Planet Yelnick

Yves on The Financial Singularity: AI Impacting Stock Markets

Guestpost from Yves Lamoureux, who was über bearish last year, but is bullish this year. Technically, he sees the current market as finishing a wave 4 down, to be followed by a blow-off wave 5 to surprising highs. It may be driven by Fed panic and QE4, if not an outright NIRP. Fundamentally, as this post discusses, he thinks trading bots are evolving towards AI trading.

The financial singularity is upon us! We think about this point in time where artificial intelligence will be capable of recursive self-improvements in the financial affairs of humans.

Machines have been allowed to trade at incredible speeds. Now they have been allowed to learn. Our understanding of market mechanisms may be altered permanently. We use the language of waves to express our viewpoint. Increasingly it is usurped by machines that have no emotions.

So we put it to you. Why would waves work if the players don’t feel a thing?

We clearly understand this point as we have developed an alternative to forecasting models based on behavioral analysis. Progressively computers destroy what was reliable patterns to trade on. We see it in action daily. Certainly wave extensions are a good example. What would turn out to be a usual length now becomes almost perpetual. Thank the machines!

Most importantly is, in this environment, the ability to adapt as fast as you can to this paradigm shift. The invasion of blockchain in finance will further the advance of A.I. Human traders will be relegated to second tier markets and eventually be banished from trading all together. We have crossed this point in time where the future of finance may just be unfathomable.

At this moment, our models have generated large buy signals on the stock market. Like late 2008, where we called the bottom, our stocks did not make new lows in March 2009.

In other words, it’s a process. Notwithstanding summer weakness, we strongly believe that our picks have seen their ultimate lows. The mother of all crashes is coming but may be years away. We spent a good deal of time in 2015 shorting everything in sight.

This year paint us bulls.

The 1929 Meme – Don't Believe It

I like to run comparison charts, that this is 1987, or 2007, or 1937, etc., that often get passed around on the Internet. Some have plausibility due to similar historical and economic conditions - 1937 for example matches 2015 if we analogize the 1915-1919 auto bubble to the tech bubble of 1994-99, and then the credit bubble of 1925-29 to the recent housing bubble of 2004-08. In that case the crash of 1929 matches the crash of 2008. The attempt to reflate the economy in 1933-37 due to revaluing gold would be analogized to the Fed's QE from 2010-now, attempting to keep interest rates low to reflate the economy. Plausible, maybe. 

Most of these comparisons, however, are simply eye-candy, pattern matching of little predictive power. Some are simply bogus. Here is one of a high level of bogosity:

This comes from a seemingly credible source, Tom McClellan of the McClellan Market Report, and it was brought to his attention by well-known chart diviner, Tom Demark. The bogosity is in the two axes: the 1929 axis covers a 100% range, from 200 to 400 (right axis), whereas the current Dow covers a relatively minor 25% range, from 12400 to 15600 (left axis). On a fair comparison (100% to 100%), the red chart should be only 1/4th the slope of the 1929 chart, and wouldn't match it at all. It would show a much more anemic rise, meaning it would be much less likely to have a dramatic fall.

Don't believe it. Whatever correction we are in is not the big one.  

Yves Expects a Correction, Will Avoid Equities in 2014

Yves Lamoureux has been on a roll recently. He made a prescient China Top call in 2007 (reported here), then turned bullish early this year and says he is up 25%. In October he predicted stocks 'crashing up' (reported here) and they have. Now he has become cautious. His current view on the S&P is reposted below. But first, a few comments from him:

We find that the study of the yield curve has a powerful predictive ability. Where we disagree with most is on the size of the drop. Market opinion would have this ending wave drop in a C wave fashion. Drops of over 50% would therefore be possible. Our count view this pullback as a wave 2. The yield curve agrees with us on this matter.

 

Our tactical approach now is to avoid the S&P as we see it likely to turn out as being a big disappointment for returns in 2014.

Instead of US Equities, he is looking into emerging market equities. Also, he suggests now is the time for a short-term play back into gold. He sees a rise to $1500 before it falls back to his target of $1000 in 2014.  

Here is his reasoning on the S&P:

How often have you seen us get worried this year on stocks? Never! We held a courageous bull stance all year and never let go. This was taped in January with Jeff Macke.

This cannot be a permanent state of affairs. Many studies are pointing to risk ahead. We would prefer to leave some upsides to others. The best part about reducing risk is also pocketing handsome profits.

Conditions are quickly deteriorating. We did preview the chart of money velocities. It is falling to such an extent that we are shocked. Perhaps the uncertainty created by taper is to blame in part. We are asked about our view of bonds if stocks fall.

We mentioned in the past that this would become a nightmare for asset allocators. We believe in the positive synchronicity of both bonds and stocks to revert to an historic correlation. We think bondscan fall while stocks fall too.

The bond bear is really just at the onset. There is incredible damage ahead for people who have enjoyed bonds for decades. To them, there are no other alternatives certainly not stocks. They will suffer in the same way that stock holders did for a little bit more than the last decade. We had been over the same period very wary of stocks and had always preferred the safety of bonds. Oh my! How things change.

The rotation out of bonds to stocks will continue and remains the foundation of our strong bull market case in stocks to come. We think we are now providing investors ample time to re-balance portfolios accordingly. Now is the time to take some evasive action!

We understand that we cannot go to cash in a big way as clients will be less than delighted. Guess what? People who feared the market, now, want a bigger stock representation. We try to use our contacts intelligently to measure the pulse of investors. We think this represents applied behavioral studies at its best. We feel that this high is a perfect point to take money off the table.

We continue to be huge bulls on Asia. We think that the Shanghai market has begun a multi-year bull market. Our advise stands to rotate out of expensive markets like the S&P and go to emerging markets that now offer tremendous cheap values.

One of the really big mistake of retail investors is to feel comfortable with their own regional markets.

This will be a costly mistake for  years to come. As many emerging markets appear to go into the next stage of growth. They will also gain an exponential revaluation. They will go into bubble mode!

Yves on Stocks Crashing Up!

Our frequent guestposter Yves Lamoureux, president of Lamoureux & Company, a market advisory firm based on behavioral economics, has a view on stocks: up!  Neely sees the S&P in a final thrust up. The grinding climb of the Wall of Worry that has characterized this market since 2009 will continue until a final, panic-buying stage sets in. We may be now entering it. From Yves point of view, so what; a tumble in 2014 will simply set the stage for more appreciation downstream. Two competing lomg-term views that share a short-term prediction.  Enjoy Yves perspective. 

Crashing up!

Climbing a wall of worry at its best

 Vantage point:

 We are of course not surprised at the reaction of players who have missed the rally.

They will spew any and all reasons for this market to crash. Yes, it will eventually encounter a degree of such devastation that we would rather keep our timing to ourselves at that moment.

The gigantic money inflows was and is still the driver of this great move. There is more money on the way. It should be showing, as we have repeatedly explained, an exponential tendency.

We model interest rates for the next 15 years and believe that savings will never carry an explosive growth path of debts.

Forward looking the gap will only increase faster. This spread in turn will pressure bonds lower. It will wipe out a generation of bond only buyers or what we see as income oriented investors.

People argue that stocks will rise as the economy performs better. We are not of this school of thought. We object to much improvements going forward for developed markets.

Our behavioral work distinguishes between losing assets and winning ones by carefully tracking shifts in sentiment, which fundamental analysis disregards.

Being long the euro currency this year best exemplifies this kind of approach.

https://businessincanada.com/2013/10/23/lamoureux-to-loonie-look-out-below/

Two recent shocks over the last decade have profoundly shaped the perception of investors. This has forced a re-balancing of assets in favor of income. This is coming exactly at the heels of the greatest acceleration of debts worldwide.

I did use the word crushed in an appearance on Yahoo Finance to describe what was at stake for bond investors.

 http://finance.yahoo.com/blogs/breakout/beware-bonds-long-term-investors-crushed-says-lamoureux-122126464.html

We will not sugar coat our language when it comes to interest rates. We have tried to shock portfolio managers in presentations this year.

We can only describe the level of apathy we have seen as unbelievable. This is what a 30 year bull market will do to public opinion.

Our bullish stance has been validated this year with great returns.

We do suspect that we are heading for a rather tumultuous 2014. We think it is a bump in the road.

Our forecast for the Dow to double from next year's low point remains compelling.

http://video.foxbusiness.com/v/2103896522001/stocks-to-double-after-mild-pullback/

As long as the market climbs a wall of worry, we will climb profitably with it.

Yves

http://lamoureuxandco.com/

Classic Formation: Fall Below Trendline, Retest and Drop

AllAboutTrends midday update shows how the S&P is following a classic structure: it dropped below a recent trendline of support, came back to retest from below, and has since fallen off. This is a bearish sign, at least with respect to the rise since mid-March. The bears are out quickly to say "it's the end!" while some more cautious pundits like Neely see a final and more vioent upwards thrust to come.  

 

Yves Calls a Top! Led by the British Pound

Sharp drop today has the bears on the prowl. Technical analyst Glen Neely cautions that in the formation we are in - an expanding triangle (actually nested at three levels), a sharp drop often happens before the top - and is a bear trap. He still expects a final runup into late March or April.

I have been expecting a triple top with the S&P highs of 2000 and 2007 - and we are close but not quite there yet (ie 1565-1600 would be a better finish).  

Yet with all this hemming and hawing and cautionary notes, there is one analyst who has stepped up to a clear and brave call.  Yves Lamoureux has called the end of the Bond Bull Market, and also a top in Gold, and now calls a top in US equities, before a Great Bull Market in equities.  Enjoy!

Is The British Pound Giving A Market Top Warning?

We have been absolute bulls on stocks. Interest rates are too low and have been for too long. The crowd has caught on. We believe in an important market top now. Some observers are calling for the end of the equity bull market. We have a separate view of this. 

A solid pullback should be part of a larger degree wave two. We maintain that stocks will double from the 2013 bottom. The market appears, so far, on the path we have been describing to our subscribers since last year.

A correction now would increase our confidence in the next stock melt-up. It is a large phenomenon and best ascribed to risk preference and behaviour. How would you explain the recent stock jump? Most participants are at loss and are mostly invested in bonds. They are playing catch up.

We, on the other hand, are exiting our long stock plays. We have increased considerably risk off positions as described recently in "How to Catch This One Impressive Rally". We are very excited about introducing investors to the coming wave 3 of 3 in agriculture. We suggest direct long exposure. Our timing relies on a proprietary weather model.

 

We show you today this one clear warning. It is associated with the British Pound. We have seen a similar behaviour back in 2009. The Pound as a precursor is a great tool. You have to combine this with patience as well. In 2009 the Pound started to move down. It did so for many months. The stock market finally caught on. It resulted in the May flash crash. We think similar conditions are in place. The "all in" crowds have a stop loss strategy. Momentum will turn down and we think it could begin a negative feedback loop of selling. Remember that in absolute terms cash is low.

The market has risen with low volume. Illiquidity events are going to be more common in our opinion. They should be seen more frequently as the Fed starts to pull back on quantitative easing.

The Pound in effect acts as an early warning system. The recent drop has to do with a huge UK money expansion. Measured on a year over year changed rate, it is up 100%. We think something more is going on.

You will see above a long term chart of the Pound. We have labelled the drop in five waves. We think the bounce is a clear correction. It is indicated as an A-B-C pattern. This suggest new lows ahead. Is the market now set up to catch on? We think so.

Now is the time for a defensive stance!

Yves Lamoureux http://lamoureuxandco.com/

 

Symmetry Bespokes Final Thrust Up

Bespoke notes how the recent drop is symmetrical with the prior summer drop - 42 days top to bottom. This suggests a bottom with a final leg up still. Tony Caldaro further notes that the recent drop "retraced 61.8% of the previous uptrend [which] fits within the parameters for the typical wave 2 corrections during this bull market."

On the other hand, Zerohedge points out that today's action betrays the signature of a serious short squeeze. When we broke below the lower trendline of the big rising wedge, short interest increased; and often when the market comes back up to kiss the trendline goodbye, it denotes a short squeeze. 

Usually the stub week of Thanksgiving is positive, and the following Cybermonday is down, so look to several days action next week to get a read on this market. We came up near the tops in 2000 and 2007, close enough to argue for a triple top, but typically the triple top would be closer (ie. around SP1550-1600). It wouldn't surprise me to see a final thrust up. Given the false break below the trendline, this thrust would likely have a false break above - another short squeeze of players betting on the upper trendline - before the end. So SP1565 is still on the radar.

The primary elliott wave counterview is that this rally is a counter-trend rally in a larger move down, and using the math of Caldaro the other way round, should go back 62% before reversing down. So far the Friday thrust got us 38% back, which is usually the minmum retrace; and now we might see a down move (wave B of the countertrend rally) followed by a final move up towards SP1430 (Dow15K). At that point one of the two scenarios will meet their end; this Shroedinger Cat bounce will either be found dead or alive.  

Free Week Gets into the Good Stuff

Now they're talking - posting the STU and the recent Financial Forecast.  Click here for free week.  

Neely has also gone bearish after calling this really well for months.  I know Free Weeks often end up being bullish signals despite (or maybe because of) all the bearish predictions, but this time the broken clock may catch it. 

Summer Rally - 1440?

Unemployment rate up but numbers of new jobs higher than expected. This could signal more workers trying to find jobs (optimism) hence the unemployment rate ticking up is bullish. In the oddball world of BLS numbers, with adjustments, the actual number of employed dropped this past month, but the adjusted numbers are higher; experience has shown that readjustments made next month will give a better picture than the numbers today. But for today, a bullish signal.

Technicals suggest a run up over the next few weeks above 1400, probably at least to 1440:

From the site: "Lines B, C, and D are parallel trendlines based on the lows highlighted via the green arrows. Line C intersects with Line A near 1,280, providing a possible strong level of potential support. In terms of upside, Line D says 1,425 to 1,440 remains possible."

Big Up Move

I hold by the view of a final move up to the 1500s, likely getting close to or at new highs, a triple top of the 1550-ish level hit in 2000 and 2007. I now see other pundits joining in.  

Carl Futia is out with one of his bullish predictions: Big Up Move Ahead. His target is the high 1400s. The following chart shows the market bottoming at a confluence of levels - bouncing off the 1292 support level, hitting the lower trendline, and remaining above the 200 DMA - and having run about the same time in correction as the prior major correction:

All About Trends also gave a Long Side Trade Trigger Alert this morning in some specific ETFs, and is expecting the same for the S&P, given the retest of the 1292-1296 level and bounce off it.  

