First Look at 2010 Stocks

Santa Rally got run over by some reindeer! We started with a normal Santa Rally the two week before Christmas. Often the Santa Rally pauses for a couple of days past Christmas then takes off into the New Year. On Tues and at the close Wed Rudolph and the few traders still at their desks almost got Santa in the air, but Santa has fallen back to earth today. Once again we confirm that seasonal tendencies are just that - tendencies. Now, we have seen very sharp pops up the first days of new months for several months, and might now see that next Monday at the start of the new year. But is any such pop likely, and if so, would it be the start of a sustainable continuation of the rally? We have to look elsewhere for guidance.

History

First a look back. Nice graphic from the WSJ shows the rally with two serious pauses: Jun (down) and Oct (flat). You can see how most of the gains occurred in three short periods: the first bounce off the March bottom, the second bounce after the June swoon, and the third bounce after the flat October. Most of May was flat, most of Aug was flat, and we have been largely flat since mid-Nov. This chart does not add in the last half hour today, which puts the Dow slightly down for the month, at least from where it opened (it gapped up from the Nov30 close). That nice Tannenbaum Green should instead be Rudolph Red, or Arctic Blue given it was up less than 0.8% from the Nov30 close, and 0.1% down from the Dec1 open - essentially flat.

 

This chart supports the view that the rally has been in five waves so far, which would normally suggest an impulse up, except that each wave is counted as a corrective "3". Thus this can be counted either as a triple zigzag or a large upwards triangle. The prior two up waves were around 3 months, which suggests another month to go, despite the Red Dow this month, but not much more than that. 

Fundamentals

Fundamentals are mixed. After a strong 2009 rally, 2010 is likely to be flat to down, at best, as we saw in 2004. More important is that the foundations of the rally are shifting:

• Bond rates are going up, whereas they were flat to falling last year
• USD is rising, whereas it was falling all during the rally
• Bernanke's QE is easing, with the purchase of mortgage-backed securities suppose to end after Q1, thus removing the primary prop under the rally: excess liquidity. 
• US businesses skinnied-down last year, allowing them to exceed earnings expectations, yet they cannot skinny down much more. To drive earnings, revenues need to grow, and that is problematic giving poor consumer spending and low business investment
• Inventories were lean during Q4, so a decent amount of inventory rebuilding should spur positive growth in Q1; yet this is not sustainable absent consumer spending growth
• Euroland seemed to be coming out of their funk, but now problems among the PIIGS (Portugal, Ireland, Italy Greece, Spain) will stress their ability to grow
• Japan was coming out, but seems to be the first to sink back to a double-dip recession
• China has been growing but it is unclear if it will sustain, given how much of it was stockpiling and driven by fiat not demand

This all boils down to the expectations of a V-Shaped recovery. The rally has baked in a robust recovery in 2010 to sustain stock levels. We should have a V in 1H10. Even you skeptics should remember that a W starts out as a V. 

Yet the revisions downward in Q3 GDP bode poorly for equities. Sure, expectations are for a 4% Q4 report, and it would be hard to screw up continued growth in GDP in Q1 and Q2, but even at two more quarters of 4% annualized this is an anemic recovery. Also the problems in Japan and Europe do not make for a solid foundation for US growth, particularly coupled with the Chinese propensity for high savings over consumption. Where is the global engine of growth if not the US? 

Hence fundamentals suggest a flat to down market, unless we get over 5% growth. 

Sentiment

Yesterday's STU and some of the comments to my prior post lay out a lousy case for sentiment. Simply put, we are at excessively bullish levels, the types seen at tops. The STU notes that:

At just 15.6%, the percentage of bears is the lowest in 22 years, since March 1987. ... It is lower than at the October 2007 peak, the January 2000 peak and the August 1987 peak, prior to the crash. Very few advisors think the market holds a large degree of downside risk, which, ironically, is one reason it likely does. ...  

At its current reading of 76.6%, the committed bulls have now exceeded the percentage registered at the October 2007 all-time nominal price high. These readings--when combined with the CBOE Volatility Index (VIX), which recently dropped to 19.25, its lowest level since August 2008, and the CBOE put/call ratio at a recent low of .696 (5- day basis), its lowest reading in 31⁄2 years--paint a picture of a high degree of complacency toward the prospects of any significant market decline. 

Technicals

Classic TA would call this a broadening top, which has had its four tops (three is typical, four is within bounds). A bit more on how to translate such TA into wave theory can be found in the three EWT's combined into the attached PDF, which you can download here. The broadening top formation is calling a top.

A reader sent me Richard Russell's Dow Theory take, which is heavy distribution, a topping indicator (the reader added the red parenthetical):

The recent market action has been characterized by many days of divergence when the Industrials rise and the Transports fall or vice-versa. Robert Rhea wrote that two or more successive days of divergence usually suggests distribution. And speaking of distribution, the action of the last 30 days has been characterized by many "distribution days" when the market declined on rising volume (that is rising volume over the volume of the preceding day). [Yesterday was another such day]  The latest count of distribution days over the past two weeks is ominous and highly unusual.

