SPX Update: The Moment of Truth

I was recently reminded by a reader that sometimes people can have very short memories, as I was accused of the dreaded "top calling."  So, to clear the air, let's take a quick stroll down memory lane.  On April 16, I wrote:

As long-time readers know, I have been primarily bullish on equities since November 2012 -- but for the first time since then, I truly have no desire to "buy the dip" for anything longer than a short-term trade.  There are some disturbing early warning signs that the market may be undergoing a fundamental change of character.  I don't presently know how long this will last, but when I see signals like this from the market, I don't screw around and risk gambling away my financial future.

On the chart I published within that article, I projected a rally to the 1570 zone, followed by a decline toward 1540, followed by a rally to 1580 -- all of which have since happened.  If we ignore the (correct) projection for that roundtrip lower and only look at the "top call" of April 16, basis the 1570 projection of that same day, then the S&P 500 (SPX) is now up almost an additional 13 points. 

To go back even farther, I was exceedingly bullish from the very first trading day of the year (see: SPX and US Dollar: Rally Likely Only Halfway Through) and continued outlining the bull case for several weeks after.  I stayed unequivocally bullish until my adjusted target zone of 1520-1530 was reached, and since then, I've hit several of the turns with pretty darn good accuracy.  If some readers are expecting more outta me than this, then I'd like to state, quite matter-of-factly, that I simply can't do much better.  I'm quite sure somebody out there can, but this year overall has been about as good as it gets for me personally.

So I would like to take this opportunity to lovingly remind less-experienced traders that there simply is no such thing as an infallible crystal ball in market projection.  If one is expecting the impossible in terms of prediction, then one is certain to be disappointed.  Make sure your trading goals are realistic and achievable, or you are doomed to an ever-shrinking account caused by repeatedly pushing your luck to the breaking point (also known as "overtrading").  Todd Harrison has a philosophy called "hit it and quit it," and I think that sums it up just about as succinctly as possible. 

Since April 16, I have been systematically outlining the bearish signals which have popped up, including things like overly bullish sentiment, and the smack-down in IBM on their earnings miss.  These don't guarantee another leg down, but nothing guarantees anything in this business.  The only thing we're ever "guaranteed" is an interesting ride.  Well, that and a ludicrously Keynesian economic policy, of course.

The rally feels like it will never end, which, ironically, is exactly how it should feel if it's going to end.  Tops never look like tops until they're in the rearview mirror, otherwise nobody would have bought a single ounce of gold near $1900. 

Note the daily chart of SPX below, and think back to how many of those tops "felt" like tops at the time.  Incidentally, if you're an intermediate trader, there is almost never any need to front-run a top.  While I will frequently front-run tops (and bottoms) in my analysis and projections, my philosophy as a trader is generally (not always, but usually) to wait until the market retraces at least 61% of the assumed first-leg down before going short -- again, this applies, for me, when looking at things from an intermediate basis or longer (short-term is another matter entirely).  That approach not only seems to be in line with "the way tops work," but also helps minimize risk by providing a clear zone for stop-losses.  I'll never understand the subscription services who tell their subscribers to front-run by selling into the teeth of a high-momentum rally (seemingly) every other week.  I see no need to take on that level of unmitigated risk. 

As I mentioned last week, if the market breaks out convincingly over 1600, then we probably need to set our sights on the mid-to-high 1600's as the next target zone.

The rally has now exceeded my initial expectations, and the moment of truth has finally arrived.

The 10-minute chart notes one of those amazing "coincidences," when the market turned perfectly at the upper boundary of the blue trend channel I drew for Thursday's update.  Note the melt-up channel has finally broken.

SPX Update: Bears vs. The Fed

This market remains a question of historical indicators and the "real" economy vs. Fed liquidity injections.  QE-Infinity (incidentally, I do believe I was the first to actually coin this term) is still in full effect, and even as I write this column the Fed is feeding the market via its primary dealer accounts, to the tune of almost $36 billion over the short-term.  As expected, Bernanke's policy of "no banker left behind" has worked wonders for equities up to this point, though seems to be doing little to help the actual economy.

Now for a bit of market history which may fight the Fed -- I haven't mentioned this statistic in about half a year, but it's relevant to share it with readers again today.  Last week, IBM announced dismal first quarter earnings results; shares have taken a beating ever since, and dropped about 8%.  This bears attention because the S&P 500 (SPX) and IBM have a correlated history when IBM trades down on earnings:  70% of the time this has happened in the past, SPX then trades lower over the next five weeks.  It bears noting that the last time I mentioned this correlation was on October 22, 2012 -- and almost exactly five weeks later, the SPX reached the November bottom. 

