SPX Update: Bears' Turn Now?

On Monday, the S&P 500 (SPX) made it into the 1320-1325 target zone I suggested on Friday and reversed; so hopefully the short term wave structures are finally starting to clear up again.  There's been no material change in the counts, however there's now enough structure to target some key price markers for the bulls and bears.

The preferred count believes the rally completed in the target zone yesterday, so the bears' line of defense is fairly obvious: the recent 1322 print high.  If the market moves above 1322.28, then 1330 becomes the next target; and if that falls, then 1345-1350 becomes the target.  The preferred and alternate counts are both reflected on the chart below.

The first alternate count would see yesterday as the completion of wave 3 of c, with 4 down and 5 up still to come -- to rule out that possibility, the bears need to take control of 1296.46.  If the downward movement (assuming we continue down after yesterday's reversal) looks tepid and overlaps the same price territory repeatedly, then I would suspect that this alternate count is in play.

A number of markets ran into resistance yesterday, including the NYSE Composite (NYA) and Dow Jones Industrials (INDU), so this seems like a natural area for bulls to take some profits, and for the remaining sixteen bears to make a stand.  Below is a daily chart of the INDU; the horizontal resistance faced by the INDU yesterday goes back to the 2007 top.

Yet another top indicator triggered on Monday, as the put/call ratio reversed its downtrend from near-historic lows.  This reversal is (yet another) bearish signal.  I'd like to quickly rehash the numerous other top indicators we've covered over the past couple weeks, counting backwards from the most recent:

1) VIX:TNX closed outside its lower Bollinger band, while COMPQ closed above its upper band.
2) Nasdaq volume as a ratio to NYSE volume reached unusual highs.
3) The NYA has formed (and continued) a negative price divergence with the SPX.
4) Daily RSI is in the upper "bear-market bounce, heavily over-bought" zone.
5) Daily MACD remains on the cusp of forming a bearish divergence.
6) My 12-year study on investor sentiment suggests that the current and severe lack of bearish investors is virtually always consistent with a top of some kind.
7) SPY has 4 unfilled gaps below the current market, all within the prior 100 trading days.  History suggests that these gaps will be filled 90% of the time.

These are some of the statistics and indicators which have kept me bearish recently while the bulls ran amok.  Granted, some of these indicators began triggering early, and have kept me from participating on the long side of the market since roughly the 1269 area.  Even if an indicator works 90% of the time, there will always be that 10% of the time when it fails.  I can live with that.  I don't need to trade every move, and when things start to look dicey, then it seems to me that being cautious and patient is not unreasonable.  I'll happily take the 90% odds all day long.

To reiterate another factor, I am virtually certain that QE3 will not be announced this time around.  Currently, my "no QE3 today" record is flawless, and I'd like to keep it that way if possible.  Given all the liquidity flowing into the U.S. from Europe, I would be absolutely shocked if the Fed decided to flood the system further.  In fact, indications suggest that the Fed has quietly been taking steps to contract liquidity.  So they'll probably give more jaw-boning to the numerous "tools" they have available to continue ruling the world, but I strongly doubt they'll take any significant action at this time. 

In conclusion, with several rare, once-a-year (and some even less frequent) top indictors triggering recently, I have to continue to stay with the odds here. I believe there's a very reasonable chance that the top is now in place.  Ultimately, however, top calling is the toughest racket in trading, and this one has been less-than-kind to me -- so until bears can break the rally channel and begin taking over some key price levels, conservative traders may want to give the uptrend the benefit of the doubt.  Trade safe.    

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX and BKX Updates: Rare Top Indicator Triggered on Friday

Before I get to the indicators and market charts, I want to do a quick update about domestic mutual fund flows, with some new data that has come to my attention.

Last week, we discussed the high number of mutual fund outflows which have been ongoing for several months.  Let's take a look at the updated mutual fund flow chart, courtesy of Lee Adler at the Wall Street Examiner, and then the new data I want to discuss.  Here are Lee's comments regarding the chart which follows:

Domestic equity mutual funds had $0.7 billion of net inflows in the week ended 1/1/12, up from $7.1 billion in net outflows the week before, which was the highest level of weekly outflows since August.  This was the first week of inflows since last April, which was nearly coincident with the top of the market at that time.  Total outflows for November were $14.3 billion and for December are estimated at $18.2 billion based on the weekly data. The projection for January based on the first two weeks is for outflows of $13-14 billion. That would continue a bearish signal on the chart.  A continuation of heavy outflows could eventually take a toll on stock prices.