A lot of other wave bloggers report a break in the down channel, which is causing them to hustle into alt counts. Easier just to see the downtrend as ended. We shal see over the next few trading days.  

Prechter has released his recent Elliott Wave Financial Forecast for Club EWI members for free. It is of course über bearish, giving a plethora of reasons for a coming major decline. It is certainly valuable to peruse, particularly around the European contagion echoing history both in the 1930s and the 1830s, the first Great Depression in the then-new US. The EWFF makes a nice comparison between how Biddle's Bank of the United States and the Bank of England tried to stem a tide of bank failures between 1835 and 1839 and the Fed's similar efforts today. They both gave up in 1839, and we had a severe drop into 1842.  

Where I see the major difference to their view is the Euro contagion today is first leading to capital flight to the US, which is showing up in bank runs in Greece, Spain and Portugal; and a rise in Treasuries with the ten-year yield getting down towards 1.7%. This capital fight to US assets should spill over into equities, hence help drive a final run up in stocks.  

Final Market Rally: Market Bounces Off Key Support Level

The market bounced off S&P 1292 on Friday's "Faceplant Day". This is a key level, since it marked the peak of the initial Wave 1 rally off the October 2011 bottom at SP1075. This mid-day alert chart from AllAboutTrends shows the bounce: 

A lot of the doom-and-gloom Elliott Wave crowd were expecting it to break, confirming (in their counts) that the long-awaited and dreaded P3 wave down had begun. If we had broken it, the rally since last October would no longer be countable as an impulse wave since wave 4 (the current wave) would have breached into the range of Wave 2 (the wave after that 1292 peak). If we now hold above, the current wave since last October looks like a classic C wave, which breaks as an impulse in either a Flat or Zigzag correction.  

If this holds, we should expect my predicted final leg 5 up to new highs (since 2009), and a Triple Top at SP 1550 +/- (going back to the peaks 2000 and 2007). If this leg 5 mimics leg 1, it should run for about six weeks and go around 220 points, putting it above 1500. Structure isn't optimal, as we would have expected wave 3 to extend (ie go 1.6x wave 1 or 5). Also, historical patterns would point to a peak in August not July, to be followed by a September/October market drop, so this may run up more slowly than wave 1.   

Will The Stock Market Run to New Highs?

This chart, courtesy Contrarian Advisor, provides a great view of where we are, and it predicts that the S&P gets to above 1500, if not to 1600, in fairly short order:

The big picture view is that since 2000 we have been in a large corrective triangle that is leading to a triple top in the S&P around the 1550 range, with tops in 2000, 2007 and 2012. The shape of the triangle is a Barrier Triangle, with a barrier around 1500-1600 and an expanding bottom below Sp800. The implication is a drop from 2013 - 2015 down to the lower trend line, meaning to new lows below the March 2009 Sp667 intraday low.  

The doom & gloom crowd remains strident in calls for an imminent P3 wave down, despite the inexorable rise of the market. Their position is getting harder to support, if it has even been very supportable for a while. After a big drop as we had in 2008, the bounce usually goes 50-62%, but seldom beyond; if it gets about 70.7%, and especially 78.6%, it almost always goes back to the old highs. We hit the 62% retracement a while ago, and odds then switched to running up to a new high.

An alternative view to the Big Triangle is that the 2000-2009 drop is a classic Flat correction. This makes the wave up either the start of a new bull market - which should exceed the 2007 highs - or a corrective X wave with another down pattern to follow. Since that structure will be horizontal, given how this correction has so far unfolded, it also suggests the X wave will go back to the 1550 range.

X waves are not well understood in wave analysis, since they seem like a "plug" of a failed structure, but they are a very standard feature in markets, especially in extended corrective structures of a sort that don't break as triangles. So far the correction since 2000 has gone 12 years, so a wave analysts should look for a triangle or a series of horizontal corrective patterns connected by X waves.  

X waves tend to be simpler than the corrective patterns they connect, and therefore are usually zigzags - sharp rises, as we have seen since 2009. This one seems to be resolving as a large double zigzag, where the first zigzag rose into 2011, and after the big May to Oct correction, we started the second zigzag, which we are still in. Simple fibonacci analysis says it should go to the 1550 range: using the weekly numbers above, the first wave rose 680 points, and the second zigzag should run 61.8% to 100% of the first one. Using 61.8% of 680 points, we get a target of 1544.  

Usually stocks run up in an election year - and even more so in the year before - and then correct hard afterwards. Why is not hard to figure: the incumbent tries to get re-elected and uses whatever ways he can to pump the economy, then takes a huge hit in the first year to give his party a shot at another recovery into the next election. This is the Four-Year Cycle, the most predictable stock market cycle because it is driven by actions in the real economy. At a simple level, one could just stay long and pull out before 2013, when a whole bucket of negative events happen, like the repeal of tax breaks that are pumping the economy up.

Technical analysis supports this fundamentals view right now. 

Trendlines and Timing Point to a January Top

The seasonal pattern has a general rise in stocks from November to May, and we are seeing the market so far conform to that pattern. Usually within it is a February correction, leading to a number of January Tops over the past thirty years.

Sometimes that top marks a major reversal, as we saw in 2009 and 2000, but usually a month-long minor correction. Prechter has been predicting a major top now for the past two years, and a number of technicians have centered on a Jan 24 top prediction.

Now, often these timing predictions when they work mark a change of trend, but it is often hard to predict in advance which way. The market is in an uptrend right now, and might continue as such into next week, when this turn window occurs. This suggests a reversal down, conforming with the seasonal pattern. It still might be a minor correction, however. 

EWI has released through Club EWI a series of charts for the public, which add an additional factor, the approach of the market from below of a major trendline going back to 1932. As you can see from the chart above, the Dow in the late '90s crested the upper trendline, which previously marked tops all the way since the 1930s, and stayed above until 2008. The drop in 2002 bounced from above off the trendline, indicating continuation of the uptrend.

Since the reversal back up in 2009, the market has moved in 3 waves (a corrective pattern) to touch the bottom of the upper trendline. Failure to break through for more than a short time (a "false break") is bearish, indicting a fall down towards the lower trendline. Breaking back above and staying there is very bullish.

This suggests the January Top could be a major one, but step back and consider the broader picture. At trendline tests, a "jitter" or series of tests is common, and we might see a triple top or triple test over the next four to seven months. A false break is tested over the time frame of the pattern, and this one goes back decades, so a period which might seem longish to us (seven months) is but a blip in the broader time scale.

Hence it would not be surprising to see a test and a drop back - the February correction - followed by another test which might stay above the trendline for months - the typical bullish period of March to May at the end of the seasonal patern. If I can paint a scenario, we would then fall back in the summer and test one more time in late summer - the common August High before a serious Fall correction.  

Special Bulletin

It is with great trepidation that I post this, given my prior post, but the comments are overflowing & I wanted to give frequent readers a forum before you jump (or not jump) to "Mamma's" new place. Have at it, and as a treat a little technical analysis below the fold.

Near Term Market Levels

The market grinds higher, and the bears still call for tops. The most immediate is the double-double level of 1334 that we touched today - a double off the 667 bottom by the two-year anniversary. Bespoke notes that a double has happened only nine times since 1928, and The Big Picture adds that a double-double (a double within 2 years) has only happened two prior times: 1934 and 1937. After those double-doubles, those markets continued higher by another 35-40%, which would put this market back to to the 1550 level, a triple-top since 2000; after which those markets fell hard back down:

The STU discussed their target levels today, as promised. Last Friday they had drawn a line in the sand at 1341, but curiously that has dropped from sight. Here they have one way to count which puts the 1341 stop out to 1346, and another which puts it in the 1352 area, where C = 62% of A. (Wave C from July 2010, wave A from the Mar 2009 bottom), with some leeway to get above 1360. In addition, we are nearing the upper trendline, which gets to 1339 on Friday, and may provide resistance after a brief throw-over. There is a lot more in this STU for those who are interested. 

This upper trendline is shown in this chart from Robin Landry. He put out an update, discussing two possible wave counts, shown in green (the near-term top count) and red (the very bullish count).  He notes that if the Dow gets beyond 12444, then wave 5 would be longer than 3, and make 3 the shortest wave, which violates a core rule. Hence while he expects an interim top before 1244, he notes how the wave structure would turn to very bullish above that level. This was explored at length in Prechter's recent EWT as well. If we blast through that level, under these wave counts, expect this market to continue to run into 2012, and to approach the triple top at the 1550 level. 

In a special added page today, the EWT looks at the large channel going back to the 1932 low, and discusses another level to watch. The STU also adds to this discussion with more detail. A line drawn from the wave 2 low (which they put in 1942) and the wave 4 low (1974) is the lower channel. A parallel line drawn off the wave 3 high in 1966 creates the upper channel. The line in the middle of those is the mid-channel. Here is their analysis:

• The 2000 high went above the upper channel, a throw-over
• The 2002 low fell to and bounced off the upper channel
• The 2008 drop broke below
• The 2009 low bounced off the mid-channel
• The Hope Rally has come within 100 pts (in the Dow) of the upper channel

 This upper trendline may prove a line of resistance. It is indeed interesting that the 2002 low bounced off the upper channel and the 2009 low off the mid-channel. 

So are we at the critical juncture? Either we top real soon, or we shoot to 1500? And "shoot" is the only term to use; under the bullish wave count, we would be entering the most explosive phase of a bull market, the midpoint of the 3rd of the 3rd. This market would accelerate, rising at a steeper pace. 

If we grind further up past these 1340-ish or 12444 levels, but do not accelerate at a steeper pace, something else is going on. A contributor to SlopeofHope gives an alternative viewpoint that puts the level at 1361. The wave counts above pick the July 2010 bottom at 1011 as the start of the final C wave up, yet both Neely and Fractal Finance dispute that. The Flash Crash fell hard into May and then went sideways all summer long. The bifurcation out of that trading range happened at the end of August, coinciding with Bernanke's QE2 speech. Using that as the start of the final wave, we get a different picture: it is breaking not as a "5" but a "3" in a distinctive zigzag form:

 

A very common relationship in a zigzag is for A = C in length, which pegs C as stopping at 1361. So look for a pullback there.

Curiously, if it rushes past that level, the wave would begin to take the shape of a five-wave impulse with an extended third wave. A normal extension is 1.618x, targeting a run to 1475 area before a wave 4 pullback. A normal wave 4 retraces 38%, putting the market back down to 1361. A wave 5 would follow, and again a normal relationship is 5 = 1, which would peg the end of this whole wave at 1550. 

Another curiousity is that the Hope Rally into 2012 would take the following form:

• wave A from 667 (March 2009) to 1220 (April 2010) over 14 months
• wave B from 1220 (May) to 1040 (Aug)
• wave C from 1040 (Sept) to 1590 in Nov 2011 if A = C

Sometimes the time relationship is not A=C but A+B = C, meaning C might end around Feb 2012. Food for thought, but not honey for the bears. Right now the bears are sharpening their sweet tooths on their levels between 1334 (double double) and 1361. 

Another Line in the Sand for the Bears

A new line-in-the-sand is SP1341. The current wave up started at the end of January at 1275, and based on its internal structure, should not break 1341 before a serious correction. Curiously, this level was explained on Friday by the STU but largely ignored by the pundit-sphere, other than a small mention by Daneric:

If this count below is accurate [see chart], wave (iii) is shorter than (i) therefore the upside for (v) is limited by rule (cannot be longer than 30 points in length on the SPX)

The rule is that wave 3 cannot be the shortest, which (since wave 1 was longer) limits wave 5 to less than the distance of wave 3, or 30 points. Wave 5 started at 1311, limiting wave 5 to 1341. You can add this level to the levels I discussed last week:

1. the Gann double-or-nothing at 1334, twice the low of March 6, 2009 (667), which for Gann perfection should occur around the two year anniversary of that bottom, or around Mar 5-9, 2011
2. the false break of the upper trendline, which is touching the 1334 level early this coming week; and a false break may pop to 1340 before dropping back below
3. the 1352 level, where the larger wave from July 2010 would equal 62% of the initial wave off the March 2009 bottom, a typical relationship
4. the 1375 level, where the whole Hope Rally would retrace 78.6% of the big drop from 2007 to 2009
5. the April Analogy, where the top is already in but the bifurcation down is a week away (in April 2010 the sharp fall was over a week after the top)

I still find it telling that very few bloggers bothered to mention this latest level to watch; it is as if the relentless QE2-driven bull market has caused a domino effect of capitulation across the blogosphere. This may be the most bearish signal of all! Capitulation precedes a peak. 

Back in April 2010, the petering out of Quantitative Easing happened about when the Flash Crash came about. At the time it was not generally seen as a cause, as everyone focused on the drivers of the Flash Crash itself; but since the rise of the QE2 market, pundits looking back have conjectured that the liquidity pump of QE is keeping the market relentless in its rise. This points to June 13 week as the next endpoint, when QE2 is supposed to end, unless QE is extended (the Fed has commented on extending it further out but at a lower level of intervention so the total intervention is still $600B cumulative). 

Given my prior post and comments being floated by Fed members about ending QE, it may be a consensus will form that QE will be ended prior to the official Fed decision. Recall that this market began rising when QE2 was announced in late August, not when it was actually started in November. It may peak when the end of QE is clear, before QE actually ends. 

It is not clear that will be the decision right now, as these Fed member comments may be in the nature of planned leaks to test the market waters, not signals of a policy decision. More likely a decision will be driven by economic data, and in particular an acceleration of recovery (if that is what happens) and more signs of inflation. The inflation data may be clear by mid March, and the economic signs may be clear at the beginning of May when Q1 GDP is announced. Thus suggests the danger zone begins around the vernal equinox (Mar 20), skips across April Fool's Day, and extends into May Day. 

Patient Market, Impatient Pundits

I see lots of pundits trying to pick the top. Fool's errand. Better to watch for a bifurcation off the top before betting on a change of trend; otherwise ride it up. The recent bifurcation carried down into a trading plateau, but not below, meaning no break of trend. We would need a sharp drop below 1275 that stays below to confirm a change.