That said, I'm reiterating this next point, because it's a discussion I seem to have awfully frequently with newer traders:  even 70% odds still mean that exactly 3 out of 10 times, the market will end up doing the exact opposite thing. Nevertheless, it makes no sense to me to take the 30% stance -- so unless the market breaks out over long-term resistance here, I'm continuing to favor the idea that there's at least one more leg down coming.

My outlook isn't coming from any sense of moral conviction about what the market is "supposed" to do next, it's purely based on the odds.  To go back to my poker analogies of the past:  when I'm dealt a pair of aces before the flop, I raise the bet not because I'm "predicting" the hand will win, or even because I think it "should" win -- I take action because the odds favor it will win, so raising is the correct play.  Yet, as anyone who's played serious poker will tell you, the odds never guarantee anything (except frustration when they go against you!).  Point being, when I see signals like I've seen in the current market, I'm inclined to sell the rallies for the same reason.  A minority of the time, though, I'll be dead wrong -- but I can't actually control that part of the equation.

This has sparked another thought that's probably worth sharing.  In order to be successful at trading, I think one has to learn to become comfortable with the idea of uncertainty.  Most of us have some difficulty with uncertainty, so we seek out ways to avoid or eliminate it, sometimes going to great lengths to do so, even if that requires we cling to a false sense of certainty.  I believe this is why some analytical services have decided to take the approach of: "Mortgage the house today, because our prediction is most definitely going to happen in the market tomorrow! No doubt about it!"

Personally, I view that approach as moderately irresponsible, but strangely, I believe it actually makes some people feel safer -- especially less experienced traders -- which means that approach probably brings in new subscribers for those services.  Ironically, to my way of thinking, less experienced traders are exactly the people who don't want to be feeling any level of over-elevated conviction.  Trading is hard enough already -- but it's ten times harder once a sense of conviction engages our emotions and our egos.  Anyway, that's just how I view it.

So let's talk about what is most definitely, without a doubt, for sure going to happen today!  Get set to mortgage the house, because I'm givin' ya gems here!  Ready?  What will most certainly happen today (and there is almost no doubt in my mind!) is:  the sun will rise.  You heard it here first!  As far as the market goes, though, we're still in the inflection zone -- so the bears will either get it done here, or they won't.

The hourly chart remains materially unchanged, though I was able to correct the ChiOsc in the lower panel (yesterday, the Java program simply wouldn't let me draw the signal line where I wanted it.)

I've detailed two 10-minute charts of SPX.  The first one notes a confluence of resistance sitting just overhead, in the 1585-1590 zone I talked about yesterday:

The second 10-minute chart attempts to interpret the near-term wave structure.  This is actually a pretty funky wave form going back to the 1536 swing low, so if you're trading this, then please do so cautiously.

Yesterday's Flash Crash Fit the Wave Structure

Over the past week, I've outlined about half a dozen reasons why the odds favor the bears should get another leg down after this rally, and now the market has finally entered the critical "retest" zone for the 1597 high.  Elliott Wave is extremely particular about exact price points, whereas classic technical analysis allows a bit more leeway, and in classic TA, a "retest" is considered as something of a zone which extends somewhat below and above the prior swing high (or low).  I tend to focus more on Elliott Wave analysis within this column, but in practice I blend the two disciplines.  In either case, the market is now at an inflection point.

Yesterday made for an interesting session, as the market experienced a mini flash-crash after AP had their Twitter account briefly taken over by terrorists, who sent out some frightening false news items.  The market experienced several minutes of sheer panicked free-fall, when the terrorists falsely tweeted that Ben Bernanke had just been spotted reading a copy of The Road to Serfdom by Friedrich Hayek.  But it recovered almost immediately, as investors quickly realized this Tweet was so incredibly unbelievable, it had to be a hoax.  I think they also Tweeted something about explosions at the White House, but the market probably shrugged that off as irrelevant.

The hourly chart remains unchanged, and the "best guess" projection I detailed on April 16 has since tracked with far more accuracy than it had any right to.  Note the levels of the Chaikin oscillator in the bottom panel (also note that for some reason, Java refused to draw the red sell signal line in the correct place!  It should be drawn higher on that chart than it is, close to the indicator's current level.)

On the one-minute chart below, there's an amazing little tidbit for those of you who love math and the harmony of the markets -- and it's especially interesting given the events of yesterday's session.  On the chart below, the rally from blue B to blue wave (3) (from 1548.19 to 1560.18) is 11.99 points.  I am interpreting yesterday's rally as an extended fifth, and extended fifth waves often target the 1.618 extension of waves 1-3.  Waves (1) through (3) were 11.99 points.  If we multiply that by 1.618 (the expected extension), it calculates to be 19.40 points.

