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 - Election years that fall in the 8th year of the Decennial pattern call for consolidation in the early part of the year followed by a strong finish. But the 6-yr cycle which is scheduled to bottom in late Summer/early Fall could play a restraining role, followed by an eventual bull market top in 2009-2010.
SPX: Intermediate trend - an extended intermediate-term consolidation is in process.
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.
Last week was marked by extraordinary volatility in the markets. On Wednesday 1/23 the Dow Jones Industrials had a swing of 632 points, selling off from the opening and closing near its high of the day. Market activity was generated fundamentally by several factors, the main ones being massive selling by Societe Generale, France's second largest bank, to cover losses in positions acquired by a "rogue" trader, and a shock and awe 75 basis point cut by the Federal Reserve after holding an emergency meeting ahead of its scheduled meeting next week. There was also action on a fiscal stimulus package and talk of a bail out of distressed bond insurers.
If you prefer a technical explanation for the market weakness, 3 weeks ago, the SPX closed below its long-term trend line and went on to close below the August low of the 4.5yr cycle the following week. In any case, technical and fundamental factors combined to cause a selling climax which should put a floor on the market for a while.
Volatility continued into Friday with the SPX having a 40-point range for the day, opening strong but selling off after reaching a Point & Figure base projection as well as a short-term downtrend line and resistance ceiling.
Most indices managed to eke out a small gain for the week with the Russell 2000 as one of the best performers. But they were all outclassed by the Banking index which was up 11%. It's been a while since we've seen this kind of performance from the banks! The relative strength in both of these indices could be significant.
Next week the Fed is expected to deliver another rate cut of at least 25 and perhaps 50 basis points.
Let's look at a daily chart of the SPX. The low of the 20-wk cycle brought the index below its long-term trend line and it was not able to move prices back above. When it failed, prices continued down and fell below the important 1360 support level and continued into a climactic low on Tuesday and Wednesday. Prices then rallied swiftly to the former 1360 support -- now turned resistance -- which coincided with a short-term downtrend line, from which they were pushed back once again.
The two oscillators gave a tentative buy signal by closing above their descending trend lines, but they failed to rise above their former highs. They will have to do this to make it conclusive. Of the two, the lower one which is the MACD of the A/D is the most bullish because since the December decline started, it has remained above the low which it made back in November.
The downward momentum clearly exhausted itself last week in a selling climax accompanied by huge volume, and there are strong indications that this was at least an important short-term bottom. But for a conclusive buy signal, we need to resume the uptrend and close above the trend line and the 1368 high. Friday's retracement is most likely a test of the lows.
It is too soon to make a decisive pronouncement about what kind of a low we made last week. The extent of the rally, the performance of the advance/decline, and especially the behavior of the indices after the rally is over will determine this. Some indicators, such as the AAII Sentiment Index which is giving its most bullish reading in 10 years, and the strong positive divergence in the NYSE Summation index suggest that this is more than a short-term low. The SPX is the only one of the three main indices which has broken out of its long term channel. The Dow industrials broke below but closed above last week and the Nasdaq remained well within.
All the important cycles which bottomed in the last half of 2007 have failed to hold up prices and have been penetrated to the downside. In the last newsletter, I suggested that this could be due to either fundamental economic factors which were currently overriding cycles, or to the 6-yr cycle which will bottom later on this year.
I have also discussed a strong seasonal pattern in the DJIA which has existed for the past century during presidential election years and which brings weakness to the market in the first part of the year. I believe that the combination of this pattern and the current sub-prime and credit crisis may well be responsible for the intermediate correction that we are experiencing. If this is the case, it should be over by May at the latest and possibly much sooner if the efforts of the Federal Reserve and the administration to shore up the economy and prevent a recession is successful. If not, we may have to wait for the 6-yr cycle to make its low in the early Fall before it ends. A lot of technical damage has been done to the averages in the past 6 weeks and it will need to be repaired. Exactly how is a question that only the market itself can answer over the next few weeks.
There is another possibility which should be kept in the back of our minds. Major cycles are due to bottom about 2012-14. If the Decennial pattern fails to bring a new market high in 2009-10, it will be evidence that they have topped. Some respected analysts believe that we have already started a bear market, but this opinion is by no means unanimous and I believe that taking this position is premature.
When the SPX broke below 1363, it triggered a Fibonacci projection zone of 1236 to 1286. There was no obvious Point & Figure pattern to substantiate that target. However, at the lows, this type of charting demonstrated its peculiar ability to signal the level of accumulation which was taking place. While the daily bar chart of the SPX only shows two bars down on Tuesday and Wednesday of last week, a one-point reversal P&F chart formed a base 149 points across, revealing that major buying was taking place. Tuesday and Wednesday formed two distinct phases, and Wednesday's gave us a projection up to 1372. On Friday the rally peaked at 1368, only 4 points away! According to the chart, the current pull-back should be a midphase decline and then a move to 1424 should be expected. The base even shows a reasonable count to 1467.
What is even more interesting is that P&F counts often coincide exactly with Fibonacci levels. In this case, if we take the recent decline to have started from 1523, 1368 represents a 38.2% retracement, and 1424, 61.8%. 1467 would be 78.6%! No wonder old-time traders who did not have the benefit of computers used Point &Figure charting extensively.
As for the retracement which started on Friday, the top is comprised of multiple phases giving multiple projections, beginning with the level where the pull-back has stopped at 1328 to much lower, with one of the most probable being about 1320 which is also a level of good support.
While the breadth figures during the rally were not impressive, neither did they reflect the severity of the decline. This shows clearly on the hourly figures, but even more so on the closing figures as you can see on the daily chart above. And look at the NYSE summation index below (courtesy of StockCharts)! There is a substantial non-confirmation of the decline. What does it mean? The next few weeks will tell us for sure, but one has to consider the possibility that this decline, as severe as it was, did not entail broad-based selling.
Market Leaders and Sentiment
Positive intermediate divergence remains in favor of the NDX. While the SPX broke below its long-term trend line, the NDX has not. Nor has it broken below its January level while the SPX has. Short-term, they remain roughly in synch.
The Investors Intelligence Bull/Bear ratio has declined from a very bearish 3.10 to an almost neutral 1.3. The ISEE put/call ratio continues to be predominantly bullish, making a pattern very similar to the August low. As pointed out earlier, the Insider buyers/sellers index was very bullish in December.
It's time to start watching the relationship of banks to the S&P 500. Until now, they have led it to the downside. If they have found a low and begin to reverse, this should have a positive influence on the SPX.
From the last Newsletter: While the market has declined to new lows in the past two weeks, reliable indicators have become more bullish. But some suggest that a little more time may be necessary before an intermediate low is made.
The low made last week, which was climactic in nature, is at least an interim low of the current intermediate-term correction. Because of the bullishness shown by some indicators, it could turn out to be something more. The base which was formed indicates that a rally to 1424, and perhaps 1467 is possible.
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