Some analysts are taking the large outflows as a sign that the public is bearish.  I have a different theory, and feel that the recent outflows have little to do with sentiment.  Before I outline my theory, let's first look at some facts:

1)  The personal savings rate in the U.S. has fallen to its lowest level since December 2007 (the early stages of the last bear).

2)  Loans taken against individual retirement savings accounts rose 20% in 2011.

3)  According to Aon Hewitt, nearly one-third of all people with retirement savings accounts have outstanding loans against those accounts.

These facts underpin why I don't think the huge mutual outflows are primarily due to a bearish public, although certainly some are.  Based on the above statistics, it seems to me that a good chunk of these outflows are happening because people actually need the money.  Certainly, demographics are at play as well, since the over-sized baby-boomer generation is gradually retiring and turning from net savers to net spenders; but that's akin to "needing the money."  In any case, I think to just write off the outflows as being symptomatic of a "bearish public" ignores the supporting facts.  The public outflows appear to be a sign that the economy is still quite sick.

That said, we still have the ongoing flood of cash fleeing Europe to give the bulls more firepower.  I'm not going to re-hash this point, as it was already covered in last Wednesday's update, but Europe remains the X-factor in this market, and could be the reason that numerous top signal indicators have failed. 

Speaking of, there was another topping signal triggered late last week.  This is a pretty rare signal, which has only occurred three times in the prior 4 years.  The signal triggers when VIX:TNX closes outside its lower Bollinger band concurrent with a major index closing outside its upper band.  It's a sign the market has become quite overbought and over-confident (complacent).  Compare the current market position with the last two times this signal triggered on the chart below.  The S&P 500 is shown in the top panel.

 
Can Europe blow-up this indicator too?  We'll find out soon enough, I suppose.

The next chart is another top indicator, which has fallen just shy of where I like to place the signal line.  However, last week it reached levels which also frequently coincide with tops.  The indicator compares the volume on the Nasdaq as a ratio of volume to the New York Stock Exchange.  When the ratio meets or exceeds 2.6, it indicates excessive speculation in the "riskier" Nasdaq stocks, complacency, and "rally chasing" by investors.  The ratio recently fell just shy of the 2.6 level, which still indicates a high degree of optimism and complacency.

Again, I ask:  Can Europe blow-up this indicator too?  

In case they do, I have spent some time looking for alternate long-term counts.  Elliotticians seem to be mainly divided down the middle as to what's happening next for the market: some are expecting a top soon, as I am -- others are expecting a massive nose-bleed rally to new all-time highs.  I don't view that as likely, but I suppose if the flood of money from Europe intensifies, it might become conceivable. However, I wanted to see if there was something in-between these two extremes which might be viable, and I think there is.

Now, keep in mind that this chart below is my alternate count, not my preferred view of the long-term -- largely because I continue to believe that the wave off the 2011 highs is an impulse wave, which means new lows are still needed.  However, depending on what happens over the next week or two, the market may give new input that requires me to shift my viewpoint.

This chart also adds another, slightly humorous, top indicator (or bottom indicator, for that matter) to the dozen other ones: 8 out of 10 times when I start giving serious consideration to an count that is markedly more bullish or bearish than my preferred big picture count, a reversal is very nearby.  A little more anecdotal than objective, but maybe publishing this chart will finally trigger the reversal. 

The next chart is the short term SPX wave count.  I can see two likely possibilities in this chart, and I'm pretty torn as to which I'm favoring.  The first is the same count that was shown on Friday, which suggests this wave up still wants to head a little higher, into the 1320's. 

The second (black alternate) has some appealing characteristics, however.  Readers will recall that I previously believed the rally to be part of an ending diagonal;  this black count explains the a-b-c appearance of the rally as being part of a leading diagonal first wave.  This would account for the overall form of the structure, and the fact that the rally has continued despite its presumed completion.

The last chart is the Philadelphia Banking Index (BKX), which also shows a wave structure that appears to be nearing completion. 

