a downtrend beginning on Monday would have an additional negative impact on these two indicators.
Buying/Selling pressure index: This is an indicator which I developed a few months ago and only recently refined to increase its accuracy. I now consider it to be my best leading indicator, and when it is supported by the action of the A/D, it is nearly infallible.
The hourly BSP index normally gives warning of a trend reversal several hours ahead of time. Last Tuesday, it began diverging significantly from the price action, thus signaling that we were approaching a short-term top. Friday's reading suggested that the SPX was not yet ready to resume its up trend.
The daily BSP index is best used in conjunction with the RSI and the McClellan oscillator, and is capable of signaling a reversal two weeks or more in advance. As of Friday it is still positive. I would be more concerned with the poor showing of the breadth indicators if the BSP index also turned negative.
RSI (relative strength index): The RSI has two important functions. It gives an indication of market momentum, and also signals when the market is overbought or oversold. By Friday, the SPX hourly RSI had lost some of its upward momentum, but was still overbought. The QQQQ RSI has been flat against the top of its range for 5 days. This indicator confirms what the others are telling us: We need to correct before we can move higher!
Projections: With the SPX rising to 1233 at the top of the rally, the price projections which were mentioned in the first paragraph above have essentially been met. In my Closing Comment to subscribers on Thursday, I wrote: The SPX is getting ready to try to overcome the 1229 level one more time but, still being over-bought, it may need to pull back a little more before it can do this successfully. Eventually, prices should make it to CA 1241. After Friday's action, I believe that the market requires additional consolidation before that level can be reached, but this could turn out to be only be an interim target. If the SPX makes a decisive penetration above 1229, this would trigger valid projections between 1254 and 1286
On Friday, after a couple of days of consolidation, the SPX tested its 1233 high but could not move above the March high of 1229. Furthermore, the QQQQ's action looked climactic when viewed on a 5-minute chart. This normally happens when a projection is reached, and there was a phase projection to 39 which the QQQQ touched late in the day on Friday.
Structure: I will let the EW experts sort out the exact labeling of the current structure. What I notice, is that the SPX has formed an up channel which begins in April, and the current rally came very close to the top of that channel. Since this also corresponds with the March high, it is logical that resistance should met in this area, especially with both the daily and hourly RSI in an overbought condition.
The up-trend which started on 7/7 formed another, smaller channel whose top was also reached on Thursday. A pull-back to the lower trend line of the smaller channel is likely and would bring prices back to about 1215.
How the SPX resumes its up trend after this pull-back will tell us if we can expect higher prices right away or if more consolidation will be required. If we are to resume the up trend fairly soon, it will be important for SPX to hold above its recent low of 1183.55.
Leading Indicators: Although they show various degrees of strength, leading indicators are all in intermediate up- trends. The XBD is by far the strongest, but the SOX has had an excellent rally, something which was essential if the Nasdaq is to make further upward progress. The banking index also had a good rally, but it is still somewhat lagging. In spite of its recent sell-off even GE is still in an intermediate up-trend after finding support at the bottom of its up channel.
The Decennial pattern: In the past, I have mentioned the decennial pattern a number of times. Since 1880, the 5th year of the decade has always been a bullish year for stocks, and has produced an average gain of about 31% for the Dow Jones Industrials. The worst performance was in 1895 with only a little over 1% gain for the entire year. The strong tendency of stocks to be bullish in years ending in 5 is as good a reason as any not to expect a market top at this time.
The first chart is that of the daily SPX. It shows very plainly why prices are meeting resistance at this level which marks the former high in March, as well as the top of the current intermediate channel.
The second chart is an hourly chart of the SPX which demonstrates that the current rally has created a shorter term channel whose top also coincides with the top of the intermediate channel. Please note that on both the daily and the hourly charts, the RSI is still overbought.
The third chart is a weekly chart of the Russell 2000. Having completed a 5-wave pattern from the October 2004 low followed by an a-b-c correction, it looks as if this index is just beginning a new up-wave. This chart also belies the notion that we are in a "secular bear market".
Finally, I am including a graph of the hundred year history of the decennial pattern for the S&P 500, from 1885 to 1985. As you can see, every 5th year has been up and this was also the case in 1995. With a perfect record of 12 consecutive decades, I am not prepared to bet that 2005 will the exception, unless, of course, there are technical indications to the contrary.
With two important intermediate term cycles making their lows a little over a week ago, there should be higher prices ahead.
Also, considering the history of the decennial pattern which shows that the 5th year of each decade has never failed to be bullish, the Dow Jones Industrial and the S&P 500 should end the year higher than where they started.
The action of the McClellan oscillator is a bit of a concern which will bear watching closely in the future
In the short term, the action of various indicators suggests that some additional consolidation will be required before the market can make further upward progress.