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
The consolidation/correction of the equity indices continues. It has been a slow price attrition affecting all indices, breaking trend lines and channel lines going back to May/June and suggesting that this may be turning into an intermediate-term decline which can last until October.
So far, with the daily volume remaining very low, this is more of a strike by buyers than a statement by sellers. But the result is the same: declining prices. However, the unpredictability of potential damages caused by hurricane Katrina, especially to oil facilities, makes the very near future unpredictable.
The new highs/new lows index remains positive, but barely, while the McClellan oscillator is giving some tentative hints of firming but it continues to trade in a well-defined down channel.
Crude oil could experience a short-term blow-off as a result of hurricane Katrina if damage to oil production facilities is not severe.
After a brief consolidation, gold appears ready to resume its decline.
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 31 st, 2005, than they were on January 1 st.
SPX: Intermediate Trend - The intermediate trend which began in May has entered a corrective phase which may be developing into a new intermediate down trend with early October as the probable low point.
SPX: Short-Term Trend - The advance which began on 7/7 peaked at 1245 in early August. The short-term trend is showing signs of finding at least a temporary bottom in the next few days. The effect of hurricane Katrina could result in a quick, climactic termination of this short-term decline.
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 ajg@cybertrails.com
What's Next?
Until the past week, there was the possibility that the SPX (and other indices) could mount a final rally to either test the highs or make slightly new highs before the decline into October resumed. But the SPX only experienced a brief, intra-day bounce when it touched its daily up-trend line before violating it. After breaking a trend line which has provided support, prices tend to stage a rebound to that trend line which now becomes a resistance line. The position of both daily and hourly indicators suggest that this is the most likely scenario, near-term.
The short-term decline is now about 4-weeks old and, as mentioned above, consists of a steady drifting pattern that is characteristic of a correction. There is a tight and well-defined narrow channel in both the SPX and the Nasdaq 100 which is more visible on an hourly chart, with prices repeatedly bouncing from the top to the bottom of that channel.
The grinding nature of the decline has been such that the hourly indicators have given preliminary buy signals in the form of positive divergence on several occasions, but none could bring about a genuine reversal. In my Daily Comments to subscribers, I stated repeatedly that these were small positives which could signal a change of trend, but that the final confirmation would only come when the down channel was penetrated to the upside.
The structure of the decline consists of two waves -- probably an a-b-c corrective pattern with the "c" wave near completion. This could come as early as next week, but it is not expected to be followed by a resumption of the up trend to new highs immediately. Too much technical damage has been done for this to happen right away. On the other hand, because the structure is definitely not an impulse wave, this should not be the beginning of a new bear market. Most likely, some sort of a rally will be followed by an additional decline into early October.
One of the principal difficulties with Elliott Wave analysis is that corrective patterns are extremely difficult to analyze (far more so than impulse patterns), because the wave pattern evolves as it progresses. Therefore, an a-b-c pattern can easily turn out to be a part of a larger pattern such as a running correction, triangle, etc... This is why cycle analysis and proven indicators are essential adjuncts to determining the correct EW pattern.
As the decline progressed, various VST (very short term) targets were met and provided a brief rally followed by more downside action. Projection targets are achieved by using Fibonacci ratios to determine how far a move is likely to carry in the same direction when a recent high or low is surpassed. Since the 1245 top, there has not been a single instance when a former high was overcome which was capable of giving a projection outside of the down trend channel. I suspect that the decline will continue until we get to 1190 before completing the "c" wave of the current corrective phase and attempting to penetrate the current down channel. 1190 is the 50% retracement point of the rally which began in May.
The hourly advance/decline index made its low about 3 weeks ago, and then made a series of higher lows which resulted in an up trend line that was finally broken on Friday. On a daily basis, the McClellan oscillator also made a low 3 weeks ago, but it has remained in negative territory and in a definite downtrend which will be reversed only if it can rise above the "0" line. This, in itself, will not necessarily produce a significant trend reversal, but it will give additional credibility to the corrective nature of this decline.