In conclusion, there are many indicators, both common and esoteric, which are suggesting that the rally is massively overbought and due for a correction at the minimum -- or a serious decline if my long-term view is correct.  The caveat, of course, is that past performance is never a guarantee of future results, and maybe the goings-on in Europe are temporarily distorting the accuracy of these indicators and wave structures.  Is this time really different after all?  We simply have no way of knowing, so I have to continue to give the benefit of the doubt to the odds... and the odds still favor a top very soon.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com 

SPX Update: A Discussion on QE3 and the Market's Potential for Disappointment

Since "to QE3 or not to QE3" is once again the big question on investors minds, I'm going to share my thoughts on this before we get to the charts.

The Federal Reserve Board meets next week, and as has become something of a tradition over the past several months, there's been even more QE3 talk lately.  The Fed is starting to sound like the little shepherd boy in that old Aesop's Fable, The Boy Who Cried QE3.  How many more times will this Virtual QE talk work?

Several top economists (I realize this is a bit like saying "several of the world's tallest midgets") are now predicting that the Fed will launch QE3 in the very near future.  Many seem to be predicting this based on the still-abysmal housing market, as recent statistics show that the ratio of homeowner equity to disposable income has fallen to an unprecedented low of 54%.  How more QE would help the housing market is beyond me... if 30-year mortgage rates get any lower, the banks will have to start paying us interest.  Call me old-fashioned, but the housing market's woes seem to be caused by the archaic principle of supply and demand.  Too much supply and too little demand are not going to be solved by the Fed firing up the printing presses again. 

Perhaps the theory is to keep inflation going up, thereby driving housing prices up, thereby bringing current underwater homeowners back to even.  But, my word, at what cost?  If that's their thinking, we're in even worse trouble than we thought with this bunch.  To achieve that level of inflation... homeowners wouldn't be underwater on their mortgages anymore, but gas would be $15 a gallon.  So we'd cure the equity problem, but we'd have the slight new problem that homeowners wouldn't actually be able to afford to heat their homes.  As Robert Heinlein said: "TANSTAAFL: there ain't no such thing as a free lunch."  I'm hoping the Fed has figured this out.    

In any case, I continue to believe that the Fed will not announce QE3 at this time, especially in light of the recent stock market rally.  There are two main reasons I believe this. The first is: why launch QE3 when you can accomplish the same thing just by talking about it?  I don't think it's coincidental that the Fed tries to make a very convincing case before each and every meeting about why they're going to launch QE3 any minute now.  But then Ben comes out of the meeting saying, "Eh, not today.  But we could!  Don't tempt us!" and shakes his finger at the camera.  These guys aren't idiots -- at least, not in regard to the PR department.

The second reason is that in observing the current board, this Fed does not strike me as a proactive body.  Virtually every major action they've taken, including both prior QE's, has been a reaction to the stock market and/or other factors.  There presently seems to be no blatant crisis to react to, since we all know that Europe is fixed for at least a few more minutes; the latest massaged economic numbers aren't horrible by any stretch; and everything has been coming up roses for the market lately -- potentially because institutions are front-running QE3.  The irony is that maybe in front-running QE3, institutional investors are preventing the very situation that needs to occur for the Fed to feel mandated to announce QE3 in the first place.  It may create something of a Catch 22... then again, maybe they just have more information than I do.  We'll find out next week.  

What really steams my boat about the whole thing is that the Fed created most of this mess in the first place -- and then completely failed to anticipate the backlash of their prior actions.  People can blame subprime mortgages and sleazy lenders all they want, but the Fed created that situation.  It's a bit like blaming the punk street dealers for your city's drug problem; the punks are just the pawns, and while they're far from innocent, in order to address the problem one really needs to blame the kingpin distributor.  Now somehow the kingpin Fed is going to "fix everything" by doing what the government always does when it attempts to fix the problems it's created:  it throws even more money at them.  (I'm aware that, technically, the Federal Reserve is not part of the government.  I'm also aware that back in 1995, technically, O.J. Simpson was innocent.) 

In my view, the problems are not going to go away even if the Fed does print more money.  This "hair of the dog" fix may continue to work temporarily, but it seems to me that digging the hole deeper isn't actually a solution.  As Albert Einstein said, "We can't solve problems by using the same kind of thinking we used when we created them."