The market is in a channel and is touching the top trendline. The recent trading range was right on the mid-channel between the upper and lower trendlines. A bounce off the midline confirms a continuation of trend. You can see this in the following chart comparing the Dow with the Trannies (courtesy EWTrends). The Dow remains in the upper half of the channel while the Trannies have broken down, a divergence in Dow Theory, which would require a reversal back up in the Trannies to support a continued bull market:

Typically a trend ends with a false break, which in this case would be a thrust above that quickly (relative to the length of the trend) falls back below. Right now the trendline is above where we are, both on a closing and intraday basis, at 1328 Wednesday and climbing 1.5 pts/day. The STU is doing a good job of watching this closely and positing potential turn levels. 

I see a lot of the pundit-sphere pointing to a 78% retrace level (of the drop from Oct 2007 to Mar 2009) as the next key level. The exact 78.6% level depends on counting from intraday highs/lows or daily, or (for more precision) bifurcation points, but a reasonable level to use is 1375. Before we get there, we have another typical turn level ahead, 1352, where the recent wave C from the July 2010 low to now gets around 61.8% of the prior wave A from March 2009 to April 2010. A typical relationship in a sharp or "zigzag" correction is for waves A and C either to be equal or to relate by 61.8%. 

If this is a wave 2, the 78% level is really the point of no return. Theoretically a wave 2 can go 99%, but the odds say once past 78% then almost always this was not a wave 2. I can make a stronger case that once a wave 2 goes much past 62%, it is unlikely to be a wave 2, and statistically once past the repetition level of 70.7%, it rarely is a wave 2. The prime exception is a wave 2 that retraces a really sharp drop of the sort we had back in 2008 (call it a "crash"). The role or psychology of a wave 2 is to make the vast majority of market participants believe the sharp drop was an anomaly and the market is back to the prior trend. The sharper the fall, the further the comeback. 

Psychology may also come into play on the two-year anniversary of the Mar 6 low. Interesting is that we bottomed intraday at 667, and are close to the double, at 1334. Whether enough astrology or Gann traders are still out there, this might cause a stutter. 

Finally a lot of pundits have been comparing this market to April 2010, where the market went into a three-week trading range with a couple of sharp drops that were recovered before we bifurcated down. The high was in the middle of this range, and the eventual bifurcation down that led to the Flash Crash occurred about a week after the top. The implication is we have begin a three week or so plateau punctuated by a final high (1330? 1334?) that will be followed by another sharp and deep drop. One of the best discussions of this comes from AllAboutTrends: 

While a slight pop to say 1330 may mark the end, or a stutter around 1334, more likely we bump along the upper trendline up to 1350-1375 before a serious pause occurs. Given the trend slope of 1.5 pts a day, this points to a turn around 20 or more trading days out, or around the vernal equinox. We might test the midline again before then, but don't get too excited. 

After the Santa Rally: A Technical Analysis

"October is one of the peculiarly dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, August, and February." - Mark Twain

January has been a cruel month over the past decade. Santa Rallies hit January and fell in almost every year this past decade except 2006 (in 2001 it was already in free-fall). The STU has a nice chart of these January peaks, which shows:

• In 2007 we had a sharp fall on Jan 22 before resuming the final rally
• In 2008 the sharp drop started early, on Dec 26, 2007, and fell hard into March
• In 2009 we peaked on Jan 6 and fell a lot farther to the March low
• In 2010 we hit a major peak on Jan 19 and fell into February before resuming the rally into April

Will 2011 follow the same pattern?

Santa Rally Rides Through Storm Clouds of Market Extremes

Don't fight the Santa. Markets are at sentiment extremes, at the highest levels since October 2007 just before the all-time top, and this has led the punditry to expect a reversal; but it rarely comes this time of year.

The Santa Rally comes on the soft whispers of machines turned off, as professionals close the books for the year and head home for the holidays. Markets tend to rise on light volume. More stats here. The rise often persists into the first few days of January, making January 10 the day to watch, but be cautious (chart courtesy Doug Short):

• In 2008, we started down in late Dec
• In 2009, we reversed hard on Jan 6
• In 2010, we ran until Jan 19

A more bearish view comes from Citigroup. They look at three similar prior markets (1906-10, 1937-40, 1973-77) and conclude that the market is likely to turn on January 3 and fall at least 20%. Their chart:

 
This outlook will be quickly dismissed by almost all market traders, given the optimism that reigns. I will provide a technical analysis in my next post, but let's first explore the fundamental viewpoint. The sentiment extremes are driven by four core beliefs:

1. QE2 will spill over into stocks and commodities (indeed already have!)
2. The bond rout rotates investments into stocks
3. The tax deals signals Obama will do what he can to pump into the 2012 election
4. The economy is actually showing signs of life

QE and Bonds. I explored the first two in a recent post on Japan's QE experience, which supports the view that stocks will tend to rise as the Fed continues some form of QE. One should take such analogies with a grain of salt, as many other conditions are different, especially the fact that the two US bubbles (dot-com and real estate) pulled Japan up; which large economy will pull the US up? This makes the final two beliefs of larger importance.

Tax Deal. I explored the tax deal in my prior post, concluding it is much less stimulative than it has been sold. It can be estimated at adding around 0.9% to GDP based on around $270B of stimulative effect over the next two years, with much of that in 2011. This is not very compelling, but sure beats the alternative of austerity and a real double-dip next year. Of course, this all happened in the lame duck Congress, and the Tea Party influence is not yet being felt. 

In general, the Tax Deal bolsters the Four Year Cycle, which is driven by Presidential politics. The Four Year Cycle makes the two years leading into elections bullish. The third year tends to be the best for stocks as the President has taken the hits from his predecessor's mistakes and is pumping the economy towards re-election. If the Prez waits too long to pump, as Bush Senior did in 1991, he risks not getting credit for the pump. (In that case, the economy had bottomed and was in a rebound through the 1992 election, but Bush got too little credit for it.) If he starts too soon, as Jimmy Carter did in 1977, he risks a flagging economy in the fourth year. Obama shot his arrows early, and we are now in the backside of the Stimulus where it will act more as a drag on growth than a spur. Best that can be said is we may avoid the 1937 analogy of a double-dip but are still waiting for a real recovery to start.

Signs of Recovery? So far Santa has left jobs behind. This recoveryless recovery is not showing the type of turn we have seen in prior rebounds. Q3 GDP just got revised up by a small amount (to 2.6% from 2.5%), which was below consensus (2.8%). Goldman has done a great job of parsing through the GDP revisions and concludes that they have to pull back from the prior optimistic view of 2011. Key changes:

• more inventory than before (1.6% vs 1.3%) - a bad sign if it doesn't sell through
• less real final sales (0.9% vs 1.2%) - this is a key indicator of recovery
• lower corporate profits (0.2% vs 1%) - this may reflect a margin squeeze

There have been signs of improvement in Q4, and I expect a higher Q4 GDP than Q3, but this report puts a damper on 2011. In particular, the consumer is not back, despite some promising holiday sales. Keeping the consumer on life support, such as the two most stimulative parts of the Tax Deal (the FICA tax reductions and the extension of unemployment benefits), is just kicking the can down the road. The Consumer Metrics Institute shows the consumer still in a funk, and starting to trend down again (the blue curve):

Is Peak Optimism Giving a Sell Signal?

Stock sentiment readings have reached extremes. Friday's STU outlines how many of the market's internal extremes are "stunning." The market enters the Santa Rally "severely overbought and deeply overbelieved." This should not be surprising, since as the The Economist notes, this year has done much better than expected:

Global output has probably risen by close to 5%, well above its trend rate and a lot faster than forecasters were expecting 12 months ago. Most of the dangers that frightened financial markets during the year have failed to materialise. China’s economy has not suffered a hard landing. America’s mid-year slowdown did not become a double-dip recession. ...

Earlier this year investors were too pessimistic. Now their breezy confidence seems misplaced.

Fractal Finance notes how markets ratchet from one extreme to the opposite, rather than behaving rationally. When fear gives way to greed, sentiment runs hot quickly, faster than reality. You can see how the market has rushed from overbought to oversold and back rapidly over the past year (chart courtesy Bespoke, showing the S&P above/below its 50 DMA):

The ARMS Index (TRIN) is at its most overbought since 1956. As ZH so colorful puts it, the TRIN is an indicator of market breadth which "essentially tracks lemming like momentum-chasing behavior." They add that historically any short-term gains after such extremes get "erased during the months ahead." The Big Picture notes that the ARMS Index has a pretty decent track record, and then supplies the following chart with this juicy comment:

This suggests that the Fed's QE2 and euphoria over tax cuts and FICA holidays are up against a rather overbought condition. 

The Friday STU continues with a whole series of extremes & inter-market divergences, worth reading if this drives your trading decisions. While they don't peg a level for the top, they say at current levels it satisfies normal relationships - for example, the S&P is slightly above the 62% retrace of the whole drop in 2007-09. Some bloggers have fixated on Sp1246, where this final wave 5 is 62% of wave 1 (of the C wave that begun at the July low of Sp1011). Other relationships could emerge, such as 1291, where wave 5 would equal wave 1.

Picking a top is a difficult game. Neely called for a short on Wed but it got taken out. His wave structure should not breach 1240. And a drop may not be the top, yet. The bullish Carl Futia expects the market to hit strong resistance at 1250, and further expects a 50-75 drop "imminently" before heading back above 1300. Even more ebulliently bullish is a self-described "former bear" over at ZH who thinks the market has a ways to run:

Bears continue to get firehosed by the infinite fiat spewed forth by "The Ben Bernank"

He points to the lack of full retail participation in the market, which normally accompanies a top. Indeed, the small investor has been steadily abandoning this market rather than piling on, not normally a characteristic of a bull market either. So his indicator could be used either way: not a top, or not a bull. 

Precious metals remain on a tear but also may be hitting resistance. Silver has been phenomenal since the late August confirmation of QE2. It has risen above $30 and breached a long-term resistance line, suggesting a pullback over the next week. It had hit that line in early November and fell hard off it, before continuing back up. If stocks reverse hard here as well, the STU believes this might mark a long-term top in silver. Of course, they have been bearish silver and gold during this whole rise. They think gold too is at a top, as the USD seems to be on a tear itself, and normally Dollar strength would result on Gold weakness. 

(There is a lot of hoopla in the blogosphere that silver is rising due to a massive short position by JP Morgan, but this JPM Massive Silver Short story appears to be bunk.)

A final indication of extremes is that investors hold the biggest commodity positions on record. Speculative contracts in commodities are 17% higher than at the prior peak in June 2008, right when oil hit $147/bbl and fell down to $32 before bouncing. This is apparently not just a bet against the Dollar, but against fiat currencies in general. The CFTC may try to kill this, which will cause a fast reversal. Despite the speculative fervor, the CRB remains below the 2008 level:

Will the Poor Unemployment Report Kill the Santa Rally?

The Santa Rally traditionally comes in mid December, but has it already started? This year we saw the seasonal strong period get off to an early start, in September rather than the normal November, which might be a harbinger of an early start to the year-end rally. Retail sales over Black Friday and CyberMonday were "way up" year-over-year, according to SpendingPulse, continuing a trend first gleened in September of increasing spending.

Before we get drunk with excitement, like our Santa here, a little caution. Friday's unemployment disappointment included an increase in seasonal workers, up from last year, but still below pre-crisis levels, and on a seasonally-adjusted basis, still below normal. This means retailers are being cautious. 

We all should be cautious about this recovery. Employment has been flat for a year, and you can see that the unemployment is ticking up slightly (the red dots in the next chart). Normally it ticks up as an economy recovers before ticking down, as workers on the sidelines come back to seek employment faster than new hires are made. A little of that is going on, but largely we have not seen job growth other than temporary or part-time work. This remains the Recoveryless Recovery. 

We also should be cautious on stocks. We have a conundrum: possibly the early discounts pulled forward sales that normally would have happened in December; or perhaps the American shopper has now become so discount driven, we will see a pause in shopping until the retailers entice with even better discounts, giving a late surge to the holiday sales pattern. How to translate these choices into a prediction for the stock market?

Monday Should Give An Important Market Tell

When QE2 was pre-announced at Jackson Hole, the market took off in the September-to-Remember rally. The fundamentalists touted its advantages to keep rates low, spur stocks to rise, and improve the economy via a cheap Dollar; they also anticipated a Republican victory in the mid-terms. When the election happened as expected, and QE2 was formally announced, markets began major reversals. Was this simply a matter of buy-on-rumor, sell-on-news, or something more?

Fundamental analysis does little good at this point. After the reversals, the fundamentalists changed their tune: QE was ineffective, was leading to currency wars, was driving rates up on inflation fears, etc. 

The reason it might be something more comes from Sy Harding, the keeper of the seasonal pattern (buy in Nov, sell in May). His weekly post comments that the seasonal pattern may have started early this year, at the end of August; or perhaps something else is happening: bullish sentiment got to extremes normally seen at a major top, and so perhaps the whole Nov-to-May pattern got compressed in a short two months. As he puts it:

Interesting enough, the market experienced a big triple-digit rally on Thursday that carried the S&P 500, Dow, and Nasdaq back up almost to their 21-day moving averages in one day. But the rally stopped just short of those resistance levels. So the question is still out there. Normally, market analysts would not be focused on such short-term considerations. But a situation is also in place that might have intermediate-term implications, thus making how the market deals with the short-term support and resistance levels more important.

Wave Theory is most useful at these points, to give guidance or at least signposts as to what comes next. Since technical analysis is probabilistic, this guidance is odds-adjusted. Some calls are high confidence, others are low. At those times, best to make no calls at all.

The lack of confidence in the punditry is why I have been off stock predictions for a bit. The pundits have to bravely carry on anyway, and so let's look at them: 

• Prechter in his monthly Theorist concurs with Sy Harding that this could be the start a something big, although the better odds are we make one more run at the 1227 level. He has been on an All-The-Same-Market view for a while, that global markets are linked, primarily to the Dollar. He lays out a convincing case that global markets all topped and reversed between Nov 5 and Nov 10, as the Dollar bottomed. At that time bullish sentiment hit extremes typical of a top. 
• Neely has called for a new short position, with stops, indicating high enough odds for a drop from here, although not a major move down. 
• The STU sees two choices, and believes how the market opens on Monday will provide a huge tell as to direction over the next few weeks: will it turn down and break below Sp1173, indicating a deeper correction, or continue up back to the 1227 range, indicating a sideways move?

