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 which began in early August continues for all equity indices. Early this past week there was a mini-climax into Thursday and a sharp intra-day reversal, but it failed to make much additional progress on Friday. I will discuss the cause of this correction and when it is expected to come to an end in What's Next?
All indices participated in the decline with the exception of the Dow Jones Transportation Index which went against the trend. The Dow Industrials continues to be one of the weakest indices, just as it was a year ago at this time.
Oil entered its 6th week of correction and has now retraced almost 10 points from its late August high.
After recently reaching a 17-year high, gold is having difficulty extending its gains.
The U.S. Dollar challenged its recovery highs early last week, and then pulled back by week's end.
Current Position of the Market.
SPX: Long-Term Trend - The bull market which started in October 2002 is now three years old and is expected to resume its up-trend after the current consolidation has ended. 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 intermediate trend which began in May continues to correct and could be approaching the end of that correction, providing no real weakness develops in the near term.
SPX: Short-Term Trend - The short-term trend has been tracing a corrective pattern through a series of very short term advances and declines.
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?
Every October, like clock-work, equity markets correct. The primary cause of this correction is the bottoming action of the 12-month cycle, and its severity depends on the market's position in the total cyclic configuration.
In 2001, the correction came on the heels of a 7-year cycle low and, because equities were rebounding sharply from an oversold condition, it only caused a one week pull-back.
In 2002, it earned its label of "October Massacre" by combining with the 4-year and 12-year cycle lows. In fact, that label is normally only justified every four years, at best. The 12-month cycle is a subdivision of the 4-year cycle and usually has a mild corrective effect on prices three out of every four years. So far, this October correction is very similar in price to that of last year's but it has lasted a little longer. How much more is there? Perhaps not much more. By retracing slightly more than 50% of its previous up-trend from mid-April, the SPX has completed a normal correction.
Measured another way, the Fibonacci projection zone extended from 1189 to 1175. Last week's mini-climax took prices down to 1182 before they rebounded a quick 18 points. Since there was very heavy volume into the lows, it is possible that this may mark the end of the correction, but the lack of follow-through on Friday is suspect. Also, the Advance/Decline oscillator that is illustrated in the chart section below, does not look quite ready to signal an immediate resumption of the up-trend.
This could mean that the decline has a little farther to go. While a 50 percent trend retracement is normal, quite often it stretches to .618 which, in this case would be very close to 1175.
Even if the correction does not extend in price, it could do so in time as a lateral movement for another 3 or 4 weeks and into the lows of the 9-month cycle which is due in November. This would give the A/D indicator the time required to develop a pattern that precedes a strong advance.
Another reason why more time may be required is that the weekly MSO (modified stochastic oscillator) is still dropping but has not yet reached an oversold condition. This is also illustrated in the chart section. Note that when it turns up, in combination with an A/D oscillator which is at the ready, it signals the start of a very strong advance.
Whatever form the remainder of the consolidation takes, it is just that: a corrective wave, and not the beginning of a major decline. Technical conditions would have to change pretty drastically before the pattern turns longer-term bearish.
On the daily SPX chart, the decline which started in mid-September from 1243 is a 5-wave pattern which looks very much like an expanding triangle, but it is not clear if the final wave is complete. When it is, it may also represent the completion of the "C" wave of the entire correction. Although I have labeled the corrective wave according to my perception, please understand that I do not follow Elliott's precise rules for labeling and use structure as an adjunct to other technical tools, not as its primary source of information. My oscillators, especially the A/D indicator and the ones that I have altered to my satisfaction -- such as the MSO-- give me far more precise diagnostic readings, especially when they are combined with cycle analysis.
There is also cause for optimism in the behavior of the Nasdaq 100 which has become slightly stronger than the SPX lately. Often, that index will lead, both up and down.
And GE, our old faithful leading indicator friend may also be waking up. Note the recent behavior. These are positive signs but they do not suggest that an immediate resumption of the up-trend is about to take place. Hence, the possibility of more sideways activity over the next three or four weeks.
In the last newsletter, I wrote the following:
If the price of crude oil has a direct impact on stock prices, then the current action of oil futures can only enhance the above analysis. Friday's drop of $2.31 in the November crude futures -- which occurred just as another major hurricane was about to score a direct hit on the highest concentration of oil facilities in the Gulf of Mexico -- is bearish for oil, at least for the short to intermediate term, and bullish for the stock market. For those who are fond of such patterns, the past six or seven weeks of trading have created what appears to be a Head and Shoulder top in the daily oil chart. The neck line is at about 62, and if that is penetrated to the down side, it will confirm the pattern. According to the Point and Figure chart, this break would trigger a drop to about 52 or lower.
Last week, oil dropped below 61, and could be heading to about 50 in the coming weeks. This would certainly help relieve speculation about inflation, the danger of which is currently aggressively touted by the Fed,
Gold, deemed by some to be an inflation gauge, may soon also allay those fears as it begins to retrace, at least temporarily -- and perhaps significantly -- from its recent advance. Commercial traders have been undeterred by gold's rise and are continuing to increase their short positions to record levels. Past history suggests that a prolonged high level of shorting should bring about a significant retracement in the price of gold.
The US dollar continues to look as if it is making a significant base, but it may be a while before it is ready to begin an important advance. The current action does not suggest that it is likely to resume its long-term decline.
For those who are concerned with the return of inflation, there is also the view that deflation is more likely, especially if the Kondratieff wave has yet to make its low.
Charts
The charts which appear in this section serve to illustrate the comments made in the above analysis.
The first one is that of the daily SPX. Note that the corrective pattern may have concluded with a C wave in the form of an expanded triangle. But also note that although the A/D indicator (lowest) has made a higher low and this is a sign of positive divergence. But it normally takes several days of up-trend under the "0" line before signaling an imminent reversal.
In the second chart, the weekly SPX, the MSO is still moving down and is not yet oversold. This could take another 3 or 4 weeks to achieve. You can also see that a good up-trend takes place when it does turn up.
The third chart is that of GE. The action of the last two days speaks for itself.
SUMMARY:
Nothing has occurred technically in the past two weeks to change the view that the equity markets are undergoing the correction which normally takes place at this time of the year.
From a seasonal standpoint, we are about to enter the most bullish period of the year.
And then, who wants to bet against the decennial pattern's perfect 125-year record? Not me!