The daily new highs/new lows index remains positive and the 10% smoothing of that index, an important gauge of the longer term trend, is still a long way from going negative.
GE (33.38) continues to be the best leading indicator. While the XBD was making new highs and the BKX was struggling to get back into an up trend, GE had given a clear sell signal when it penetrated its 35 support (I had warned that it would in a previous newsletter). However, it appears to be near the completion of a wave pattern which would signal a temporary low. It also has strong support just above 33. By analyzing the price action of GE, we can probably predict the future course of the stock market.
First of all, GE is a very slow moving stock. By breaking below 35, it gave a long-term sell signal which should eventually take it to 30, but this could be many months away. This can also be considered an advance warning that the stock market has made or is about to make a long term top (the corrective nature of the present decline suggests that the long-term top in equities is still ahead of us).
Of more immediate interest, GE appears ready to make a short term low followed by several weeks of rally. Since it made its high about 3 months ahead of the stock market, and if it has, let's say. a 4 to 6-weeks rally, AND if it continues to give the same warning lead time, this could put the final market top 3 to 4 months away. Of course, this could be faulty logic but an interesting speculation.
CAVEAT: With the worst-case scenario being currently predicted, Hurricane Katrina has the potential of altering the above short-term analysis.
Oil may be approaching its final price target which may or may not be an important high, but which could bring about a good correction. The ultimate near-term price is not predictable because of the influence of hurricane Katrina on oil futures over the next couple of days, but it is interesting that the negative divergence of the Oil Service Sector is currently very pronounced.
Gold could have a fairly serious decline just ahead. The gold COT are showing 2 consecutive weeks of the highest short positions since last November's top. The price pattern which recently began with a decline seems to have some room on the down side before it finds support.
The Housing Market: A recent remark by Fed Chairman Greenspan is being interpreted as signaling a possible end to the housing boom. The housing sector index (HGX) and the sharp decline in the price of lumber futures, seem to confirm that the current advance may be over-- at least temporarily -- and perhaps for a long time.
Another non-technical warning comes from my wife who is a Realtor in the Prescott, AZ area. She notes that a couple of months ago listings were practically non-existent but now, there is an abundant inventory of homes on the market. This area has been very representative of the national housing boom with prices increasing sharply in the past couple of years.
Charts
This section contains four charts which I'll analyze one at a time.
1) The Weekly chart of the SPX shows what a relatively minor decline this has been, so far. The channel lines delineate the perimeters of what is probably wave "C" of a corrective pattern which started in October 2002. One interpretation of the entire move would be an incomplete zig-zag pattern with one more up-leg to come after the current correction. Whatever the structure, until the lower channel line is violated, there will be no confirmation that this bull market is over.
2) The daily chart shows the confines of the potential "C" wave discussed in 1), but also shows the smaller channel going back to May which was violated last week. I have also added some indicators to make the analysis of the current index position more accurate.
a) The RSI (top oscillator) showed little divergence at the top and is now approaching an oversold level from which reversals normally take place.
b) The middle oscillator is a modified version of stochastic which also shows a very oversold condition.
c) The bottom oscillator is my own BSP index which is also very oversold. This indicator in particular tells me that the next rally, which appears to be imminent, should be followed by an additional short-term decline before an attempt at new highs is made.
3) The hourly SPX chart shows the well-defined "c" wave channel of the move which started from 1245. The same indicators that are shown on the daily chart, also tell me that the current correction has just a little more to go before we can get a rally which will complete the a-b-c pattern from the top and that will be in a position to challenge the downtrend line.
4) The last chart is the daily chart of GE. You can see that the RSI has made a 5-wave pattern from 37 and is not only oversold once again, but showing positive divergence as well. The bottom heavy line is the support line where prices are expected to find support.
SUMMARY:
Until I see evidence to the contrary, I will stick to my forecast that the top of the bull market is still ahead. However, last week's action caused a penetration of the lower up-channel line and this suggests that a mild, corrective, intermediate-term decline is in place which will probably not be able to reverse until at least early October.
The nature of the next rally could be an indication of what to expect for the rest of the correction.