Fractal Finance also provides a useful description of the past three months. Markets are order-seeking mechanisms and when they find order they move quickly in a thrust, anticipating the future gains before they arrive. When they reach the limits, they pause to seek order again, driving the market into a sideways move which can often seem volatile. The reversals we have seen so far are the choppiness from being on the edge of chaos, seeking order. The market spiked up to 1227 and came back down into a prior trading range, but has not yet bifurcated out of the range. This suggests a period of sideways motion. The bifurcation out of the range will be the confirmation of a new thrust beginning. They usually come after a triple test of the top or bottom of the range. 

Let me illustrate with this chart from Wave Principle. It shows the plateau that formed after the thrust from the end of August. The green lines mark the general zone of chaos in the plateau. We then came above it and have now fallen back into it. We are sitting right on the upper end of the plateau, waiting for a break one way or the other. As you can see, we have so far tested the bottom twice, once before the jump above the plateau, and the second time earlier this week:

Pulling back to the larger picture, we have a much larger plateau that stretches back to January 2010 (and arguably even farther back) and so far has had two tops at the 1220 level. A third test in the 1220-1235 range would be expected, although not required. Prechter thinks it will come in January. Sy Harding would have expected it in May under the normal seasonal pattern.

Let me marry wave theory with fractal finance. The move up since Jackson Hole seems to have ended at 1227, but the not the whole primary wave since the low in July. The recent top likely only reflects an end of wave 3 and we are now in a wave 4 with a higher high ahead above 1227 in wave 5. If we break below 1173 on Monday, that indicates a sharp correction characteristic of 1227 being a major top (although it doesn't confirm it, just increases the odds). If instead we move sideways, that suggests that we are in a wave 4.

Let me illustrate the choices with the next chart from EWTrends, showing the market since July: 

If we count the action since the low in July as the primary wave, wave 1 (red) went up for six weeks into early August, and wave 2 (red) fell for three weeks into the end of August. Wave 3 (red) ran up for over 7 weeks into mid-October, where it started a plateau. That plateau was a short sideways action that didn't retrace much of the prior wave, which makes it more likely to be merely a minor wave 4 (blue) of wave 3 (red), and not a major wave 4 (red) of the primary wave. The subsequent spike up to 1227 was also relatively short and brief, again making it more likely to be a minor wave 5 (blue) rather than a major wave 5 (red).

You can see that the chart leaves it a ? which way to count that sideways move, but the STU believes the odds favor it being but a minor wave inside of wave 3 (red). Prechter in the Theorist (EWT) agrees:

We can also count the rally as done, with barely discernible fourth and fifth waves, like the last rally into 2007. But on the basis of form, this must be considered an alternative interpretation.

Wave 4 of the primary wave should go for weeks, to be followed by wave 5. Wave 2 (red) was a sharp correction, so this wave 4 will be sideways, either a flat or a triangle. Possibly we stay sideways into mid-December and then have the proverbial Santa Rally into a January top; but sideways corrections tend to take an annoyingly long time, and could put the triple top out into Q2. Here is what to look for:

• a sharp drop Monday below the 1173 level suggests a flat, which could then rise ABOVE the 1227 level, emboldening the bulls, before falling back down again for that triple test of the low
• a rise towards 1227 Monday suggests a triangle, which is likely to bounce between 1173 at the low end and 1227 at the high, coming to an apex before the final thrust up in wave 5 (red)

Since this short stub week before the two-day Thanksgiving holiday in the US tends to be up on light volume, I favor the triangle case. Also be on guard for the two edge cases:

• a continued drop below 1130 (the dotted line in the chart above) and the top is in 
• a sharp rise above 1227 and these pundits have a lot of explaining to do

The Last Bear Hangs In There

Contrarians are waiting for capitulation by the final few bearish analysts before picking a top. Most have gone silent after the market broke the April highs this week. The WSJ trumpeted today that the Dow has now recovered all the loss since the Lehman debacle two years ago (see chart, courtesy Bespoke):

A number of traders like to fade the most popular bear, Bob Prechter, and thus are waiting to see how his monthly service, the EWFF, explains the new highs. Rather than turn into a latter-day bull, the EWFF remains firmly bearish, but had to jump through an analytical contortion to get there. They now see the Hope Rally as a large ABC zigzag with the first leg running all the way to the April highs. In a zigzag, waves A and C break as impulsive five-wave structures. In order to get there, they had to concede that that wave A was a five-wave move even though they admit it lacks a clear five-wave structure in its impulsive waves (1-3-5) and lacks alternation in its two corrective waves (2-4). Tony Caldaro should be smiling, since he was the first major wave analyst to call it that way. The mea culpa from the EWFF is "there are times when lower probability outcomes occur, and this was one of them." Somehow this is very unsatisfying from what normally are tough analysts.

In contrast, the third major wave analyst, Glenn Neely, has stayed true to his methodology. He has a different wave structure for the Hope Rally, where he ends the first wave up a year ago amidst that choppy Sept-Nov action, calls the Nov-Feb period last year a corrective X wave, and counts the action since as a large corrective pattern where wave A went to April highs, wave B is the flash crash and its aftermath, and we are now in the final wave C. He thinks odds favor a short right now. No ewaverer he. 

Interesting is that both major pundits are coming to a similar near-term outlook. Neely expects a down wave 4 and a final up wave 5 to complete his C wave. Prechter sees wave A ending in April, wave B ending at the July low of Sp1011, and wave C has breaking so far as a 1-2-3 pattern where we are in 3. He too thus is looking for a wave 4 down and a wave 5 up to complete the pattern. He leaves open an alt count where the July low is but wave (a) of B, and we are in wave (b) of B with a (c) to go. This might get confusing with all the waves but it implies that after the little waves 4 and 5, we have a correction to Dow9500 and then a final rally.

Martin Armstrong, still in jail, has restarted his own market numerology, which pegs a major turn point to June 13, 2011. So far all the wave prognostication has prematurely called tops. Perhaps Martin's date will be closer to when the Hope Rally truly fades. 

How should contrarians play this? Turns out the net bullish sentiment (bulls less bears) is at its highest of the whole Hope Rally - indeed a three year high (ie since the 2007 top). Futures traders are 94% bullish, the highest since January 2007. How much upside is there when bullish sentiment is higher than at all prior tops, including the all-time high in 2007?

My take: continue to watch the Dollar. It broke below the three-year support level yesterday, but has come back above. The bullish case in stocks is based on a bearish Dollar. A Dollar bottom reverses all the recent trends driven by belief in QE and the Bernanke Put. If it remains above it may have put in the bottom. 

Bullish Golden Cross to Follow Yesterday's False Break

In Fractal Finance, when a break comes out of a trading range, then reverses back in quickly (relative to the length of the range), it is a False Break. Yesterday the Dollar continued an upwards break, but today fell back into last week's congestion zone. The S&P did the same in reverse. Under wave theory, what looked like the start of five-wave impulses in both indexes turned into three wave zigzag (sharp) corrections, as you can see from this chart by Principal Analysis:

The S&P had done a triple top in the e-mini futures but only a double top in the cash index, so a third retest is underway. If we break above the trading range, under Fractal Finance this is very bullish.

Another bullish indicator is the Golden Cross, which now is inevitable:

According to Traders Narrative, the Dow had the Golden Cross on Oct 1, and the Naz is also about there. We had a Death Cross back in June, and it proved to be of little importance. In general I do not give much credence to these crosses, but they are interesting to the extent they create momentum among traders who do follow them. 

The bears are running out of things to hang on to. It is close to the kickoff of the seasonal strong period (Nov-May) when bears should go into hibernation. The bears can point to the S&P triple top, and to the reversal today not retracing all of the break yesterday. This bearish wave count is best put in this chart from the site which sounds like a Euro luxury car, gi61et:

Here is a chart of same not-quite-all-the-way retrace in the Dollar Index (courtesy Contrarian Advisor): 

For those of you who like to fade Prechter, tonight's STU became short-term bullish, or perhaps more precisely, short-term on the sidelines. They read the false breaks in both the Dollar Index and the Dow/S&P as corrective waves, and therefore expect a final wave to come to retest or even break recent levels (below 76.14 in the DX). It would take another reversal back up above the 78.36 high in the Dollar Index to change this. Yet they remain agog at the bullish extremes in stocks - levels above both the April high and the Oct 2007 high.  Some sort of stock correction is overdue, although it appears it will wait for the Dollar to bottom. 

Those sentiment extremes came a couple of weeks before the actual top. This would suggest any clarity will await both the Nov2 mid-term election results and the Nov3 expected launch of QE2. The Repub's taking back the House seems in the bag, with around 55 seats likely to switch. Another 44 seats are contested ("99 seats on the wall" was the quip by Politico.) If the 44 split evenly, the power reversal will be historic. The Senate seems too close to call, with a gain to 49 seats likely but getting to 51 seats (necessary for control) problematic. As a consequence, uncertainty as to the future political climate remains an issue. The launch of QE2 is pretty well assumed, but the scale and timing are uncertain, and may be influenced by the Q3 GDP report on Oct29.

Neely expects an imminent strong up move in stocks to complete wave 3 of the final five-wave C. Target would be 1200. After that comes the overdue correction, but not an end to the upwards trend. The interesting site TradeYourWayOut has a bullish view which points to a top in March 2011, but first they expect the overdue correction:

Bullish Breadth Extreme

The market has settled over the trading range and seems to have Sp1174 in its sights. In a Fractal Finance view, by closing above the trading range (1130-1150) and staying above, the odds are favoring a continued bullish break up. The 1174 level is an important one, since it represents the 'fourth of the prior third' (the big bounce right after the flash crash went all the way back to 1174). Tonight's STU notes how this is the most common retracement level. This level is also the 78% retrace if we count from the July low (it is 1181 if we count from the May25 low). The 78% retrace is the last line of defense for the bears. Above the 1174-81 levels, and it is difficult to maintain a bearish posture under wave theory. 

There are several caution flags for the bulls. The Nasdaq is diverging, as the recent tech leaders took fairly big plunges today. Nice chart from EWP:

Sentiment readings are not supporting the rally, such as the 5-day S&P A/D ratio (discussed in the STU). Perhaps the most interesting breadth reading comes from Traders Narrative, which noted yesterday how the number of S&P stocks above their 50 DMA is nearing the levels of prior tops. This metric began to pop up across the blog sites today. EvilSpeculator has tracked this indicator, and discussed it on Sunday, concluding "we have not been this overbought in years."  Here is the chart:

Now, in a thrust up sentiment levels can remain extreme for a while, so hitting such levels is not suggesting a quick reversal. It does suggest, however, that when the reversal comes, it will be sharp and unmistakable. 

The focus is now to the unemployment report on Friday. The STU notes an interesting win-win argument floating around:

• if unemployment is lower, it suggests a recovery, and is bullish
• if unemployment is worse, it suggests the Fed will be more aggressive with QE2

When fundamentalists win both sides of the argument, contrarians get ready to fade their position. Put more prosaically, if the market anticipates the win-win, it will rise on the rumor. So sell on the news. 

Final item is to watch the USD. It continues to sink in the Dollar Index, down to 77.3 today and closing under 77.5, with only 4% bulls. The Euro is approaching $1.40 with only 3% bears. The STU notes that the 'fourth of the prior third' level is $1.403. The next stopping point for the DX may be the lower trendline from the lows in March 2008 (Bear Stearns!) and November 2009, which is around DX76 (yesterday's chart courtesy Contrarian Advisor):

 

A Chartfest at the Turn

We are right at the Oct5 turn window. As the market continues longer in its trading range, the odds of a top increase. We are closing on the point where the rise from the beginning of September to now becomes slower than the rise off the July 2 bottom. Let me run through a series of charts with a discussion of whether we are in a topping period which is about to end.

Bullish Arguments

The market today opened down and ran to the 1131 level, testing a bottom hit a week ago. Both the Dow and the S&P broke below last week's bottom, intraday. The bounce off it comforts the bulls by closing above a serious support level, but looking a week further back shows we are close to bifurcating below a two-week trading range. The prior test of 1132 bounced immediately in a V, but this one is stuttering along the bottom of the trading range. See chart courtesy Contrarian Advisor:

  

Carl Futia draws trendlines around this range in the e-mini and predicts a drop to the lower trendline (es1127) followed by a bullish bifurcation up. 

SlopeofHope has a fascinating guestpost showing a potential fractal pattern with the runup to the 2007 top, where we plateaued for a while before bifurcating up:

In a Fractal FInance view, the market is an order-seeking mechanism which runs in a thrust when it finds order, then pauses in a plateau as it seeks the next level. After the Fed's late August meeting where QE2 was made more likely, the market thrust up over three weeks then paused at 1148 on Sep22 and has sat in a trading range between 1150 and 1132 for the two weeks since, with one false break below to 1123 and another above to 1157. We have hit the upper range four times, and failed to break through on the fourth try. In a chaos theory sense, energy is now leaving the system.

Bearish Indicators

The SlopeofHope post notes that volume is not confirming the rally, and is more indicative of a distribution pattern than accumulation. Others have noted how the MACD is rolling over, a bearish sign:

The bearish consensus view, which you can read at sites such as EWTrends, is a break of 1123 will confirm the change of trend. If you look at this closeup of market action, you can see a potential bifurcation down forming. From a Fractal Finance point of view, it only needs to thrust below 1132 and stay there for a few days to confirm the change of trend:

The most telling technical indications come from the divergences across the major indexes. MarketThoughts takes on the 'pause before the next top' argument by looking at how the Nasdaq has already broken below the trading range: 

The STU tonight goes farther, and points out that the Nasdaq 100, which includes the most important Naz stocks, has closed at its lowest level in two weeks. Could be that the tech stocks, which have helped lead the September to Remember charge, are now signaling the October Surprise. 

The most important bearish indicator is in the Currency Wars: the Euro has now hit a level which the STU highlights as a "beautiful picture" of relationships for a top in the Euro. At an overnight $1.38, it has retraced 61% in both time and price from the April low of $1.19, and is right at the fourth-of-the-prior-third level (of the extended first wave down off the $1.51 high in 2009), a common turn point. With only 3% Euro bears, sentiment favors a turn. The change in the Euro's fortunes will of course reverse the Dollar's slide in the Dollar index, where sentiment is also decidedly ready for a turn, with only 5% bulls. 

Neely also favors a turn down in stocks. Neely sees us in a bullish wave up, but in need of a deep corrective wave. He has been counting the whole move off the Feb5 low as an ABC corrective pattern, with the A wave to the April highs, the B wave to the end of August, and the September to Remember Rally as wave 1 of the C wave. Time and price suggest a reversal here and a deep drop of at least 50-62% of the rise, but not to new lows and not below the lows at the end of August (1040). He speculates that wave C may take the form of a Terminal, which in orthodox wave theory means an Ending Diagonal - a five-wave pattern that breaks as an ascending triangle. 
 