Alright, off my soapbox and onto the charts.  The market broke through the key resistance level of 1300-1310, and the bears now need to reverse this move quickly, or risk an accelerating melt-up.  The 1300-1310 level hasn't truly been back-tested yet, but if it holds as support, the market could make a fast run to 1350.  Conversely, if it fails as support, the bears have a potentially powerful whipsaw to run with.  While there are numerous indications that the market is overbought, prior melt-ups have sometimes occurred from such levels. 

Today is options expiration, and as I mentioned last weekend, January's OpEx Friday has been solidly negative in 10 of the prior 13 years -- so maybe the bears will get some help there.  A good reversal back under some key levels would make the breakout a whipsaw, and whipsaws usually lead to strong moves in the opposite direction of the prior trend.

If this is indeed Minor Wave (2), it is allowed to retrace up to 100% of the prior wave without violating any structural rules.  However, this weekend I intend on revisiting the long-term charts in depth and doing my best to determine if that scenario still appears to be the most likely (usually this type of decision on my part is a signal for the market to decline immediately). 

Sentiment still seems to indicate that a decline is probable -- since bullish sentiment as measured by the latest surveys is quite elevated, and the put/call ratio is reaching unusual extremes.  There are a lot of investors looking for more rally here, which means there's a big chunk of money already committed to that rally, which means there are less buyers to actually drive that rally.  It would be unusual for a melt-up rally to start with investors as bullish as they are, because the market rarely rewards a crowded trade -- but past performance doesn't guarantee future results and all that.

The short term charts depict essentially the same counts as yesterday.  Both counts were expecting some further upside, which the market provided.  This wave remains one of the more difficult structures I've faced in the past few months.  The challenge is that the entire wave leaves a great deal to interpretation and there has been little in the way of clarity.  The blue wave 1 (below) could conceivably be 1-2, i-ii (see second chart).  The entire third wave is a mess of structures that look more like a-b-c's than impulse waves. As a result, I have simply felt unable to nail down the short-term with much confidence. 

The first chart shows that there are enough squiggles to count this as a complete 5-wave move, although the one-minute chart suggests 1320-25 could still be in the cards for this wave.  1315 could possibly be the top -- but if this wave were behaving normally, I would be more inclined to think 1320ish.  Not surprisingly, it's very unclear. Below 1302, and I would no longer consider 1320 probable over the very short term. 

The second chart is the more bullish interpretation.  The count below suggests that the rally is moving into an acceleration upwards.  I have a hard time wrapping my head around this possibility, because of the ridiculously bullish sentiment and all the bearish secondary evidence.  But I'm trying not to let that evidence blind me to other possibilities, because as I said yesterday, price action always rules.

I think there's a dangerous tendency bears have to look at a rising market and say, "Are these people clueless as to what's actually going on in the world?"  Maybe. Maybe not.  The market doesn't generally do a very good job of pricing reality into the equation, otherwise there would never be crashes in the first place.  For example, the problems of 2008 (and beyond) were all written on the wall in 2007 and earlier -- but the market kept going up anyway, because the majority was simply oblivious. 

To draw another example, the housing market was quite obviously in a bubble for years, but prices kept going up anyway.  It usually takes the majority a long time to catch on, and while you did well to sell your house and walk away in 2005, had you somehow been able to "short" houses and started doing so in early 2005, you would probably have been hurting by the time the housing crash actually got rolling. 

Conversely, the problem with ignoring reality is that the masses tend to catch on all at the same time, and the exits suddenly get crowded fast.  Traders have to walk a fine line in both regards.

Objectively, the action yesterday was bullish.  Price broke out of the bearish "three drives to a top" type pattern that the market was in, and MACD also broke out to the upside.  Bears really need this to be a blow-off head fake, because the market was signaling strength yesterday.

