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 last newsletter began with: 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.
That was true until, by another strange coincidence, Hurricane Katrina devastated New Orleans and then, most of the indices took off with the NYSE composite and the XBD registering historical highs this past week and the Semiconductor Sector Index close behind. Even the stodgy laggard Dow Industrials Average had a decent rally of some 350 points! One notable exception was the Dow Transportation Index which moved the other way, and was especially weak in the past couple of days.
The McClellan oscillator is performing better than it has in many weeks and getting back into positive territory but will have to show more upside momentum to indicate continued market strength.
The NH/NL index remains positive, but is beginning to show some negative divergence to price.
Daily volume was much improved during the rally.
Oil was not able to make significant headway in spite of the disruption of supplies and damage to facilities caused by Hurricane Katrina and has now pulled-back more than 7 points in 7 days, retracing to its 50-day MA where it should find at least temporary support.
After another short-term decline, gold had a good rally back to and slightly beyond its recent high which was largely induced by the weakness in the dollar, although the latter has began to find its footing.
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 12/13 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 1st.
SPX: Intermediate Trend - The intermediate trend which began in May had a short corrective phase followed by a good rally, and is currently challenging its recent high. It may be ready for another pull-back.
SPX: Short-Term Trend - A short-term rally began just about the time that Hurricane Katrina came ashore and is continuing, but is beginning to look a little toppy.
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?
The last newsletter stated: 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. For a while, it looked as this would not materialize, but this is precisely what is happening currently. The potential for a significant extension of this rally to new highs does not look very strong, but a slight penetration of SPX 1245 before reversing is possible. Let's dissect the market technically and see why.
Cycles: A little while back, I mentioned that the "October Massacre" was caused by a very regular 12-month cycle which caused a sharp market decline every four years, in conjunction with the 4-year cycle low which is due once again next year. This can also be reinforced by the occasional coincident bottoming of another large cycle in the same time frame. However, normally it does not bring about a significant decline in price. As an example, the last two Octobers only saw a 2-3 week decline of about 50 points in the SPX. This year is not expected to be much different, but since we are entering the last few weeks of the 12-month cycle down phase, this is a good reason to expect a short-term top to materialize soon.
Another cycle which could affect the stock market is the 9-month cycle which is due some time in November. This cycle appears to be much more influential during bear market phases but just the same, we'll keep an eye on it as its low approaches.
Breadth: In the last two weeks, the McClellan oscillator broke out of a declining trend line which started 14 weeks ago. There has not been much follow-through since then, but I think that the breaking of long, valid trend lines is just as significant on oscillators as it is on price charts. The penetration of this trend line by the McClellan oscillator may mean that a positive shift in short-term market psychology is taking place, and this will be confirmed if a rather mild pull-back takes place during the next two or three weeks.
The 10% smoothing of the NH/NL index gives us a good feel for the intermediate trend. By staying well into positive territory, even during the recent correction, it indicates that there is no serious deterioration in either the intermediate or long-term trend of the market.
Structure: I have been of the opinion that the decline which started in early August was only a correction of the move which began in April/May. This is still my belief, and this is why I think that the current rally is the "B" wave of an A-B-C corrective pattern. Momentum indicators suggest that this wave is very near its top and that the "C" wave is about to begin.
Momentum indicators: In the chart section, I will show an indicator which has an excellent record of predicting the tops and bottoms of each market thrust. This is a modified version of standard stochastic which I have manipulated in order to arrive at its present form and which, as all indicators, requires a little study of some slight pattern variations, but is nevertheless a powerful analytical tool which is easier to analyze than the conventional stochastic oscillator. It has two significant features: 1) It is an indication of an overbought/oversold condition, and 2) It is capable of showing positive and negative divergence, a feature which gives it an even greater predictive ability when this occurs.
Also, as all indicators, it is best used in conjunction with other tools and especially trend lines.
As you will see on the SPX chart below, it is applicable to all time frames. But when the daily and hourly readings coincide by reaching a high or low point simultaneously, the market is near a fairly significant reversal. This is the condition of both of these time frames right now, and one of the main reasons why I believe that the short term rally is near its peak.
Other momentum indicators, especially the daily MACD, are signaling the same condition.
Price target: The daily chart has a long-standing projection of 1254 minimum and 1286 maximum which has not been invalidated by recent market action. This rally could conceivably extend into that projection zone. However, the hourly chart has several bona fide projections which fall short of that level, some of which have already been achieved. So the higher targets -- if they remain valid after another phase of the correction -- may have to wait a little longer for fulfillment.
When the last newsletter was written, Katrina was already in the process of devastating New Orleans, and I issued this caveat: With the worst-case scenario being currently predicted, Hurricane Katrina has the potential of altering the above short-term analysis.
What I find remarkable is that once again, the stock market seemed to be moved by cyclic forces which our minds cannot comprehend, but which are often associated with geopolitical or geophysical events. The terrorist attack in London on 7/7 marked the low of the 120-week cycle as well as the end of the 72-week (360-degree) fractal.
The rally which started on August 31st was preceded by several days of positive divergence in the McClellan oscillator, a condition in that indicator which always seems to precede a reversal. More importantly, it also marked the completion of a 90-degree phase from the April lows. So we have here again a geophysical event associated with an important cyclic reversal.
Oil: Once again, a comment about oil made in the last newsletter deserves quoting: 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. This prediction is now history!
Gold: The "serious" decline which had been forecast for gold has been put off for a little while, but could still be ahead of us. This time, it seems that Katrina did affect the performance of the dollar which had a reverse effect on gold (unless, of course, cycles had something to do with these occurrences). But it is interesting to note that the commercial traders did not cover much of their short positions 2 weeks ago, and increased it slightly again last week.
The chart pattern of gold is not bullish, and this could be the last gasp on the upside before the "serious" decline takes place. Much depends on the action in the coming week.
Charts
As I mentioned above, the following charts include the daily and the hourly SPX with the modified stochastic indicator at the bottom. I have marked the top and bottom of the indicator with the corresponding price high and low. You can see how well this oscillator predicts reversal points: first when it achieves an overbought or oversold condition and secondly, when its pattern diverges from the price pattern.
Note that currently the oscillator has not began to lose its upside momentum on both charts, something which tends to happen before a reversal. Also note that in order to provide greater clarity, I have drawn the trend line which needs to be broken on the hourly chart instead of the daily chart.
The third chart is that of the NYSE composite which shows no indication of important distribution as it continues to make new historic highs. Quiz: Do you think the bull market is over???
SUMMARY:
With the NYSE composite continuing to scale new historic heights, one has to conclude that the bull market which started in October 2002 is still alive and well.
On an intermediate term basis, the market is probably in the process of making a well-contained corrective pattern, with the short term looking vulnerable to a 2/3 week pull-back.
