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
A well-contained corrective action continues, characterized by some volatility. There were a couple of wild days this past week perhaps, at least partially, the result of options expiration. A strong rally on Wednesday which took the Dow Industrials up almost 150 points was followed by a sharp 125 point reversal to the downside on Thursday.
For most indices, the low point of their correction came seven trading days ago and, as of Friday's close, most were trading in a lateral range with the exception of the Nasdaq which looks as if it is attempting to get back into an up-trend. If this divergence continues it could be significant, because the Nasdaq led the market up and out of its correction a year ago, and a historical pattern could be recurring.
Crude oil has continued to retrace and traded below $60 -- an eleven-week low. Unleaded gas is following oil's lead and also traded at an eleven-week low.
Gold has retraced abut 20 points from its recent multi-year high, and the dollar has stalled around its recovery highs.
Current Position of the Market.
SPX: Long-Term Trend - Although the bull market which started in October 2002 is now just over three years old, it is expected to continue after the present market correction has ended.
SPX: Intermediate Trend - The intermediate trend which began in May continues to correct, but there are early signs that it may be coming to an end.
SPX: Short-Term Trend - For the past two weeks, the short-term trend has gone sideways, but the most logical scenario going forward would be to make a final dip slightly below its recent lows in order to complete its structural pattern and to fulfill its downward projection.
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
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.
This is how this segment of the last newsletter began, and the market action of the past two weeks has done nothing to change this view. If anything, it has reinforced it. The 12-month cycle appeared to come to a final mini-climax on 10/13 and what is now taking place is probably base-building activity during which some residual selling could take the SPX slightly lower before a new up-trend can begin.
Three conditions are usually required for the final low of a downtrend to be in place.
1) The structure of the correction must be completed. My last analysis stated: 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. I will stand by that statement, but with a revision of the wave structure. The expanding triangle label was incorrect. Instead, it is much more likely that the "C" wave is tracing out an a-b-c-d-e pattern, with the "e" phase still ahead of us. This is clearly labeled on the hourly SPX chart which appears in "Charts".
2) Prices must enter a final, valid projection zone. Each time a price level is penetrated to the downside, it triggers a projection, until the final one is reached at the same time that the other two conditions required for a low are met. Since prices went beyond 1175, the next valid projection falls between 1146 and 1166. So far, the "climactic" phase of the cycle reached 1168 before staging a rebound to 1197. But the wave pattern does not look complete, and since a number of short-term projections fall between 1150 and 1163 (confirming the longer-term projection), I believe that the odds favor one more small decline before the market makes an attempt to resume its up-trend.
3) The advance/decline Index (and other indicators) must show the kind of pattern which indicates that buyers are beginning to overcome sellers. This normally shows up as positive divergence to price. We don't see this condition yet, but for the first time since the beginning of the correction we have the A/D and momentum oscillators in a position to show this divergence when the market makes its final low. However, the next move down cannot be significant or prolonged.
It looks as if we may be close to fulfilling those three requirements.
Even when the traditional October correction has been completed and a reversal has taken place, there will still be some head winds which will limit the impetus of the initial recovery. Two cycles, the 20-week cycle and the 9-month cycles, are due to make their lows about a month from now. It is even possible, but not likely, that the correction will last until the two cycles have bottomed. The market behavior of the next few days will give us some clues.
While analyzing the behavior of a broad-based index such as the SPX in conjunction with breadth and other statistics is important, it is also important to look at the behavior of other indices that have traditionally played the role of leading indicators.
The Nasdaq 100 has proven its worth as a leader in the past, especially since it has led the SPX up after every October correction, recently. As you will see in the chart section, there is no question that it has begun to outperform the SPX. But this is only a beginning and will only be meaningful if the Nasdaq continues to lead.
It is also worth noting that the Banking Index is starting to show some strength and that the Securities Broker Dealer Index has remained in a strong up-trend with only a minor pull-back.
Short-term, GE has also performed well. But its longer term has suffered such a set-back that it may have lost its meaningfulness as a leader unless the longer-term reversal is a warning about the market's long term trend.
Oil has already retraced a sizeable percentage of its up-trend. The Point and Figure chart shows a distribution top that implies a potential drop to the low 50's. Should that happen, and since unleaded gas seems to be tracing out a similar pattern, this should alleviate one of the market's main concerns and perhaps the most important one: Inflation!
In fact, gold -- considered by many to be the best inflation gauge -- is also cooperating in this regard by retracing in a pattern that appears to be the beginning of something more than just a minor correction. Although the COTs have covered a minimal amount of their short positions in the past week, these are still at a very high level. Even more negative for gold is the fact that, although bullion has significantly surpassed its 450 high, the XAU has remained below its comparable top. Since it has a history of leading bullion, this non-confirmation could prove to be a big disappointment for the gold enthusiasts.
Finally, let's not forget that, according to "experts", the Kondratieff Wave low is still ahead, along with its customary deflationary period. Of course, the CRB Index is still in an up-trend, but is there a whiff of a top forming in the fact that it has gone sideways for the past 4 weeks? Too early to tell!
The US dollar is currently stalled at its recovery high of about 90. For sure, there is no weakness suggesting that it is ready to resume its downtrend immediately, but it could be a little while before it can break out to new highs.
The primary purpose of the charts included is to get a clear picture of where we are in the undergoing correction.
On the daily SPX chart, you will notice that I have drawn two channels: the main channel, and a channel within a channel, which is shorter, but steeper. The August downtrend can be labeled as wave "A", the test of the highs is wave "B", and the smaller channel is wave "C" which does not look complete. Although prices have stabilized in the past couple of weeks, they are still trading within the confines of "C" and will have to break out to the upside in order to challenge the top down trend line of the entire correction. Looking at the indicators which appear below, the bounce which started in the middle of this month is only an oversold rally which is unlikely to extend into a serious up-move until the "C" structure is complete.
When 1183 was penetrated, a projection zone which extends from 1146 to 1166 was triggered. I believe that "C" will be complete when prices have met this target and reversed while positive divergence shows in the RSI and A/D.
Let's now turn to the hourly chart of the SPX for a more detailed analysis with our focus on the smaller channel or "C" wave.
This move started on September 12 and has extended to the present. You will notice that each phase of the move is clearly an a-b-c pattern which I have labeled A, B, C and "D?". While D? already has traced a clear a-b-c, it may be intending to extend further into d-e. We'll soon find out. After completing this smaller formation, it should then complete the larger pattern by making a new low, which would then become E.
When 1171, and then 1168 are penetrated, it will initiate a shorter-term projection zone from 1150 to 1163. This would confirm the longer-term projections which were shown on the daily chart.
The pattern of the hourly indicators are pretty much self-evident. Right now, they are in a no-man's land, but with a clear bias to the upside, as illustrated on the A/D index. We would need to see weakness develop in both price and indicators to start a move to new lows.
I want to emphasize that the scenario which has been described here is the most logical foreseeable one. If some alternative picture emerges, we'll have to analyze its implications.
Finally, the last chart is a comparison of the NDX to the SPX. These are hourly charts on which the divergence shows up more clearly.
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 it is simply a matter of identifying the end of the correction. There are early signs that it is near, but it would be premature to say "for sure" just yet!