There are several wave counts right now, all of which point to a top soon: 

• Neely thinks his timing rules require an end to his triangle wave E very soon, with the sharpest drop in months the likely outcome
• E. Robin Landry had been expecting a top in Mar/April 2010 after a year-end pullback; with no pullback, he expects a top in the first few trading days of 2010 as traders push off taxes for 15 months
• Market Oracle had MarketTimingCycles provide a forecast, which has us in 5 of A of 2, meaning a serious B wave drop to come shortly. More on this count in my Sunday post, here
• Tony Caldero has us in a wave 4 of a final wave 5 of the rally, but the last tick blew his count, or at least made it "sloppy." As he says today: "Monday should be an interesting opening."
• EWI has us at the end of the final C after an expanding triangle wave B. An EWFF is due at the end of the month (today!), but may come out next week. Like Tony C, looks like they want to see how Monday opens before enshrining their opinion in digital ink.

The chart below comes from the final STU of the year. It shows the expanding triangle that has been the STU wave count for a while. Tuesday's peak at Sp1130/Dow10580 ran the Dow up to the upper trendline, as they predicted. Usually in an expanding triangle, the wave 5 (or C) that follows truncates (ie. doesn't even run as far as the top of the triangle), as the formation indicates exhaustion of the prior trend and rotation out of favored stocks. A longer run to the trendline is a bit unusual. 

Summary

My take has been that we will likely top in Q1, especially by mid-Feb as data comes in suggestion the V shaped recovery is a bit of a U. This busts all the models for earnings growth in the S&P in 2010, and is a huge red flag that the Stimulus has stalled and the economy is poised to fall back down again later in 2010 or in 2011. Oddly enough this view based on fundamentals is consistent with the Bradley astrological view, shown in this next chart:

 
The pathetic end to the Santa Rally and all the indications of distribution raise the question of whether the top is in already. A lot of pundits out there have attributed current weakness to year-end tax planning, the expectation being a rip-roarin' return to equities next week as the new year dawns. Yet the Japanese bubble peaked in late Dec 1989 (Dec29 I believe), last year we peaked on Jan6, and in 2000 we also peaked in early Jan. A peak between last Tues and the end of next week has historical support.

The wave counts suggest a top is near but not necessarily immediate. The STU count could have the top in Tuesday, per the chart; but if so the fall off it should be a clear bifurcation below the prior trading range, meaning below Dow10235. The last half an hour today was pretty sharply down, although not that far (yet). It did however break Sp1116, which blows Tony C's count, and brought the Dow down below where it opened on Dec 1 (10428 today, 10437 then, a gap up from 10345 on Nov30). 

Another count that I have mentioned a few times is that Tuesday marked the end of leg D of the triangle, not wave C. You get there by consoliodating legs ABC into one leg A. The triangle morphs from an expanding one (with wider gaps as it continues) to an ascending one with a flat bottom and an ascending set of tops. This count says the top is not in, and neither is the final wave C. Instead we should expect a drop the first week of the new year back towards the bottom of that ascending triangle - the support shelf at around Dow 10250 +/- 15 pts. Then a move in the final wave C towards Dow 10700/Sp1070, which could run into Feb.

Thus we have two interesting counts to watch next week:

1. the bearish one that the top was in on Tues, we open down next week, sand break Dow10235
2. the still-bullish one that we are still in a corrective pattern and need a much stronger wave C up to complete the rally, but will also open down next week, yet bounce off Dow10250 

If we do indeed open up Monday, this likely means the final wave 5 of C will exhaust by the end of the week. (it makes today the end of wave 4 and next week the final 5 of C.) As Tony C says, next Monday should be interesting. 

Comments

[DG]

Yelnick,

I see you're not resting on your posting laurels and are posting to the bitter end of 2009. Great recap to end the year!

[Mr. Panic]

Blue moon lunar eclipse today followed by an annular solar eclipse on January 15,2010 which officialy opens up another Puetz crash window. This lunar eclipse also might activate the destructive,very rare triple total solar eclipse of past July(also featuring the greatest duration of the 21stcentury at 7+minutes---January's annular eclipse is 11+minutes), of the Saros series which has repeated a destructive 18year cycle going back to Jan 1721 (which preceded the latter collapse phase of the South Sea bubble). Coincidentally, I have read (but haven't confirmed) that the last blue moon lunar eclipse occurred in 1991 (as July's Saros series last did also)in the midst of the last real estate crisis. (Fred Folvary has noted 18year real estate boom bust cycles in his work).

McClellan Oscillator dropped below the 0line today after reaching its highest levels of the last few months usually the indication of the onset of stock market decline. Since late August, the averages have been forming a 3peaks and a domed house pattern and with today's action it appears the domed house has completed. Wave C on the EWI chart would be the final spike high of the dome or pts 23-27 on the 3peaks and a domed house pattern (see Alphahorn's blog during the past month for an elaboration of this pattern) The May through August 1987 stock charts feature an almost identical although not as pronounced pattern.

[Roger D.]

Mr Panic I agree completely.