The Bears Are Looking Excited - About 1939!

We gapped up to Sp1157 and then fell in five waves. The counter rally that faded at the close was 3 waves. This is a signature of a change of trend, with the five-waves pointing in the new direction. Of course, the bears have been calling "top! top!" so much they have lost credibility, yet they are out in force tonight across the blogosphere. They may be back in hiberation tomorrow, but let me set forth their case. (Kilroy Bear picture courtesy SlopeofHope, home of the happy furries.)  

The pattern of five waves down and three up is clear across many indexes. This sidebar chart is from Daneric. (Click to make it larger.) The level reached today - 1157 - is right at 1158, a favored target of many bears, where the September to Remember C wave would travel the same distance as A wave from the July bottom to the August top. The time is slightly shorter than the STU turn dates from this morning's post, but fit the STY target of 1158 as well as the Gann 90-day rule between the July bottom and an Oct 1 top. The gap up and reversal is the signature of an exhaustion gap - a gap at the end of a strong trend which reverses back below. The September to Remember rally is the best September since 1939, and one of the best rises for any month - qualifying as a strong move. You can go down a list of additional technical indicators that point to a top here. 

Readers know I have been reporting on various historical analogies, with the 1937-38 double-dip the most closely aligned with today. There is some bullish buzz around 2004, which I may highlight next week depending on where the market goes, but it would be remiss not to look deeper into 1939, the last great September to Remember: after the rally in 1939, we fell 40% to a major low in 1942, and remained in a bad market for a decade. We didn't break out of the Depression Market until 1949. Take a look at this 1939 chart, courtesy The Market Ticker, who highlights where we are in pin:

Now, that other September to Remember is really remembered for a different reason: Hitler invaded Poland, kicking off World War II. It is fair to say the world conditions are quite different.  All we have going on besides our Imperial Adventure in Afghanistan is a brewing Currency War between China, Japan and the US. Not the stuff of legend, nor even worthy of a Hitler Video. 

Market Removes False Break, Neely Goes Bullish

I have been tracking whether the break this week was a False Break that would be rapidly reversed or a Bifurcation up to 1174. When we fell back into the trading range (below 1128) yesterday, it raised the question whether the break above was a false break, but I added the cautionary note that we have to remain below or it did not change the prior view of a bifurcation up, just raised a warning flag. By going back above it removed that flag. 

Amidst a lot of bearish angst, we now have a bullish prediction beyond what is flying around the blogosphere - I will save that for the end.

Kudos to EvilSpeculator and their Zero, which warned of a bear trap. Indeed it was! Molecool says to watch the JPY spread with the AUD. Something funky is happening: the BOJ tries to debase their currency and fails to move it much. Impotence of the central bank, or something more sinister? Rumors of China buying Japanese bonds to in effect unwind the BOJ's actions. Here is what happened today (from ZH): 

Today's STU also focuses on currency reversals. The Dollar Index (DX) broke through a trendline from the Nov 2009 low at 74.17 through the Jul 2010 low at 80.09, and fell hard for the last two days to below 79.60. We are down to 8% Dollar Bulls, similar to the 7% lows of those prior two low points. Ben's QE2 is working black magic, killing the Dollar as it props up the deficit. Watch for a DX reversal as the signal for a top in equities. 

It is informative to scan the many ewave blogs to see where the bearish consensus is herding to: Sep30 or Oct1, the next Gann spot, at 1158, which strikes me as a bit low. JT, a reader, left a concise comment that if the Flash Crash down ended on Jul2 in a leading diagonal (LD) formation, the expected bounce should go 78%, or to 1174. You might expect that EWI would agree, since Prechter wrote the book on that relationship (78% retrace after an LD), but they do not see the drop as an LD. Instead, the Friday STU sees the gap open today as a classic thrust out of a fourth wave triangle, which means it is either spent or will be slightly above 1150. 

AllAboutTrends calls this a Climax Run, pointing to the negative divergences in the RSI vs the retest of recent highs. They too think it is about spent. MarketThoughts speculates that we may have had a small ending diagonal (ED) today, which means we should gap down Monday. They urge readers to watch the Naz, which now seems to be leading the other indices.

So the bears have their story and they are sticking to it. Fractal Finance says after a trading range, a bifurcation occurs. If we run up strongly, that indicates we are bifurcating up. Always watch for a False Break, but they have to reverse fast back into the range. We had a False Break to the downside on Jul2, going below the 1040 level, but came right back into it quickly relative to the time scale of this trading range (now four months and counting). It could be we reverse back down - this might have been a last gasp today - but if not the bears have to wrap their positions around a bullish case. 

Neely plans to issue a report next week arguing for the bullish run. We shall see how Monday and Tuesday run before he launches his view, but he gave me permission to preview it. 

Punchline: we may exceed the April highs in late 2010 or early 2011. 

He has counted the action since the Feb5 low as an ABC flat:

• The A wave went to the April high at 1220
• The B wave began with the Flash Crash and broke as a double flat that ended with a failure (higher end to C wave than A wave)
• The C wave began on Sep2 and should break in five waves. 

He has gained confidence in this count because the C wave so far has run faster than the prior wave from Jul2 to Aug9 - this indicates a change of trend. Wave 1 of C is nearing an end, which creates an utterly stunning Bear Trap: wave 2 of C should soon start, and drop 50-62% of the rise (or back below 1100), encouraging the shorts. Then wave 3 up towards new highs. 

Seasonal timing would give us a poor October followed by the normal November - January rally before some Feb weakness. 

Key factor to watch: if this wave up begins to plateau from here, as it has for a week, it would slow the ascent. The inside b wave ran from 1011 to 1129 from Jul2 to Aug9, or 38 days. If this one stalls below 1158 beyond Oct9, it would have slowed too much. Hence it is likely that wave 2 starts pretty soon, likely by end of this coming week. 

Final comment: I do not have any affiliate relationship with Neely, but do get a complementary subscription. I have noted a number of times that his trading service is much more actionable than others I follow, and he is willing to stay with predictions that go against the ewave herd. If this begins to play out his way, you might check his service out. 

Fractal Finance Suggests the Summer Rally is Over

We have now closed back within the big trading range between 1040 and 1130, and right on the predicted turn window of Sep23. This makes the recent pop to 1148 a False Break if we remain below. This would mean the Summer Rally is over.

It is too early to definitively make this call, but the odds have increased. Molecool over at EvilSpeculator is pimping his Zero indicators, which I must say look pretty impressive. Mole may have created a new and useful indicator. To be watched. Zero is NOT pronouncing the end of the Summer Rally. 

A break below the recent 'plateau' around 1114 would further increase the odds, and below 1090 confirm it (see chart, courtesy EWTrends, which shows the initial thrust off the bottom and the two trading ranges around 1100 then 1120): 

Bob Bronson had predicted a top between the autumnal equinox (now) to the end of the month, and believes it is in today. He also points out that leading indicators are turning over, which makes the recent NBER pronouncement of the end of the recession quite ironic. Their contrarian timing is impeccable! Also, any return to negative growth will be an official double-dip, as we have now come out of the first dip, even thought we never got back up to where we started. In the double-dip of 1980, we came back up then fell down. In the original double-dip in the 1930s, we never got back up before falling again. 

Bronson's double-dip charts are pretty interesting, and include a prediction for the path and timing of the next phase of the Great Recession:

Critical Retest Underway - Market is Threatening to Bifurcate Up

In the last three days the market has followed a typical pattern: run up into FOMC and then fade after. (You can really see this head fake over in the bond market.) On Monday we closed above Sp1128 for the first time since last May, and stayed above yesterday, but today have come down to 1132 twice, so a retest is on. For Fractal Finance, if this is a False Break, it needs to come back to close below 1128 pretty quickly, preferably by my turn date of Sep23 (tomorrow). Otherwise, unlike with orthodox wave theory, the pattern suggest a bifurcation upwards. Carl Futia provides some guidance (1174 in the short run, 1250 thereafter):

Bears Pushed to the Edge

Scan some of the bearish sites and you will see shock and dismay at today's rally above the 1130 resistance level. As they topple and capitulate, it is almost time to call the top. Fractal Finance is being stressed, as it needs this break above to come back below 1130 by the end of the week, but my timing of the autumnal equinox (Sep23) is looking plausible for that top call. 

The nested 1-2 count of EWI is blown, and they have a new count: a double correction, which they describe in their tutorial (free) in lesson 5.1. The implication is this is wave C of a zigzag off Jul2, and while the STU gives other targets and a deeper analysis, typically the C leg of a zigzag goes the same as A, which in this case is 1011 to 1129, so it should go from 1040 to the 1158 range (say, from 1151, the Jan top, to 1174, an interim top in the Flash Crash).

Fractal Finance is now 4-0 over orthodox wave theory, but before it can notch the last win, this needs to turn into a false break. Neely, lying in the weeds all summer long, is comfortably in his prediction of this rally, but curiously is urging readers to stay out as he doubts the staying power. Even the bullish Carl Futia sees the market as still overbought. Midday today he expected churn around 1127 before a run to 1174. 

Market is Overbought With Sentiment Running High

An overbought market with very high bullish sentiment is usually the formula for a pullback. Sy Harding has a good dissection of the current market, and predicts the pullback, He is the keeper of the seasonal pattern, and notes that between mid-Oct and mid-Nov at the mid-pont of the Presidential Cycle is almost always an excellent time to buy, even this year which many argue is different. You can read his case in this post. But we are not there yet. 

We are running into resistance at 1130, which also suggests a pullback. In addition, the market conditions which spurred this three-week run may be turning around this coming week. For example, the dramatic rise in the Yen has caused the Dollar Index to fade, which in has been good to stocks and commodities. Late last week we saw political moves to weaken the Yen. A strong Yen reversal should spur a Dollar Index rise, shifting one of the major drivers of the last three weeks.

A further reason for a pullback is the rampant bullishness. Prechter's latest EWT does a great job of comparing the current levels of bullishness with other tops, including 2000 and 2007. Among other tidbits are that mutual funds have the lowest levels of cash in the past 60 years, even lower than 2000 and 2007.

This EWT is an interesting read, and includes a counter-opinion to Sy Harding's firm belief in the continued viability of the Presidential Four-Year Cycle. In April, just before the top, the EWT was entitled A Deadly Bearish Big Picture - very propitious timing (and another great call like the one in late Feb 2009 when Prechter went bullish, which he is given too little credit for.) The April EWT delved into cycles (among other items), including the four-year cycle. The EWT sees it as abating in importance, pointing to the lack of a crisp four-year bottom in 2006, and instead they see a 7 year cycle emerging as more important, pointing to critical macro-event turn points in 1973 (oil crisis), 1980 (peak gold, peak rates), 1987, 1994, 2001 and 2008. (At the time they first postulated this in 2004, they predicted 2008 as a bad year). In the April EWT, they charted a 7.25 year cycle in stocks that somewhat followed the event cycle: 1980, 1987, 1994, 2002, 2009, with the next bottom now predicted for 2016.5.

Curiously, this means their beloved P3 down should not go to a shockingly low bottom until 2016, not now. It is rather difficult to square the 7 year cycle of the EWT to the near-term bearishness of the STU. The 7-yr cycle is still in the uptrend part (first 3.5 years) since March 2009, or 2009.2, and should head to its next peak in 2012.7, or August 2012. This suggests that even if Sy is too reliant on the four-year cycle, he may be just right on his call to be prepared to go long after the (possibly) coming October bottom and play the traditional Presidential re-election pump-priming rally.

Perhaps we get a near-term low between Sp850-950, and then have a pretty good run up into the 2012 election summer. This would fit a wave structure where the Hope Rally is a wave A, the current correction a wave B, and an 18-month C wave is ahead. Within the current wave B, the Flash Crash fell 180 S&P pts, the sideways summer has come back up to 1130, and a final wave down that is about as big as the Flash Crash would go to 950. If that final wave extends the normal 1.6x, it would get to the 850 range. If that is the plan, it better get started, as Sy Harding's mid-Nov buy date is not that far away. 

Market is Thrusting Out of the Triangle (And Friday Could Be Wild)

An update on the running triangle of a couple of days ago: the thrust out of it has begun a new plateau between 1116 and 1127 (Dow 10480 to 10590) which EWP argues is resolving into a triangle that may have ended mid-day today and be in its final thrust. EWP expects Friday to be wild:

The pattern is pretty clear in the Dow, although not textbook. The implication is the thrust should go about the widest part of the triangle, or 100 pts, targeting Dow 10640. 

Curiously the S&P lagged and has not made a new high (above 1130). Its target sits right at 1130, completing a triple top back to the August and June tops. 

Several convergences may make Friday a bit wild. It is options expiration for a start. There are divergences across indices right now, beyond the one noted above about the S&P vs Dow. And as Walter Murphy notes in his newsletter, bullish sentiment has gone back over 50% of AAII analysts in a mere three weeks! It took five months off the 2009 low. Kenny is all over this, and provdes this chart where you can see the huge blue spike of sentiment during this September rally:

Market is in a Thrust Out of a Running Triangle

Interesting pattern has developed. We got to 1127, right in the range of the triple top, then began fading. The wave pattern is well captured in this zoomed-in part of a Daneric chart, that we recently completed a running triangle (B leg larger than A) and have been in the thrust out of the pattern. Normally the fifth wave thrust after a triangle goes the distance of the widest part of the triangle, which in this case is the B leg from 1091 to 1111 or 20 pts. From the end of the triangle at 1105, this pointed to 1125, close to the 1127 momentary intraday high so far today. 

 

The thrust up must be faster than the triangle. Neely says twice as fast, meaning it completes in half the time, which means it should end today or tomorrow. So it could be done ... but we now hit a really nuanced area between orthodox wave theory and NEoWave. The STU has called this a thrust out of a running triangle. Neely notes that a running triangle indicates powerful forces (in this case bullish), and can propel the thrust to spike much higher than that - going usually 1.6x the triangle width (32 pts, targeting 1138), and at times 2.6x (44 pts, targeting 1150) - happy predictions for the head & shoulders crowd, and emboldening to the bulls. 

