Friday, December 19, 2014

SPX, RUT, INDU, COMPQ, BKX: What if Virtually Everyone Has it Wrong?

I'm going to reach into the archives during the first portion of this article, in order to lay the groundwork for my ongoing thesis that perhaps just about everyone (bulls and bears alike) is about to be duped by this market.

Back in November, I put forth the theory that the market was unwinding a high-degree fifth wave, which would then be followed by a significant intermediate correction.  On November 17, I published a "best guess" target of 2065-75 for that wave.  But as we reached that target zone, while I thought a correction was due, I did not believe the rally was over yet -- to the contrary, on December 8, I wrote the following:

Friday's market didn't perform the way a third wave should, and this has left a number of complex options open.  The charts might get a little confusing, so before we get into that, I'm going to give a brief synopsis of my thinking regarding the intermediate term:

1.  RUT and NYA have, so far, failed to make new intermediate swing highs.  Odds are good that needs to happen before a meaningful top becomes possible.

2.  SPY has been up seven out of the past seven weeks.  Over the past 18 years, this has happened seven times (go figure).  In 100% of those prior cases, the market formed, at best, a minor correction before making new highs.  In 0% of those prior cases, the market formed an immediate major top.

3.  Last week, we looked at an RSI top study.  Given the market's behavior in the past, it remains highly unlikely that any kind of final high is in place. 

4.  Therefore, while there is not yet enough pattern present to determine the exact depth of any (pending) near-term correction, I do believe it will simply be a correction, and resolve with new highs.

5.  I currently believe the odds are good for an intermediate correction to follow after the next rally takes us to (presumed) new highs -- but let's not put the cart too far in front of the horse...

As the market decline deepened, I'll admit that I began to wonder if I had been "caught looking" at the top, and if maybe I was wrong on points #4 and #5 -- nevertheless, I continued to refrain from becoming bearish, due to the other above-mentioned issues having solid weight in my mind.  In fact, on December 15, I wrote:

If this had been a normal market for the past few years, then I'd probably already be rabidly bearish.  But this has not been a normal market -- and once bitten, twice shy, as they say.  Or as George W. Bush so eloquently put it:  "Fool me once, shame on you.  Fool me twice, and I'm going to punch some central bankers."

I mean, let's face it, bears have been here a few times before.  It goes like this:

1.  Support levels begin failing, VIX spikes.
2.  The pattern starts to look exceedingly bearish.
3.  CNBC trots out several analysts who all share the nickname "Dr. Doom," and they each talk about how the fundamentals are garbage and the market is clearly headed to zero or below.
4.  Bears see a bunch of green in their accounts and start to feel excited...
5.  One of the major central banks announces some radical new program, such as that it will be providing free, unregulated personal printing presses for each and every banker who'd like one.
6.  SPX gaps up 257 points, and shorts are left running for cover as the market rallies relentlessly.

Well, we can't say we haven't seen this movie before.

And, just to wrap the archives up, on December 17, I ended with:

In conclusion, there isn't much to add down here.  If the decline is simply a correction, then it's in the zone where it could bottom -- the first thing bulls want to see there is sustained breakouts from the down trend channels.  If it isn't a correction, then bears are likely just getting warmed up for an intermediate decline.  It's interesting to note we seem to have reached an important inflection point as the market awaits more info from the Fed.  

As we know, that inflection point was accurately identified, and generated the current breakneck rally.  That brings us to the present.  And here's where it gets really interesting:  What if my original November hypothesis was correct?

Most technicians are either still bearish and expecting an imminent top shy of the all-time high, or they're viewing this rally as wave (3) of (something) and expecting a moon-shot.  Is it possible that virtually everyone's wrong?

The potential I have been favoring, and will continue to favor for the time being, was as I outlined on December 8, as follows (sorry for the repeat below, but it saves readers from having to jump back to the beginning):

4.  Therefore, while there is not yet enough pattern present to determine the exact depth of any (pending) near-term correction, I do believe it will simply be a correction, and resolve with new highs.
5.  I currently believe the odds are good for an intermediate correction to follow after the next rally takes us to (presumed) new highs -- but let's not put the cart too far in front of the horse...

This has been a bear-killing rally since 1820.  And if the current rally does indeed reach new all-time highs, it could be the proverbial straw that breaks the camel's back.  Bears will feel like it's the end of the world, and many will finally capitulate.  Bulls will feel unstoppable, as their mantra is again rewarded: "Buying the dip ALWAYS works," they'll say to all the downtrodden bears, who have vowed to never again short the market.

It's the perfect setup for an intermediate decline.

Fifth waves aren't really supposed to be obvious, otherwise there would be no one to buy them, and we'd never even have a fifth wave (no buyers = no fifth wave).  Ever wonder who the guy was who bought the market at the exact top tick of a long-term peak?  He was the guy who had no clue we were in a fifth wave.  And he wasn't alone, it's just that all the other folks who had no clue we were in a fifth wave got in a few points earlier.

The chart below shows my intermediate preferred count:

The moon-shot count remains possible, but I think we'll be able to identify the inflection points in real time well enough to know if the market is on the moon-shot track, so I'm not going to worry about it just yet.  I think the preferred count presents an excellent setup for a surprise sustained decline -- because for a sustained decline to materialize, the majority simply have to be net long, expecting more rally, and scared to short.

And how scared will everyone be to short after the last two declines have ended in face-ripping rallies to new all-time highs?  So I continue to favor new all-time highs in SPX and INDU -- and I think RUT, COMPQ, and BKX all support that conclusion.

I think RUT also supports the idea that this could be the final rally before a deeper correction, as it appears to be completing five waves up at multiple degrees of trend:

 COMPQ (continued, next page):


So, all that said, let's play devil's advocate to my above thesis.

INDU's long-term chart says we can't rule out the moon-shot idea entirely (but then, a "surprise" intermediate decline should be a surprise, after all -- and things need to look as bullish as possible):

Finally, INDU's short-term chart says that, technically, we cannot yet invalidate the more direct bear count.  But until there are some downward impulse waves, there's nothing to give the bear count much weight.  I remain open to it primarily because complacency is stupid.

I would thus never give my long positions enough room (in the form of stops) for a count like this to hurt me much.  When you're near an inflection point, and there's potentially 600 (or more) points of upside, one might carry a stop with a matching risk/reward -- but when you're 200 points off the all-time high, one's approach, by necessity, changes.

In conclusion, RUT is the first index to fully confirm that its last decline was simply a correction.  The charts seem to argue that odds have to continue to be given to the bulls for new highs in INDU and SPX as well -- but as we approach the old highs, keep in mind that the room for complacency diminishes.

As outlined, in my perfect world, I'd like to see those new highs, ideally in a fashion convincing enough to get everyone even more ragingly bullish (starring Robert Dinero... get it?  Robert De Niro starred in Raging Bull, and "dinero" is cash.  Okay, it's late.  Forget I said anything.) right before the market begins an intermediate decline.  In the meantime, I'll track the structure on a micro level to try and identify that point as it happens.

Have a great weekend heading into Christmas week -- and, as always, trade safe!

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