In conclusion, the bottom line is that bears need a quick whipsaw to stay in the game over the short term.  Based on all the evidence, I'm inclined to think the bears will pull out an upset soon.  If indeed institutions are front-running QE3, and no QE3 comes, perhaps that will be the catalyst bears need.  In any case, theories, sentiment, and indicators aside, the current price charts have to be respected.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX Update: Rally Reaches Important Resistance Zone

Wednesday's market action pushed up into the 1300-1310 resistance zone I've been talking about for a couple weeks, and this is the bears last real line of defense in the short term.  We've looked at so many indicators over the past couple week that seem to be signaling a top (sentiment, divergences, numerous indicators, unfilled gaps beneath the market, wave counts, etc.), that it's hard to believe the bulls will push through here.  But ultimately, the price action rules.  If the bears can't stop it here, the S&P 500 (SPX) is clear for a run to 1325 -- and potentially to 1350. 

Logic dictates that I have to continue to favor the bears at this juncture, due to all the circumstantial evidence. But indicators and historical studies don't always play out as expected.  The bulls have an intact uptrend; while it seems the bears have just about everything else.

For the bulls to show that they're serious, the market needs to break above, and hold, 1310.  A head-fake breakout briefly above 1310 wouldn't do much technical damage to the bear case; but sustained trade above that level might.  You'll see what I mean when we look at the longer-term charts.  In any case, we have to be prepared for the possibility.

Fundamentals seem to favor the bears as well, especially if you believe that governments need to take in more money than they're spending in order to be considered solvent.  But as Keynes said, "The market can remain irrational a lot longer than you can remain solvent."

Given the current fundamentals, my twist on that old saying would be: "The market can remain insolvent a lot longer than you can remain rational."    

Certainly, despite particular fundamentals, there may be bullish influences acting behind the scenes that we simply can't see.  The cash fleeing Europe into the U.S., which we discussed yesterday, is clearly one contributing factor.  The European Central Bank's operations are certainly another -- and Lord only knows what Uncle Ben's up to half the time.

The charts are now pointing to a big move -- which direction it heads is going to depend on whether 1310 is captured by the bulls or not.  There's one potential count which could put finally the bulls to rest -- but it's one of those patterns that, if it doesn't play out for the bears, could morph into another melt-up rally.

Before we get to the short term charts, let's take a look at some longer-term indicators and patterns, and some of the reasons I remain inclined to favor the bears over the intermediate term.  The first chart shows a very interesting divergence between the broad-based NYSE Composite index and the SPX.  In 2009, the NYA supported the SPX's rally -- in fact, it often led.  This showed that investors weren't just buying a few select stocks, but were buying the broader market -- "A rising tide lifts all boats," as they say.  Currently the NYA is lagging the SPX considerably, and has yet to break above its October highs.  The last time the two indices diverged like this was August 2008.

The next chart is a daily SPX chart and shows some secondary indicators.  These indicators behave in certain ways during bear markets, and in different ways during bull markets.  There are two things of note on the chart: 

1)  The relative strength index (RSI) is still in "bear-market bounce" territory. 
2)  Standard deviation was still showing bear market volatility levels as recently as last month.

The next two charts are the short term wave counts.  Whoever wins the battle around 1310 will probably determine which of these is unfolding.  The preferred count (below) suggests the top could form today or Monday.

 
The alternate count suggests the market could run into the 1325-1350 zone.  The concern I have with this alternate count is that the move it suggests could potentially flip many long-term indicators into a bullish position.  If this second count unfolds, we'll have to watch the indicators carefully - but we'll worry about that if and when we come to it.

In conclusion, the 1310 zone remains important.  Again, based on the preponderance of evidence, logic dictates that I favor the bears over the intermediate term -- but logic doesn't always work when it comes to the market.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX Update: How Much Longer Can Europe Support the U.S. Markets?

There is an unusual pattern that's developed over the past couple weeks, where the market gaps higher in the morning, then gets sold for the rest of the day.  This is often a reversal pattern, but it has so far not yielded a meaningful reversal.  This made me curious if this had happened before in quite this way, so I spent a good chunk of the night looking through daily charts covering the past 2,700 trading days on the S&P 500 ETF (SPY) to see if I could find a similar pattern to the current rally.  Amazingly, I couldn't.  Perhaps the closest analog would be April/May of 2008, but that's not exactly right either. 