But Neely has more precise requirements for such a running triangle, including that the trendlines should slope (in this case upwards). You can see such a pattern from 1987-1994, an upwards sloping running triangle that was followed by a very strong thrust, the extended fifth wave of the dot-com mania. In this case the running triangle is a barrier triangle - it hit a flat barrier rather than sloping upwards. This makes it merely an "irregular" triangle to Neely, which implies a thrust that is only "slightly" greater than from a normal triangle. Getting to 1127 fits that, as would a final attempt to hit 1130 later today or tomorrow. The market is about to overlap, however, which suggests a top is in, or we are seeing an ending diagonal (terminal pattern to Neely) form of the fifth wave thrust. 

Market is Approaching a Triple Top

The S&P has twice run into the 1130 area and fallen back, and is getting close to a third test. We have been in a trading range between 1040 and 1130 since last May (after the flash crash) with a momentary spike down to 1011. A triple top will signal a reversal down. 

In looking at the market in a Fractal Finance fashion, triple tops or bottoms almost always characterize the end of a trading range. The fourth or B wave triangle is a classic example, and is a continuation pattern of the larger trend. The occurrence of a triple top or bottom at a different position creates a reversal pattern. The classic head & shoulders is a variant of this phenomenon, as is the diamond pattern. Many have spotted the potential for a head & shoulders type of triple top combining the Jan high (1150), the April high (1220) and a retest at 1150, if we go that far; but the current pattern instead suggests resistance at 1125-30 and then a drop. Recently we had a triple bottom at 1040 which at the time I commented should signal a reversal up, which it did. 

Although the triple top/bottom per se has not been a part of orthodox wave theory, the triple top/bottom was a major topic in tonight's STU from EWI. They point out how it has marked major tops and bottoms since 2000:

• The top in 2000 with peaks in Aug 99, Jan 00 and Apr 00
• The top in 2007, with peaks in July, October and Jan 08
• The bottom in 2002, with bottoms in in July, October 2002 and March 2003 

The most dramatic of these is the 2002 bottom, which Zoran Gayer called the Iraqi War Triangle:

   

(As a comment on Zoran's wave count, he had not yet matured his thinking, so posited a wave 2 triangle and expected a drop. Wave 2's do not have triangles, so shortly after this he advanced his theory to encompass the triple bottom pattern as a trend reversal, not a continuation.) 

According to the STU, triplets typically come after a long move, such as the runup to 2000 or the drop into 2002. Sometimes these triplets form a diamond pattern, a common technical reversal pattern that is more general than the head & shoulders. 

In Fractal Finance this is a way of describig the core fractal of the market, of a Thrust (the long move) and a Plateau (the trading range around the top or bottom). The plateau forms a range that could be drawn as a box, and often has a False Break along the way, which is spike outside the box that is quickly reversed back into the box - the "head" in the head & shoulders or the middle of the diamond in that pattern. 

This thrust & plateau can be contrasted with the V shaped reversals of the sort we saw in March 2009, but that can be understood as part of a larger plateau on a bigger time scale. Time scales can confuse. The V shaped reaction is the False Break at a larger scale. The bottoming process in 2008-9 formed a plateau at a higher level (around Dow 8K), then shot below and reversed back up. It wasn't until after the July 2009 bottom that we finally bifurcated out of that range. 

At an even larger scale, the market has so far formed a double top around Sp1550 as part of a large trading range from 1999 to now. That range is the plateau following the very powerful thrust up from 1982. One implication to keep in mind is that Fractal Finance would suggest we do not go to appreciable new lows before running up to test the old highs around 1500 one more time; indeed, more likely we hit and bounce off the bottom of the 2000-2010 plateau at around Dow7500. This third top is not required but the triple top is commonplace. Timing is not imminent, given the seven year gap between the first two peaks, but may be what happens if we have a powerful rally into 2012. This is a different perspective than orthodox wave theory, and would suggest the ultimate bottom is after 2012. 

In the near term, the Dow has come right to the downward trendline that connects the April high and the August high, and sits at the 78% retrace, about as far as it should go under the STU wave count. The S&P has shot above the trendline, apparently to close a gap. A reversal back below the gap (1110) would make an exhaustion gap and could signal a reversal. Any appreciable move higher would make the STU have to reconsider their wave count. 

 

From a Fractal Finance point of view, however, the most likely scenario is a retest back to the 1127 area. Interesting is that Carl Futia, who uses a variant of the box or plateau approach, expects the market to run into the 1127 area and hit resistance. He then expects a break down followed by a move up towards 1300. Again, Fractal Finance would instead expect the reversal to continue down. 

 

All in all, the next few days should provide a good test of Fractal Finance against orthodox wave theory as well as the bullish Carl Futia's box approach. The timing for the triple top and bifurcation down under Fractal Finance remains the autumnal equinox around Sep 23. 
 

Triangulating on the Bigger Picture

Let me provide a perspective in between the bulls and bears. It is centered on the market structure that could be developing in the past few months: a triangle, indicating a sideways period. The implication is that the whole market action since 2000 is in a larger triangle that should continue for many more years of a large trading range. Tony Cherniawski of The Practial Investor charts the triangle that may be the best explanation of market action since the Flash Crash:

 

In this view, the current wave we are in, leg e of the triangle, can end any time, although given the structure of the triangle (a barrier triangle with a resistance line at Sp1125-30), it remains most likely we get back up in that range before we complete the pattern. This triangle also appears in most other indexes, including the Wilshire, the Naz and the RUT, although notably not the Dow, which counts instead as a double flat, with the June- to July drop an X wave, which means it might go slightly higher than the August top before reversing. What happens next I will discuss below the fold. 

Was Last Week a Buying Panic?

The first three days of the month started fast and furious, but this week volume has dropped and we remain in trading range. EWP believes it was a buying panic, and expects a rollover. The low volume plus the VIX dropping below the lower Bollinger Band are sell signals. They note that this is the third such signal this year; the other two happened at the January peak and the April peak:

 

The expected drop may not be right away, but the signs point to a flagging rally. The market has rushed up to the declining trendline from the April top through the August top, and has failed to break through. Walter Murphy comments on this today, noting that a sustained break above (for at least a day) is required to confirm the uptrend. Also, the put/call ratio is nigh on oversold levels:

 

The wave structure is at the 2/3 retracement level - a bit higher than normal but at one of the Fib levels - and also can be counted as a five-wave C leg ie. complete. It would also be reasonable to count the flat trading range of the last few sessions as a wave 4 with a final wave 5 spurt up. The next retracement level is the 70.7% "repetition" level (half the square root of 2), a level not noted in orthodox wave theory but found to be useful in Zoran's work. The S&P rode to that level today (1103). 

The STU tonight had a good discussion of all these points, plus added a counter to the pundits who loosely claim that there are too many bears for a top to be in. It is one of those parenthetical discussions which make the STU useful to cut through the noise of casual blather on market conditions. They note that at real market bottoms, bears overwhelm bulls day after day (they give examples), whereas in this case the days when bulls outnumbered bears has been decidedly more bullish than bearish since last November, when we first hit the levels we are now at (from off the March 2009 bottom). Good stuff. 

Fractal Finance Gets its Big Test Next Week

We are in the second half of the last preseason game between Fractal Finance and Wave Theory. So far Fractals are up 3-0. On Monday I posed the test: fractals predicted a bottom and a run up to at least 1074 if not a triple test at 1125-1130; waves predicted a fast drop "early" in the week from a nested 1-2 formation. Fractals won the first half of that game as the bounce came (off a triple bottom) and the nested 1-2 formation was blown up. 

While the nested 1-2 is gone, an alternative wave structure is stil intact: that the drop from Aug9 to Aug27 (or 30) was a complete five-wave down, a wave 1 down, and we are now in wave 2 - a single 1-2 not a nested 1-2. I discussed how the drop counts better as a three-wave pattern down, since the final waves (iv) and (v) are lost in the clutter along the triple bottom at 1040. The impulse waves (1 and 3) are also about the same length (60 pts) while wave 5 is a stub, which means no wave extended; a pattern characteristic of a three-wave zigzag not an impulse. (Under Neely rules, one leg of an impulse HAS to extend.) We have also blown past the normal wave 2 retrace of 50-62% and stand around 2/3 back up. This wave structure is well captured by AllAboutTrends, which expects a pullback next week: 

The next test is at 1111, the 78% retrace. Theoretically a wave 2 can go back 99% and not break the count, but it seldom goes beyond 62%, and almost always when it breaches 78% it keeps going. 

All in all, the STU is relying on a Hail Mary pass to save their count. 

Tonight's STU fights back to resurrect their count, with two interesting observatioons:

1. Back to 2008 again, we saw a truncated fifth where (at least in some indices) the bottom of wave subwave 5 (of the first wave down off 2007) was about where subwave 3 ended
2. This wave 2 has come back to the larger upper trendline of the drop off the April top, as shown in this next chart from EWTrends

We might therefore see a bit of a pullback as the trendline acts as resistance. Whether it will mark the point of a bearish reversal to new lows we shall see, but I think it unlikely. The STU has two bearish-reversal scenarios to consider:

1. a drop down right away or at worst by Wed next week; or 
2. a larger B wave down followed by a C wave up that should go beyond next week into the week after

If they get their B wave we may have the preseason game continue into some sort of overtime before it gets resolved. If you want to follow this a bit closer, EWI is running a Free Week promo next week, centered on their Euro and Asian STU services. 

The Fractal Finance view does not need to to belabor minute details of wave structures to make its prediction, but I know a lot of readers would like it translated into patterns they are more familiar with. Let me offer it below the fold.

Bulls and Bears Grasping at False Hopes

Market trying to bust out today after several falsie attempts:

• On Friday, Bernanke opines in dolorous tones, market spikes and bulls celebrate
• Monday comes, market fades, bears line up their shorts
• Funky month-end close-out spike yesterday, bears cry foul! 
• Positive ISM report today, market has best runup in a while, bulls gloat, bears run for cover

This has gone all all summer and we are still stuck in the middle of a trading range from Sp1040 to Sp1130. A C-Cup sized range to be sure. Let me try to put this in perspective. 

In a Fractal Finance view, a trading range reflects the entropy (uncertainty) after a strong move. We had a pretty good move in the Hope Rally, from 667 to 1220, or 80% in 14 months. From the perspective of the huge drop off the 2007 peak, we came back 62%, a normal type of retrace, but overall still a large move in a shortish time. At the bottom in 2008, we went through four months of consolidation in a trading range before the Hope Rally. We have only been through three months of consolidation since the Flash Crash off the top. We are also in the unfavorable season for stocks in general (May to Nov). Point: consolidation should not be a surprise.

I have my fourth preseason test of Fractal Finance vs Wave Theory underway. Fractals predicted a bounce to at least 1074, and we got that in one day. Waves predict a fall early this week, and we are hitting the outside limit of "early", so they need a drop to start tomorrow. It is, however, too soon to claim a fourth win in a row. The wave count from the STU is a nested 1-2 off the Aug9 top, and while it got squeezed today, it is not busted. More on that below.

The biggest cause for concern is that uncertainty is increasing. In Fractal Finance, uncertainty means a trading range, but if the consensus shifts too negative, the market will lose its support and begin to seriously sag. The uncertainty is centered on the faltering recovery. Obama's "Recovery Summer" is a bust. Many believe the Fed is busted, too; but while Bernanke may be out of bullets - he is not out of bombs, which he could drop from his helicopter. The uncertainty is also political. If the Repubs retake the House, we are in for policy deadlock plus investigating committees nipping at Obama's heels for the next two years. The uncertainty is also about future policy jiggles. It is not evident that Obama will triangulate as Clinton did in 1994; but he might. You can see op-eds emerging that say we have nothing to fear but uncertainty itself, and it is probably time for the government's final recovery policy to be launched and then left in place. Fiddling begats further uncertainty. 

The ISM Report today also increased uncertainty. It is out of line with regional reports, as I noted yesterday. CalculatedRisk, which follows this sort of report closely, notes how the regional reports are noisy, but come back to alignment with the national report, which means: either the next ISM drops, or the next regional reports strengthen. A peak inside the ISM report shows it was up on lagging indicators and pointing down on leading indicators:

Econoday notes that there was still some concerning information in the result.

“Lagging factors gave what is a bit of a deceptive boost to the ISM's manufacturing index masking a further slowing in the key leading index of new orders,” the firm said in a report on its site.

Specifically, new orders slowed to there [sic] lowest point since the recovery in manufacturing began in the second quarter of 2009.

UPDATE: Econophile does a deep dive Thursday evening and comes to the same conclusion: the positive report hides future weakness. This chart shows the two key leading indicators (new orders and shipments) both continuing to fall:

UPDATE: Rosenberg is out the next morning with his take: Yesterday's ISM Was Likely Wrong, To Be Revised. Key point: only 1% of the time is ISM up when the three leading indicators (new orders, backlog and deliveries) are down. He also found the decline in exports - when "the overseas economy is rocking and rolling" - disturbing. He concludes with the observation that in the past 30 years, ISM dropped to 47 after a decline like it has in the order/inventory ratio. 

Autos are reporting right now, and are down a lot year-over-year - albeit last August was skewed by Cash4Clunkers - and are also down month over month. They are likely to miss expectations. The WSJ headlines: US Car Sales Plunged in August. Does this forebode a poor Sep as well? 

Credit Suisse is arguing the mid-cycle slowdown is about to turn back up. They point to global PMI as suggesting a 3.5% growth rate (see first chart), and see the current dip in new orders as consistent with past recovery cycles (second chart)(charts courtesy PragCap):

So does this mean we should load up on the long side? Carl Futia thinks so, pointing to the congestion near highs getting smaller while those near lows larger, a sign of distribution from bear to bull:

Or was this a panic/exhaustion day? The STU count maintains a nested 1-2 down, but there are problems with that count, The outside 1-2 should be longer (in time and distance) then the inside. In this case wave 1 fell from 1130 to 1070 or 60 pts, and then bounced to 1100, or 30 pts, a 50% retrace. The inside wave (i) bottomed at 1040, or also 60 pts down, and so far has bounced to 1081, or over 40 pts - more than the outside wave 2. We have reversed 62%, which is enough for this to be done, so they hold to an imminent drop. But I see the nested count as already suspect, and expect it to be fully busted, which happens if the inside wave (ii) breaks 1100. 

Interesting is that the STU leads tonight with their 2008 comparison I showed over the weekend, and followed that with a fractal comparison to the current pattern and the larger flat from May25 to Aug9. The fractal suggest a reversal down, but the 2008 comparison suggests a continuation to retest the Aug9 high. Uncertainty. 