19.40 + 1560.18 (the peak of blue (3)) = 1579.58 -- which was the exact to-the-penny high of the wave before the flash crash. (Insert Twilight Zone music here...)   I find this all the more fascinating given the "unpredictable" event in the form of terrorist activity and the market's subsequent 16-point plunge.

While I remain in favor of the bear view, the 10-minute chart shows the near-term bull count in rough detail.

SPX Update: Clues from a Proprietary Sell Indicator

Yesterday's article was long on words, so today we're going to focus more on charts.  There's been no material change in the outlook, since so far the market hasn't done anything even vaguely unexpected, but I've refined a few charts and potential targets.

The first chart I'd like to share is one of my proprietary signal indicators.  While I'm not publishing all the constituents which actually make up this indicator, I have noted the prior few years of signals on the S&P 500 (SPX) chart below.  This is one of the signals which is presently keeping me in favor of the bears for another leg down.  Note the present similarities to the examples of 2011 where two sell signals fired off in close succession.

Today, we're going to start off with the one-minute chart and build from there.  One of the challenges in market prediction is the anticipation of how a corrective wave will unfold.  Corrective waves can be quite complex and thus extremely difficult to anticipate perfectly in advance.  Beyond that, the "easiest" market reads are almost always done in real-time, since the market gives off new information by the minute.  It's almost impossible to anticipate every potential turn which will come down the road in a given session (and even more impractical to try and outline them). 

But since a static published column obviously doesn't have the luxury of speaking in real-time, what I try to do is look several steps down the road to give readers some idea of what I'd watch during the session.  Assumptions have to be made in order to do this, and the first assumption I'm making is that this is indeed a corrective rally, as opposed to a new impulse wave which will head to new highs.  Accordingly, I've noted the two most likely possibilities for a corrective wave on the chart below.  If the market sustains trade above 1577, then we'll have to look more seriously at other angles.

 
In the event that my thesis of a corrective rally is wrong, on the 10-minute chart below, in black I have noted the rough turning points I'd watch for an impulsive rally.  Again, presently the only invalidation level for a corrective wave is the prior high -- so all we can do is watch key resistance at 1577 for our first clue that something more bullish may be afoot. 

Why Barron's Prediction of Dow 16,000 Favors the Bears

This weekend's Barron's Magazine cover features the exclamatory prediction of "Dow 16000!" and depicts a bull (replete with a huge Cheshire cat grin) on a pogo stick bouncing over a fat, slow, and apparently confused bear.  Clearly, the message this cover wishes to convey is:  "Have another margarita, bulls! There's nothing at all to worry about!" 

If I were still bullish, I'd worry about that.  (And it goes without saying that one should never drink more than two margaritas before hopping around on a pogo stick.)

This cover is the lead-in for Barron's latest Big Money Poll, and the following quote is found within:

“The stock market isn't the only thing that has set records this spring. Barron's semiannual Big Money poll of professional investors also is setting a record -- for bullishness, that is. In our latest survey, 74% of money managers identify themselves as bullish or very bullish about the prospects for U.S. stocks -- an all-time high for Big Money, going back more than 20 years.”

Barron's has a bit of history with bullish magazine covers, and it isn't terribly encouraging.  There are some logical reasons that publications such as Barron's sometimes make great contrarian indicators, and I'll cover these in a moment. Unlike my column (and many other columns here on Minyanville), publications like Barron's are generally more focused on reporting the past than they are on predicting the future.  This is not to imply any kind of slight against them, or that there's anything wrong with news-based publications -- we have to get our news from somewhere.  To be honest, sometimes I'm envious: Writing about the past allows an infinitely higher degree of certainty -- and involves a lot less head-scratching, fewer sleepless nights, and virtually no potential for "getting one wrong" (or criticism about the same, for that matter).  As Yogi Berra once said, "It's tough to make predictions, especially about the future."

Interestingly, Barron's Big Money Poll in May of 2007 was also quite bullish in tone, and predicted Dow 14,000 -- and that prediction was featured on the cover in a similar way in 2007.  This level wasn't actually too far off, and was reached in October 2007 after a rally of about 6%.  We all know what happened after that.  The bullish cover of 2007 was a whole lot closer to the top than it was to the bottom.