There's nothing bullish about this chart. FRT is a major REIT and is about to go through it's next phase of deleverging.

There are so many crash charts out there right now it's damn scary.

IMHO the LT trend has resumed and it's going to be a real killer.

Roger

http://www.screencast.com/users/fast996/folders/Default/media/e9a30eb8-9bf4-4def-ba21-41163c9d346f

[Glenn Loser Neely]

Hi I am Glenn Loser Neely...

This is my year!!! 2010... I will be wrong again and again!!

Please follow my NEO garbage at.

www.neowave.com

I am a loser...

GLN

[Michael]

One note on the Bradley Siderograph, as Manfred Zimmel has noted the Bradley has not had a very good correlation with the US equity market as of late. In fact, for the past 3 quarters the Bradley has had a fairly strong correlation with Crude Oil and the USD - - - rather than the stockmarket.

For people unfamiliar with the Bradley Siderograph, I would suggest that the chart above that Yelnick posted is not as it seems and that the Bears do not "own the market" after the Month of March. That is a most highly misreprentative view of the Bradley.

The Bradley predicts turning points ONLY and not the polarity . . . meaning a high in the chart may also be a low, and vice-versa.

The first significant Bradley date is March 1st. After that, there are three minor turning point dates in June, one in early July, and another major turning point date shows its face on August 10th.

[Golum]

The triangle morphs from an expanding one (with wider gaps as it continues) to an ascending one with a flat bottom and an ascending set of tops. This count says the top is not in, and neither is the final wave C.

Correct. A healthy nu yr to u.

[Wave Rust]

For SPX-
the second worst case, this is a 4th of 5 of 3.
the worst case is that this is a 4 of 5 of C of primary A.

the best case is that this is possible 4th that takes out 1114.76 on Monday and then reverses up. Then the 1's and 2's begin again.

EWI, STU and Neely are doing pretty good counting this dichotomy of indices and commodities. Difficulties are always seen before during and just after a 4th like we just saw for the last 6 to weeks.

The Dow and SPX covered a few gaps on Friday.

BUT, I could be wrong. The subtle high of NDX on 12-14-09 for a 1 was clever. Then look at that 2 that followed wow! Or, was it just a weird 5 and it'a all over for the up for awhile.

Happy New Year

wave rust

[Mista B]

I'll leave my stock market prediction at saying I don't think the rally has much farther to go. Valuations are pretty high, and it's tough to see bond yields dropping further (especially for companies). I'm not seeing any pickup in activity on the ground, and given the shape the banks are in (credit card, CRE, business, and mortgage lending are still worsening) I don't see how anyone thinks it's going to improve in 2010. That companies and individuals are getting lean and mean is a good thing in the long run. It's absolutely necessary. But in the short run it means the recession is still on, regardless of the GDP number.

[Hockthefarm]

The December CI provides a nice view from 5000 feet in their piece "On Allocation". Equities as a % of Household Financial Assets and Bonds as a % of HFA should be enough to send most of us to ground.

http://tinyurl.com/ya3s4zq

But when you look at the pension mess and FED manufactured bond mess, one thing becomes very clear: The gubmint cannot allow equities to have a major decline this year.

Prechter and Dent have concluded that the gubmint cannot support the economy to the extent required to prevent an implosion (debt deleveraging and demographics). But both agree that the gub will pull out all stops in an effort to postpone a major decline.

My question to the board is how can you possibly time the unknown? No one has a clue how long government is willing or able to suspend capitalism. Given enough resources, a simpleton can run any company for a long, long time.

Hock

[Hockthefarm]

Here is the January CI:

http://www.contraryinvestor.com/moprinter.htm

So much for the mountain of cash on the sidelines.

Flat to down seems like a great call for 2010. A good year to sit in the "cash patch" I think.

Hock

[Hockthefarm]

Great piece by Trim Tabs discussing the source of the rally:

http://tinyurl.com/y9qmm3n

It sure makes sense.

Hock

[vipul garg]

Michael,
saw exas..
looks good for 3.75 and 4.50..

[Kevin Martin]

Even with four crossing one, the whole thing can still be an ending diagonal.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3568637

KBM

[cloudslicer]

I have been following a radio show up where I live called the technical view hosted by Ed Handley (he does elliot wave). One little side note he brought up is that for some reason the years ending in zero since 1900 have been bad years for the market with the worst declines occuring in Q1.

He have the move off the March 2009 lows as P4 of C. With the final 5th wave down to follow.

[Rob]

Cloudslicer:

I listended to his Thursday program on Friday. The takeaway I have is that he does not feel the move of the March low was wave 4. He stated that there were 5 waves down into the March low.

[cloudslicer]

Rob,

I think the 5 waves down he was referring to was the 3rd of the C. We still don't have wave 1 overlap at the Jan/08 lows on the S&P (we do on the Nasdaq). To my knowledge that is his wave count. That implies a retest of the March 2009 lows for P5.

I don't think he changed to the alternate bullish count. He did say that even if your bullish the levels that we are at now are going to be retraced in the wave 2 down when 1 completes.