The primary alternative view has the drop from Aug9 to the recent triple bottom at 1040 as a five-wave drop, completing wave 1. The tricky part for this to work is for waves 2 and 4 not to overlap, but 2 bottomed at 1069.5 and 4 topped at 1065 - close but no overlap. The whole drop maintained a channel down. There are a lot of sites showing this; here is one from EWTrends:

From a Fractal Finance perspective, this chart and the next one show that the congestion at the bottom - the plateau after the thrust down - triple bottomed at 1040. Normally a triple bottom is a great indicator of a reversal, and the thrust up today is a classic bifurcation out of the range of the plateau. This strengthens the case that Fractals will win the bet. Normally where the market would now go is to retest the prior highs around 1125-30, which, if it holds, puts in a triple top. From a wave perspective, this would also mean that the drop off Aug9 will be best counted as a "3" not a "5", per this next chart from Elliott Wave Principle:

It is possible to count the triple bottom as containing a small degree waves 4 and 5. It is also possible to count the first three waves down as five waves, given a small 1-2 pattern to kick it off. In both those cases this would be a wave 2 back up, and it would be at the normal 50-62% retrace at 1084-1095. But in general the best wave count is the simplest, and that has this as three waves down. While the prior chart points to 1100 as confirming a three-wave pattern, it is simpler than that: this wave has already gone into the territory of wave 2, so cannot be a wave 4. 

What if this drop is a "3", meaning corrective? How bullish is that?

• Neely counts these waves as a double flat (abc - x - abc), and he anticipates a rally. He was calling for the turn of the month to be the turn of the waves, and he (so far) got it spot on. His count has the whole drop off Apr26 as a larger B wave, and he now thinks we are beginning wave C back up. Wave A began last Feb5 and went from 1045 to 1220; wave C starting at 1040 would go to 1150 if the C wave equaled 62% of A (a normal relationship); or to new highs if C = A. 
• Alternatively, the sideways market from May25 can be considered a double flat (I have also seen charts that show it as a triangle) which is in its final leg up, with an expected high at or below 1130

My take: whether or not we fade back tomorrow (common after a strong move) and then have weakness after the unemployment report Friday, I expect a continuation up to at least the 1087 area if not a runback to 1130. Fractal Finance requirements have been met with the move today, but in general would expect the larger plateau from May25 to now to complete with a triple top around 1130. 

Market Will Test Fractal Finance This Week

I posed a simple test between Wave Theory and Fractal Finance last night. This is the fourth such test in the past few weeks, and so far fractals are ahead 3-0. Call this the preseason. The test is whether we have begun the dreaded P3 wave down to new lows, or have a sideways market for the next few weeks. The key is whether we break Sp1040 in short order, and stay below, or meander sideways. If we break above 1130, both lose!

The Fractal Finance model looks for Thrusts and Plateaus, and watches for the Bifurcation Point when we thrust out of a plateau (a trading range). We are currently in a small plateau between 1040 and 1067, which is inside a larger plateau between 1040 and 1130 that goes back to May25, the bottom of the action after the Flash Crash. Here is the near term plateau, courtesy Contrarian Advisor:

Tonight's STU is confident the downturn has *finally* started. They are working off a nested 1-2 count since he Aug9 high, which is captured in this next chart from EWP, who says the chart is shouting that the downside is Quite LARGE:

The STU view is that we should not retrace back above the inside wave ii high at sp1065 (es1072 in the overnight futures). The STU is working off some pretty powerful ratios and markers: 

• the Hope Rally, a big wave 2, went back 62% of the fall in the Dow off 2007
• the recent summer rally retraced 50% of the drop off the Flash Crash high in April
• the downward trend since has been in a fairly tight channel, an indication of an impulse wave

We now have nested 1-2s at three degrees of trend: the Papa 2 at the April high, the Mama 2 at the Aug high, and now the Baby 2 Friday. The STU expects a drop down that gains momentum and volume:

Wave (iii) should quickly draw prices below the July 1-2 lows at 9614 (Dow) and 1010.91 (S&P)

Could be. Yet volume is not confirming. While we had a 90% down day today, we had anemic volume again. Market Thoughts also worries over the low volume as deconfirming wave (iii) down (see next chart). They also note divergences across several indices, and have a scenario to make it all fit: that we are not in nested 1-2's but in a wave (i) down which should bottom shortly, perhaps below 1040 but above 1010, and then we have a Labor Day Rally.  Here is their take on volume:

Curiously, even the normally bullish Carl Futia is now near-term bearish:

If this market is about to rally as I expect we should see strength above the 1050 level early tomorrow. Failing that I think a further drop at least to 1025 and probably to 1010 will be the next development.

I have not mentioned Neely's views much recently, but it is worthy to note that he thinks we are about to rally. His model has us in a B wave since the Flash Crash, which is about to end in time and price, and it should be followed by a C wave rally. This pattern began on Feb5, with the runup into the April high an A wave. He thought this B wave was breaking as a triangle, but it seems to be better counted as a double flat. He is the most bullish of the wave theorists right now. If we break 1130, where both orthodox wave theory and fractal finance would lose, Neely could be considered the winner. 

The Fractal Finance near-term view is a sideways move, and this drop is part & parcel of it. Interesting is that a sharp False Break below 1040 followed by a Labor Day Rally would be consistent as well if the drop and bounce is fast. Hence watch whether we continue down on increasing momentum, or slink sideways into Sep, which suggest a run up above the recent plateau into at least the 1074 range if not higher. 

Lots of economic news this week, and it is the last week of vacation season. The market is normally somewhat positive into Labor Day, and quiet; but we are seeing fireworks on forex markets due to Japan initiating a new round of stimulus. A sideways move should not surprise, and it may be accompanied with an increase in swings in global markets. 

Morning Musings From Fractal Finance

The market is set for a fall, according to the STU, which has us back in a nested 1-2 down. They allow for the inside 1-2 to evolve instead as waves a-b of a flat correction, so a bit of an upside surprise may be in store this morning as the c wave of that flat unfolds momentarily. MarketThoughts proclaims "I am Spartacus!" for the multiple nested 1-2s, which augur for a gap down at the open, but hey too allow for a larger flat to emerge. Daneric shows the 1-2s as well as the alt count of a flat. which suggests a reversal back to the Sp1087 area:

 

This sort of ambiguity is part and parcel of wave theory, and can be very off-putting, so let me see if Fractal Finance can give better guidance. So far it has bested wave theory in the last two tests. 

The Fractal Finance view is a gap down without ambiguity. We had a sharp thrust down off the August top two weeks ago into a trading range, the "plateau" around Sp1075-87 from Aug12-17. We had a false break below and now can confirm a false break above. This chart from Carl Futia (who is bullish) shows the recent activity:

 

The trading range to the left of his ovals from Aug12 to Aug17 is the "plateau". Carl's first oval circles where we popped above and came back down, which confirms it as a false break. The second oval has us below range of the plateau, then back into it, and now below again. If we do get the small c wave, it should not go above the top of the recent range, or Sp1087. But can we improve the odds beyond that?

This next chart from EWP is telling: it shows momentary candlestick spikes that precede a move in the opposite direction - the message from a false break. The pop at the open Monday is another one of those, and predicts the next move is down, below the trading range:

Hence Fractal Finance is predicting a gap down this morning as the start of the next thrust down. I wrote this post Monday afternoon so as not to sneak a peek at the morning futures for guidance. Let's make this a fair test.

A lot of pundits are watching around 1060, but 1041-45 is a better range to watch, the level of resistance since last Feb. 

A Little Fractal Finance Magic

In my recent post, The Market is Due for a Bounce, I mentioned how Fractal Finance required a bounce, not a final wave 4-5 down as allowed by orthodox wave theory. Of course the bounce happened; and then Fractal Finance required it to be a false break and settle back into the trading range of 1074-1087, which it has now done. So far so good. So what is next?

I have been using EWP for charts and count, as they are clear and simply stated. Their most recent chart notes how declines have been sharp and bounces sloppy, a sign of a down trend. Last night they expected a decline, and got it today. They see the odds favoring a deep drop, but await confirmation, which is a break below where we got to so far today.

 

The Wed STU had an interesting take: that the bounce yesterday created a nested 1-2 with the break out of the trading range on Tues being wave (ii) off the recent drop, and the drop & rebound Wed being the inside waves i-ii. The Tues bounce filled the gaps mentioned in my Bounce is Due post, and retraced a little over 50% of the wave (i) drop, both suitable indicators of an end to a wave 2 bounce. The wave structure broke as a flat, which completed. If this is a nested 1-2 pattern, the market should have had a sharp break down. Today started that way, but has stalled within the prior trading range, as Fractal Finance predicts from a false break. 

The STU allows for a more complex pattern to develop, with a target of the 62% retrace around Sp1106 by Friday (tomorrow) or possibly into Monday. Given the five-wave up pattern on Tues, a zigzag could have been developing, but the deep drop today obviated that. If the market does continue back up tomorrow, a likely wave pattern is a larger flat, where the first wave back was wave A. The next chart shows this, courtesy Market Thoughts.

 

In Fractal Finance, the base fractal is a Thrust and Plateau, as shown in the final chart. In comparing this to wave theory, the sideways corrections (flats, triangles and double- or triple-corrections) form the 'plateaus' of disorder. The impulsions, impulses and zigzags, mark the 'thrusts' of order. Sometimes it helps to re-envision wave patterns that are given traditional labels. The recent ending diagonal, for example, entered a plateau around the turn of the month, and it was the sharp break below it that marked a change of trend - the bifurcation point. 

Often a plateau contains a false break below, followed by a similar one above. This happened over the past two weeks. A bifurcation does not occur until the thrust out of a plateau completely leaves its range. The test comes quickly. A false break needs to return back to the range in a much smaller period than the length of the plateau. (The market is fractal, and a plateau can hours, days, or even decades, as we saw from 1966-1982, or are seeing from 1998 to date.) So far this week, the plateau which began 7 trading days ago was re-entered within 2 days, meaning it has been a false break. 

Typically a bifurcation occurs at a triple-top or bottom, which wave theory usually would count as the ends of waves 3 - 5 - 2/B. Sometimes these triplets form a head & shoulders where 5 is higher (at a top, or lower at a bottom) than 3 or 2/B; but often they all hit around the same resistance zone. In either event they are distribution patterns, with positions rotating from smart to dumb money. The chaos theory, a plateau reflects a market seeking order - the pattern of distribution, as the relative buying/selling pressure equalizes as the direction of the market becomes vague. Hence a final run up tomorrow to around the same 1100 level a third time would be within the theory. 

More likely, however, is a the market melts down from here. The drop today ticked to the level of the prior false break of Monday. Typically a second false break is the precursor to a bifurcation. Hence tomorrow is another test of Fractal Finance:

• most likely we continue down
• if we have a triple top, we should not breach 1100

The Market is Due for a Bounce

Summer doldrums, very low volume, and no conviction - except among the punditry, which expect a short term bounce. The pattern under Fractal Finance is pretty clear: we had a rise in July into a trading range, bifurcated out of the range & have stayed below, indicating a change of trend, and settled into a new trading range. The market was range bound for the past few days, but spiked below and came back above today - a false break. This suggests a break to the upside, to be followed by a drop. 

 

This chart from EWP is pretty consistent with all the major ewave sites today, including Daneric, Kenny and MarketThoughts, whose chart for the past five months I recommend. The bifurcation out of the range around Sp1110 and 1128 is pretty clear, and it had now fallen in a five-wave pattern with a strong third wave down. This is also how the STU counts it today. Typically a minor wave 2 bounce goes 50-62%, which suggests an outside level of Sp1106 (Dow10525). The gaps at Sp1189 and Dow 10380 shoud be filled on the way back. 

The economic news has trended towards poor, so it is being watched closely. The next two days have reports which could jink and jive the market. The bounce today off the false break (labeled wave 5 above) is not itself compelling as a start of a wave 2 bounce, so the STU warns of a possible retest or drop lower. The Fractal Finance model says otherwise - the false break is done for now. We shall see which one gives better guidance over the next two days. 

Morning Market Warnings

Overnight futures are down, although this does not always presage how the market opens. Hank Wernicki at Elliott Fractals nonetheless sees a hard drop Wed after the Fed's punt Tues. The market popped a bit on the Fed's announcement, then tanked into the close. 

An interim EWT went out tonight evening giving reasons why the rally since the Flash Crash is likely over. Well worth a look. The most interesting observation in the EWT is that the pattern of the past three months matches the pattern in 1987 between the Aug25 last peak and Oct2, two weeks before the crash. 

The USD seems to have found a bottom, and has moved sharply up since last Friday. Mr. Bond, as David Rosenberg is want to say, is also signaling a stock drop. Rosie points out that when bonds fall as much as they have since April (down 120 bp in the 10-yr), a stock (and economic) downturn follows. 

Does the Market Have a Final Twist in Store?

The market topped on my turn date, August 4, but after the poor employment report, had a sharp drop that was not made up by the close today. Technical indicators are waning, such as declining volume during the up move from the past month and the lagging of more speculative indexes (Nasdaq, S&P small cap) to the major indexes (S&P and Dow). A very clear head & shoulders has formed between the January shoulder, the April head and now the August right shoulder. Interesting is how evenly spaced it is - the time from the right shoulder to head, and head to next shoulder, is almost identical. Most telling - and all over the blogosphere - is the wedge pattern in the recent market rise, an ending diagonal, which I showed several days ago. Even the STU now accepts the ending diagonal pattern. All of this increases the odds that a top is in.

I have been on the theme that Mother Market will take the path that fools the most market positions. The STU was reluctant to accept the ending diagonal because it was so widely touted in the financial punditry and blogitry - if too many market participants take positions based on that belief, Mother Market may still find one more twist, to trap bulls and bears alike:

• Bear Trap: The Big Tease may have minor waves 4 and 5 to go. The last two days fit that wave 4, which if so should continue sideways for a week or more before a final thrust up towards Sp1150. This is a potential bear trap: the sideways move increases confidence in shorts, and the thrust up causes them to scramble to cover
• Bull Trap: EDs often have a false break above the converging trendlines followed by a sharp drop below - a "throw-over" discussed in some detail in the STU tonight. This is a potential bull trap: the sharp thrust causes bulls to pile onto what looks like a bullish breakaway up that then reverses sharply down

Supporting the case for a bullish breakaway is the new high in the NYSE cumulative advance/decline line. This case gets dissected in Trader's Narrative: there are a lot of non-operating entities in the NYSE, and the S&P does not show the new peak. 