When market publications which usually stick to reporting the past decide instead to predict the future, there is somewhat of an intrinsic "conflict of interest."  Barron's didn't become hugely popular by publishing stuff nobody wants to read -- so by the time they're willing to boldly predict something on the cover, it's at least partially because they feel that cover will make the majority of people want to buy their magazine.  Bears obviously don't want to read an article about "Dow 16,000!"  People who own equities do.  This tells us, in a roundabout way, that "bullish" has gone very mainstream -- and in this way, these types of magazine covers help indicate when sentiment levels are approaching extremes. 

The problem, and I've written about this many times, is that by the time everyone "knows" something about the market, it's usually dead wrong.  When we're talking about bullishness, there are only so many buyers out there -- and it obviously takes a constant influx of new buyers in order for any stock to continue heading higher.  Even if a stock were the Greatest Most Amazing Stock in the World (just as a "totally random example," let's say this amazing stock were, ahem, Apple (AAPL)), once everyone who wants to own Apple already owns it, then at that point, the share price has nowhere to go but down.  

Think of it like an auction where -- unbeknownst to the buyers ahead of time -- there will be 50 of the exact same item auctioned off sequentially, one at a time.  Further imagine that no one at this auction knows in advance that there are only a total of 49 buyers present for this particular item.  In this situation, the first few times the item comes up, the bidding will be hot and heavy since the majority of buyers are still competing with each other.  This drives the bid higher each time, and, more importantly, establishes a psychology of "fair market value" for the item in everyone's minds.  Since the price is continually being bid higher anyway, each subsequent auction then commences with a higher starting bid, and the buyers naturally take no issue with this. 

There will continue to be some degree of competitive bidding, and accordant price increases, right up until the second-last buyer (buyer number 48) secures his item.  Then, with no more buying competition, buyer number 49 will simply pay the high starting bid -- and for a brief moment, this last buyer will actually think he got a "really good deal" because no one bid the item any higher.  But trouble starts (seemingly out of nowhere) when the auctioneer tries to sell item number 50, because suddenly nobody wants it at the opening bid.  He lowers the asking price -- but still, no buyers.  What no one there realizes just yet is that all the potential buyers have already been converted into "owners," so there's simply no one left who's interested in the remaining inventory.  The auctioneer looks around in surprise, and drops the price again, but still no buyers step forward.  And now a new kind of trouble begins, because at that point, all the people who just bought this item feel like idiots.  They're not "happy owners" anymore -- in fact, now they're thinking they probably paid way too much! 

The feeling that we got "ripped off" -- or that we own something nobody else wants (especially an "investment" nobody wants!) -- brings up strong emotions.  These emotions can be exceptionally powerful when it comes to the markets, because emotions in that arena are tied to our sense of financial security, which in turn is tied to our deepest, most primal instincts for survival (none of us can survive for long without any financial resources!). As a result, when the above analogized situation occurs in the stock market, it can actually generate an outright selling panic.  The panic psychology is further compounded by the fact that equities have absolutely no practical use whatsoever in the physical world.  You're essentially buying a really fancy piece of paper, solely because you're hoping you can sell it to someone else for more than you paid for it.  This "greater fool" psychology makes the stock market much more emotion-driven and volatile than the markets for most physical items.  In any case, once a "no more buyers" situation is reached, the asking price will have to continue dropping until such a point as either new buyers find the lowered price attractive, or previous sellers find it attractive once again, at which point a new price floor can be established.      

Do note that I'm not predicting a selling panic tomorrow, I'm merely noting that the sentiment precursors are in place, and a 20-year high in bullishness shouldn't be ignored.  Since I always try to see both sides of the argument, though, I think it's also important to note that these types of sentiment indicators are purely relative, and that makes them difficult to time trades with.  For example, I remember some contrarian investors talking about what a great time it was to buy equities in 2008 when the polls came in showing bears numbered around 60%.  They said it again when bears numbered 65%, and again at 70%, and again at 75%... and so on.  The market didn't end up bottoming until bears numbered over 90% -- so the key takeaway is that numbers which look extreme this week can end up looking mild by comparison in a month or two. 

Moving on to the charts, I continue to feel it's more likely that this is a reaction rally and that bears will take the market back down again after it's over.  The 10 minute chart shown second has a bit more detail about upcoming resistance levels.

It's worth mentioning that last Tuesday's projection (reprinted in the red breakout box below) has played out exceptionally well since.  Hitting three turns in advance on a "best guess" isn't too bad -- especially considering SPX traversed more than 80 points during that time, and the market's now right back to almost exactly where it started (!). That projection correctly anticipated about 85% of the move in terms of points captured, as well as the correct turning points -- so if you traded that roadmap, then you probably did okay. Hope it helped anyway!

