A 3-dimensional approach to technical analysis
Cycles - Breadth - 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
Current Position of the Market.
SPX: Long-Term Trend - The 12-year cycle is still in its up-phase but, as we approach its mid-point some of its dominant components are topping and could lead to a severe correction over the next few months.
SPX: Intermediate Trend - An intermediate trend is underway and is expected to continue for another few weeks.
Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which determines the course of longer market trends.
Overview
Two weeks ago, I wrote: The internals of the market are not terrific and unless it changes, this move may be living on borrowed time.
And last week, in my last Week-end Report to subscribers: There are visible changes which are taking place in the intermediate-term trend.... Signs of a top are everywhere!
I had called for this week to be down sharply, but had not expected an 87-point drop in the SPX and a 700-point decline in the Dow! I think that the severity of the selling took many by surprise.
One index that had been persistently weaker than the others was the Russell 2000. And, of course, the banking index! They were flashing warning signs along with deteriorating A/D figures. News about the sub-prime problems (cited as the main reason for the market decline) had been around for some time but were minimized, partially because the Fed chairman continued to assure investors that the housing problem showed no sign of affecting the rest of the economy. All of a sudden the psychology changed and perception that the era of easy credit may be over has increased. Could this have anything to do with cycles?
What does this mean for the stock market? Are we at the beginning of a severe bear market? Probably not. For now, let's just call this a good, long overdue intermediate-term correction which has a few more weeks to go.
What's Ahead?
Momentum:
The daily chart of the SPX (courtesy of StockCharts) shows graphically the sharpness of the decline. The index has now broken an important trend line and former level, but it is approaching the 200-DMA which often acts as support for prices. Even more important, it has also reached the February high, which should also provide temporary support.
The negative divergences to which I referred in the last newsletter are now much clearer with the benefit of hindsight. The RSI (top) and the Money Flow Index (bottom) failed to make new highs along with price, and when the RSI began to roll over and break its trend line, it signaled the start of the decline.
Both indicators are now in a downtrend and will need to stabilize before a reversal can take place. This will probably take more than a few days to accomplish, although a countertrend rally should be imminent.
On to the weekly chart! Last week's analysis stated: More negatives appear on this chart, with the index hitting the top of its channels. The two top channel lines intersect just about where the price closed this week. This should prove to be a very strong resistance level and is also an inflection point. This is what it looks like now. Besides hitting the top of the channel, the SPX also had to contend with resistance at its 2000 top which it surpassed by a fraction, but could not get beyond. And the indicator at the bottom of the chart had a series of declining tops going back to February and was shouting caution.
Now, prices have retraced all the way to the bottom of the channel, another source of temporary support along with those shown on the daily chart.
Also, if this is the bottoming of the 20-week cycle it should bring about a good countertrend rally as it turns up, but notice that the bottom indicator is not yet oversold and that every important decline of the past has not reversed until it was.
I will discuss the cyclical forces behind this decline in the next segment.
Cycles
In the last newsletter, I mentioned that there were two separate cycle series affecting the market and suggested that the 20-wk cycle may belong to one and the 4.5-yr to another. We are about to test that theory because the immediate pressure behind the decline was not simply caused by the 9-wk cycle, but was most likely the bottoming of the 20-week cycle which normally makes its low every 18- 20 weeks. Of course, it was assisted by the 4.5-yr cycle which is now in its down phase, and if the latter were to make its low here, it should be reflected in the market action by an immediate resumption of the uptrend. However, indicators suggest that the decline has further to go and is more likely to reverse at a point which would coincide with the low of the larger cycle in September.
I need to repeat what I wrote last time because it is also pertinent to the current market action:
We must also keep in mind that one of the most dominant long term cycles, the 2-yr cycle, is in the process of topping and will start to bring downward pressure on the market between now and the end of the year.
If the 2-yr cycle has already topped, it is beginning to add pressure to any other cycle which is in a down phase, So we may have 3 cycles currently pushing the market down and this may be why so much weakness developed so quickly.
Looking forward, the 20-wk cycle should have a limited effect on the market when it turns up but could generate a good rally and subsequently slow the descent for the rest of its term. After the 4.5-yr has bottomed, it is probable that the long-term uptrend will resume until the end of the year.
Projections
Last week, I had expected the SPX to decline to 1496-1501 by week's end. That target was significantly exceeded, and the index has moved to another important projection level between 1456 and 1459 which is determined by combined Point & Figure and Fibonacci targets. Considering that this level coincides with the February top which should provide important support, and that we are at a cyclical low time-wise, it would not be surprising if the market should end its decline on Monday and reverse course.
As far as the projection for the 4.5-yr low, the preliminary target is about 1440. This will be reexamined as we go forward and the market action produces a P&F pattern from which we can derive a confirming count.
Breadth
As a result of the recent weakness, the McClellan indicator is in a sharp downtrend and has reached a level that it has not seen since the June-July 2006 lows. This indicates that more selling probably lies ahead because the index will need time to steady itself and show a rising pattern with positive divergence as the final low is made.
Naturally, the short-term indicator has had an effect on the summation index and sent it plummeting. It too will have to stabilize before we can have a market reversal.
Market Leaders & Sentiment
GE made a new bull market high as the SPX hit its peak, and the NDX went to a new high as well. Both have retraced sharply in the decline, but the NDX, especially, shows strong relative strength to the SPX, as the chart below (courtesy of StockCharts) shows. This is not the way that major tops are made. Historically, both GE and the NDX are noticeably weaker than the large cap indices at the end of a bull market. Therefore, it is fairly safe to assume that we are only in an intermediate correction.
The sentiment indicators also do not show the degree of bearish reading required for a major top. The 50-DMA of the ISEE is not at a level associated with bull market highs, and the daily readings have been quite bullish for the past couple of days, suggesting a near-term reversal.
Summary
The SPX made an intermediate-trend peak at 1555 -- its former all-time high of 2000 -- and suffered a severe decline last week. Various indicators, cyclic conditions, sentiment, and projections are suggesting that it could have reached a temporary low and is ready for a good rally fueled by the 20- week cycle, which is probably bottoming in this time frame.
Longer-term, the SPX is likely to extend its decline into September before it can reverse its intermediate downtrend.
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