The percent of stocks above their 50 DMA is at a high level (75%), but not at a peak; this is usually bearish as it is hard to sustain - unless the market is in a bullish breakout. 

Next week should be interesting. The bulls need the breakaway or their case gets swamped by the increasingly bearish technical indicators, and yet the apparent start of that breakaway may be the false breakout of the ED throw over. 

A Top of Sorts is Near

Today was my turn date, which means a top this week.This might be it, or just an interim stop before we get back to the Sp1150-75 area. Turn dates are chancy things, and it appears to me that we have more upside, in part because I think we get back to Sp1150 before falling, and also because I expect the Dollar to reverse at about the same time. It has retraced 57% of the rise in the Dollar Index, and should be expected to go a bit farther, to the 62% area, before bouncing.

The stock top and Dollar bottom may resolve this week. Friday has the unemployment report, and it will be watched for guidance on the economy after the mixed GDP report last Friday (which is likely to be revised down from 2.4% to 1.7% given poor news on durables Monday). The STU thinks after the 8:30a pronouncement, market sentiment may break, beginning the fall.

As you might expect, the STU thinks the top is nigh based on wave structure. This chart excerpted from Daneric shows the recent pattern: a triangle fourth wave and the fifth wave thrust out of it. The thrust has gone back to 62% retrace in the Dow, but is below that in the S&P. A thrust the width of the triangle is normal, and targets near 1140, which is the 62% retrace given a bottom at the low point (1011 on Jul2).

In my Big Tease count, and the STU count, the low point is May25 at 1040, giving a target of 1151. Look for a thrust to 1140-1150 range in the next two days.

The STU also comments that each move up since Jul2 has broken in five waves, meaning they do not see this as a triangle formation, nor an ending diagonal, with one exception: the Nasdaq had a clear overlap of waves 2 and 4, and has fallen behind the Dow and S&P, compressing into a fairly clear wedge.

The bullish view is best expressed by Carl Futia, who brings out the Three Peaks and a Dome formation. The next two charts show the formation and the current count of Carl. The implication is very bullish: the market should now run up above Sp1200. This gives a good contrast over the next two days: an impulse up that crushes through the 1140-1150 level supports the bullish case, while a sharp thrust that stops in that zone supports the near-term top view. 

   

 
 

Market Pundits Converging on a Scenario

It is passing strange when market pundits converge on a common point of view from very different directions. The wave theory punditry & blogitry have been all over the map, but now are gaining conviction over a near-term peak in August, maybe within a few days of my Aug4 turn date (ie. this week or early next). The market has been in the Big Tease, which is working maximum damage on bull and bear alike, and pushing the pundits to the precipice. Today was the bulls turn to get momentarily exuberant. Will swimming against the bullish tide pay off for the pundits, or are they all about to tumble down the wall of worry into the abyss of irrelevance?   

Neely has been saying how in the middle of a formation, predictability is the lowest. He has had the market in a final corrective pattern since the Jan-Feb drop: an A wave to the April peak, and a B wave which is breaking as a triangle. We are now in leg D of that triangle, and predictability has increased, as has his conviction that the D leg will end soon and the market reverse down.

The STU got prematurely enticed by the S&P futures overlapping waves 4 and 2, and expected August to start down. No mention of that today. Just as well - the futures do not lend themselves to wave theory as well as the cash indexes since they expire, and that distorts the picture. The Dow did not have that overlap, and although they saw it in the S&P cash, over common time frames (eg. 15 mins) I saw no overlap, it was the slightest of overlaps (1088.9 vs 1088.1). They have us in the final thrust up (wave 5 of V of C) and note that we are at the 62% retrace of the whole drop off Apr26. Wave 5 could be done; or could have gone only to inside wave 3, so has a bit more to go in inside waves 4 and 5. 

Robin Landry has a similar view, and expects a top in the first half of August at below Dow10800. He sees the wave count as complete today, just as the STU does; but allows for the final jink and jive of little waves 4 and 5. 

So three of the major pundits come to a similar view from very different places. 

The blogosity of ewave sites has also converged on another view with the same consequence: that we are in an ending diagonal (ED) C wave. This chart from Blankfiend shows the ED at the end of a wave count like the Big Tease: wave 1 ends on May25 and wave 2 is breaking as an expanded flat with a deeper bottom to the B wave than the end of wave 1. 

The ED is a clever way to get rid of the overlap of waves 4 and 2: in an ED, that overlap is expected. The final thrust up should compress, with 3 shorter than 1 and 5 shorter than 3, and converge somewhat to a point of lower highs and higher lows. So it seems to work, and you can see similar charts from Daneric, EWtrends, MarketThoughts, and others too numerous to mention. Market Thoughts gives guidance that for 5 to be shorter than 3, the outside level in the S&P cash is 1150.

While clever, the ED has some challenges, including that all waves should be "3s" while the STU was adamant today that there are clear "5s" in the C wave, perhaps anticipating all these blogostic EDs. 

My Big Tease count has a different read on wave C: that wave (iii) of C is not yet done, and what is listed as major (iv) above is instead minor iv inside (iii). It is that minor iv which the STU was worried overlapped with minor ii inside what is labeled (iii) above. (The STU counts that (iii) as (v), having found a small waves (i)-(ii) inside what is labeled (i) in the chart.) This means we would be in wave v of (iii), and have a bigger waves (iv) and (v) to go. Such is the fun with wave theory! 

Hence the Big Tease is not limited by the ED short wave 5, and instead should go above 1150 in the current run up, possibly by Aug4; and then might get to 1175 later in August. Right now we have to see how the next few days go.

ContrarianAdvisor gives another view, more in line with Carl Futia's "box" approach. I highlight it because it is also similar to Zoran's Factal Finance approach, of a "plateau" or trading range following a sharp thrust - in this case, after the Flash Crash drop, we have been in a two month trading range. 

This box analysis also predicts a top soon, after running back to the top right of the box. Zoran often expected a False Break above the box, then a drop back inside. Watch for either hitting the 1131 area and dropping, or punching above then falling back below. A Bifurcation to confirm the False Beak and the end of wave C would have to fall pretty sharply below the bottom of the box, or Sp1010. 

A final convergence comes from a reader and frequent commentator, DG, who has taken Neely's approach and extended it. He posted this chart a bit ago and I thought to share it with you. You can read his analysis in this comment. His work says the final leg of an expanding triangle, leg E, should end by Aug6, or the end of this week. 

Market Entering the Danger Season

Stocks tend to follow a seasonal pattern, with a strong period from Nov to May, a sideways move over the summer (which often starts with a June Swoon, creating a Summer Rally in July), and a drop in Sep/Oct. Sell in May indeed:

 

August has marked notable tops, such as Aug25 in 1987 and Sep3 in 1929 (not quite Aug but close enough), as well as the last peak before the huge drops into Nov 2008 and Oct 2002. Since the recent end of the seasonal strong period was in April not May, it is possible that we peak early in August, not late; or even have peaked already at the end of July. Keep in mind that that these sorts of patterns are tendencies only. In 2009 August was choppy but did not mark a high. 

The more immediate question is that the wave structure is signaling a top is in. We peaked last week and have been dropping since. The wave count would either make that peak a completed wave, or an end to wave 3 of the final wave. If we are in the wave 4 that follows that wave 3 top, with a final snap up wave 5 to go, the market should not fall into the territory of wave 2. Well, we peaked at Sp1088 last week and came down to hit the 1088 level on Friday (see chart, courtesy Kevin's Elliott Waves):

Friday's STU goes farther and highlights how we breached that level in the Sept S&P futures (ES), and slightly overlapped in the S&P cash as well. The Dow has yet to overlap, which would be at 10265, but the Naz overlapped its Jul21 wave 1 high at 2236. Wave Theory thus indicates that the trend is down, at least in the ES and Nasdaq indexes, and *maybe* the S&P. EvilSpeculator urges laser focus on Sp1088 over the next few days to see if the "touch" shows a support level or is the &P going to follow the ES down. 

The Big Tease Market is Doing Its Job

The Big Tease market scenario has the market in a course to tie the bears and bulls into knots, and it seems to be doing its job. The wave structure is an expanded flat since May25 as wave 2 of the Flash Crash drop off the Apr26 high. The target remains Sp1150 range. The timing remains the turn of the month, or around August 4.  

The STU has shifted their count twice, and now is in the most bearish version of the Big Tease, which has us in a final wave (v) of C. They too count it as an expanded flat off May25. They also track a nine-day turn cycle, which peaked yesterday, so under their view the Big Tease may be done. If so, it should drop tomorrow. 

They note another way to interpret this wave (v) of C, as having finished merely minor wave iii of (v) up, and now meandering in a typical wave iv. This allows for another "stab" up. They can draw a channel around this wave (v), and a drop below today's low (Dow10463) would breach the lower trendline. If we stay below, that confirms the change of trend; but at this point in a move we might see a false break and then have the "stab" up, living up to the principle of fooling bull and bear alike. 

An interesting alternative view comes from several sites: that this wave 2 is not an expanded flat off May25, but a zigzag off Jul2. In this count, the Flash Crash did not end until Jul2. Market Thoughts uses the chart above to show the wave structure in July. It shows the wave 4 of C hitting the lower channel, and a possible wave 5 to end this C wave. The bigger picture going back to April is captured in the next chart from Daneric, which shows the five waves down to the July bottom. This is the Naz chart; the S&P chart is similar. This chart shows a more bearish count like the STU, that we have ended wave C and therefore wave 2. The big P3 starts tomorrow!

What if it doesn't drop tomorrow? Where might it get to? Interesting is that both variants of the Big Tease give the same target: 1150 range.

• In the Big Tease with the expanded flat wave 2, the A wave went from Sp1041 to 1131, or 90 pts, and if normal relationships were to have held, the targets for C would have been 1100 (where C=A), or since that is busted, to 1155 (where C= 1.6x A)
• In the variant of the Big Tease with the zigzag, the A wave went 90 pts, and if C=A (a common relationship in a zigzag), the target is 1150

The second most common relationship in a zigzag is C=0.6x A, which gives a target smack dab where we topped yesterday. Could the STU be right? Far be it from me to challenge the masters themselves, but I do not like their wave count for the final C wave. It has a very small (i)-(ii) compared with (iii)-(iv)-(v). Eyeballing the top chart above, The blue 1-2 inside wave A is what the STU thinks is waves (i) and (ii), and then then what is labeled the rest of the big A is wave (iii), the big drop labeled B is wave (iv), and the incomplete C wave is wave (v). Seems disproportionate. 

The Big Tease may have a Big Trick up its sleeve. Note that in the expanded flat version of the Big Tease, what is labeled as the big blue ABC above would instead be labeled as subwaves within larger wave C, and in a flat, wave C breaks as 5 waves. The big blue ABC above would be waves (i) (ii) and (iii) of C, and we have (iv) and (v) to go. Wave (iii) all be itself may fly to 1130-50 range, perhaps by Aug4; and then we have a larger wave (iv) and a final stab up to the range of 1155-1175. 

If this happens, a gaggle of ewavers will consider wave 2 done at 1130-1150, and be placing bets on the big P3 down. Instead of a hard drop, we will see an annoyingly stultifying sideways wave (iv), which should end with a dramatic short squeeze to create the "stab" up. Then as the bulls pile on in surprising ecstasy, down we go. 

Weekend Bits

When the market bumps along a trading range, it frustrates bull and bear alike. I think we are about to sprint up in the Summer Rally. First, let's look past the news, which is mixed at best: 

• ECRI below 10% signals double-dip but UK showed surprising GDP strength avoiding double dip
• Some banks failing EuroZone stress test, but Euro remains bumping up near $1.30, further depressing Euro recovery
• Bernanke seeming to back off monetary stimulus in favor of fiscal, which has huge implications for the double-dip. 

For ECRI fans, here is a good chart by Doug Short which shows we have entered recession territory, accompanied by analysis of what this has signaled in the past, which I can summarize as: the Fed bailed us out of negative ECRI indications previously by lowering rates, but they cannot go any lower this time

 

Unemployment shows we are still in a jobless recovery, and it may be structural since we rely so much on production overseas rather than filling our factories. As David Rosenberg opines, the bad news is good for bonds, and can be good for stocks in the short run. How good? 

We may now be in the proverbial Summer Rally, and it may be short but sweet. Consider this chart from EWP:

It says we remain in the Big Tease, and the market is about to run up fairly strongly into the turn of the month towards Sp1150. The Big Tease has us still in a wave 2 corrective mode since the Flash Crash, an "expanded flat" where the B wave breaches to a lower low but reverses: the bounce up to Sp1131 was wave A, the drop to Sp1011 was wave B, and we remain in wave C. Given waves (I) and (II) as shown above, we would now be in wave iii of (III) of C, and should now run fast. To support that view, EWP notes how we have been rising in 5 wave moves and declining in 3 wave moves, indicating the direction is up. This would be the happy Summer Rally.

Of the major pundits, Neely thinks we are in the middle of the his wave B and hence the least predictable part. He has wave A being the run from Feb5 (1045) to Apr26 (1220), and the Flash Crash and its aftermath as a wave B triangle. Leg A down was the Flash Crash, leg B was the bounce to 1131, and we remain inside leg C.

Prechter's service had a high-odds count earlier this week that got blown up yesterday. Tough business being a pundit. Their special STU yesterday held to Sp1100 as a barrier, but we breached it today. Their alt count allowed for that, and today they posited their continued view of a nested 1-2 i-ii. The inside wave ii has gone 78%. Theoretically it could go back 99% and go really close to 1131, but practically it shouldn't be much beyond 78%. Hence they may have to fall back on their other alt count, which is similar to the Big Tease, albeit they expect the final wave to end around the June high at 1131. 

Curiously, if it does push to 1131 level and then drops, rather than setting up the dreaded 3 of 3 down, it might instead signal an inverted head & shoulders with an upside target of 1250. The head & shoulders is often seen and seldom realized. A number of bloggers today also anticipate a leading diagonal, again a rare pattern which some pundits (Neely) do not recognize. Here is the inverted h&s chart at Slopeof Hope:

 

I am working on a posting a discussion of 1937, which seems to match the current economic climate better than 1929, 1987, or a plethora of other analogies that fly around the blogosphere. A good summer rally and then a terrible plunge match the market pattern in 1937.