We'll see if the original roadmap continues to track or if Friday's slightly altered view comes to pass.  On Friday, while I (correctly) projected the rally into the blue target box, I also slightly favored the idea that would mark the end of the upwards correction.  I noted that I didn't feel I could see "two turns down the road" at the moment, and what would happen after that rally wasn't entirely clear to me.  After studying the charts over the weekend, it does appear there may be some additional upside momentum left, so I've noted the next resistance levels on the chart below.

More Warning Signs for Bulls

On Tuesday, I outlined some of the reasons why I felt the market was undergoing a fundamental change of character, and discussed why I believed the power had shifted to the bears.  Since then, even more warning signs have cropped up for bulls.

The most obvious is the fact that most indices have now broken their intermediate uptrends.  Additionally, the decline in the S&P 500 (SPX) appears to be a five wave impulsive move, which suggests that the trend has shifted, and the next highest degree trend is now pointed down.  Whenever we see a new five wave leg forming in the opposite direction of the prior move, we can generally anticipate this first leg will be followed by at least one more leg of similar length, or longer.  There are other warning signs as well.

The chart below shows the 5, 10, and 20 day exponential moving averages of SPX and the Dow Transportation Average (TRAN).  This is based on a trend-following system which was popularized by Gerald Appel, who rose to stardom by developing the now-ubiquitous MACD indicator.  Okay, maybe "stardom" isn't the right word, since us traders belong to a pretty specialized subculture -- it's probably unlikely that your barber or landscaper has posters of Gerald Appel hanging in the garage, and I doubt he's ever hounded by paparazzi.  

Anyway, the last signal from this indicator was a buy, back in November 2012.  As we can see on the chart, TRAN has already given bearish crosses, and SPX is now extremely close to joining in.  Of course, there are no "magic bullet" indicators, and this one can be prone to whipsaws around tops, which is another reason I use multiple indicators and charting systems.  Nevertheless, this is one more potential red flag in the making for intermediate traders of the bullish persuasion.
  

  
The short-term wave structure in SPX is open to a few different interpretations, but I'm presently inclined to favor a path similar to the one shown below.  We'll have to see what today's session brings, but I suspect we'll see a green close today.

Tuesday's "best guess" projected path has since tracked nearly perfectly, but as mentioned above, I'm not certain if it will continue to do so.  I have left it unchanged on the chart below, but right at this exact moment I don't necessarily feel that I can see two turns down the road for the market.  I do somewhat prefer the path outlined above, which would see a rally for today, then a decline into Monday, then a bounce for Turnaround Tuesday.  Let's get through today's session first, then we'll take another look at the near-term path in Monday's update.

Do note that the red iii/C is not presently intended as a "final target," it's merely a general outline of expected direction at this stage.  Note that the trend line off the November lows has been broken for the first time since then.

SPX and Gold: Song Remains the Same

In the last update we looked at some of the reasons why lower lows are likely to follow Monday's low, while I noted that a snap-back rally could begin immediately.  The market spent yesterday's session in rally mode, and closed near the high of the day, which fit the pattern -- so as yet I have no reason to alter my thesis that lower lows await. 

It's currently unclear to me if yesterday's high will mark all of the (assumed) corrective rally, or if the rally will turn into a two-legged ABC -- in either case, I expect SPX to close in the red today.  There's no material change in the outlook for the S&P 500, so my best-guess projected path remains exactly the same as it was yesterday (though the price action did allow me to delete the rising blue line which was previously drawn in the place where Tuesday's rally has since occurred).

 
While I expect lower lows, we can't ignore the fact that SPX and the Dow Jones Industrials (INDU) both remain in technical uptrends.  A breakdown of the rising green trend line on the chart below is the next step for bears to gain confidence. 

Incidentally, for those who still doubt the value of technical analysis, I would like to note that I charted the blue channel (below) a pretty long time ago -- yet the rally was rejected immediately upon running into the upper boundary of that "imaginary" channel, and the same occurred in reverse when it fell back to the rising green trend line.  The next break of either will be telling.

Finally, given the recent volatility in gold, it's time to update the long-term chart.  Once again, simple trend lines worked their magic, as the recent decline found support at the rising blue trend line.  Given the wave structure, I would be surprised if gold does not ultimately break through that support level.  I've outlined next support and some potential targets -- trade above key resistance is required for me to re-examine that outlook.  Given the numerous failed retests of the all-time high and the subsequent breakdown of the topping pattern, it's hard to view the last couple years as anything other than a significant top.