This looks like distribution to me: ramp the heavily-leveraged futures at night for a fraction of the cost of the cash market, then sell your inventory when the market opens.  In this vein, there are two interesting fundamental factors at work right now:

1)  There have been huge inflows of cash into the U.S. from foreign investors who are fleeing the European system, and some of that money is finding its way into stocks.  This is bullish as long as it continues, and it seems to be primarily what has driven the current rally.
2)  There are large outflows from domestic mutual funds.  This is bearish as long as it continues.

I have an interesting speculation that perhaps the U.S. fund managers are ramping the futures each night and, effectively, distributing to the Europeans.  Who knows.  But it's a strange pattern nonetheless.  One would think that, at some point, most of the money that's going to flee Europe will have done so already and the well will start to run dry.  When that will happen is far beyond my ability to anticipate: it may have happened already (data in this regard lags the market), or it may be at some future date.

My friend Lee Adler at the Wall Street Examiner does a great job tracking market liquidity, and most of my data in this regard is garnered from his Professional Report subscription service.  Here are two charts from his service, which illustrate the situation. 

The first (on right) shows deposits into U.S. trading accounts -- based on supporting data, these are presumably coming from Europe.  As Lee states in his report:  "This remains a bullish influence for U.S. markets; a.k.a.- the last Ponzi game."  The data is from the week ending January 4, so it lags by a couple weeks.

The second chart (right) shows domestic mutual fund outflows.  The most recent data here is also from the week ending 1/4/11.  Weekly outflows have reached the highest levels since August.  Lee states, "This continues a bearish signal on the charts... a continuation of heavy outflows could eventually take a toll on stock prices."

So as of the week of January 4, the market was in a bit of a battle of liquidity inflows and outflows.  Whichever source wins that battle heading forward is going to determine future market direction.  I believe the European inflows simply can't last forever; and that seems to be the only thing keeping the U.S. markets afloat right now. As I stated earlier, since this data lags, a victor to this battle may have emerged already.  This is why I generally use stock price charts first, and data second -- because the price charts are real-time, and should theoretically contain everything the market "knows." 

The short-term wave pattern could now be viewed as complete, meaning the top may be in -- however there has been nothing to confirm any sort of trend change yet.  What I would really like to see is a full daily candle beneath the lower trendline to confirm a top, but the market is still a ways from that.

The first chart I'd like to share is good old classical technical analysis; after that we'll look at the wave structures.  The chart below highlights three factors which suggest a turn may be at hand, all noted on the chart.

So there is continued evidence for a top, as there has been for roughly a week... but the market is still hovering.  Some might take that as a bullish sign.  Personally, unless the SPX breaks through 1300-1310 and holds it, I'm not going to get overly excited.  But I've been wrong before; and the money flowing in from Europe is certainly an x-factor that bears watching at this stage.

The next chart is the second chart from yesterday, which shows a potentially-complete five wave structure to a top.  If this count is correct, the top is now in.  It's also possible that wave five of 5 is still unfolding, with yesterday's low being four of 5.

 
The next chart is an alternate short-term count.  This count has a few things going for it, such as it effectively explains the bizarre structure of the recent rally (which looks like a series of a-b-c's).  I'm keeping this count as the alternate for the time being, but market action could shift this count into the preferred role.

NOTE: CHART ANNOTATION ERROR -- THERE IS NO INVALIDATION FOR THIS COUNT.  That's what I get for doing too many things at once some nights.  :)

In conclusion, unless the market breaks the key levels of 1300-1310 on the upside, and holds that break, I continue to believe that a top is close at hand, and that the market has given no real signals to become long-term bullish.  At the same time, it's not yet given any concrete price signals to be short-term bearish either.  There continues to be a great deal of evidence for the bear case, as outlined today and over the last week or two, but the bears need to start taking back some key levels to validate that evidence.  The first level for bears to capture would be 1285 -- and then 1277 and 1270 below that.  If the first count is correct, then perhaps this is the week the bears finally get 'er done.  I believe the influx of European cash which has been supporting this market is (clearly) a finite source, and likely to be tracing out some type of bell curve.  When that liquidity clears the apex and hits the slope, the market is going to run out of juice.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX and US Dollar Updates: Dollar Ready for Second Stage Lift-Off

Friday started off very promising for the bears, with a break below the significant support zone of 1285; however the bulls were able to get the market back above this zone before the close.  As I wrote on Friday, everything that happens between 1285 and 1300/1310 is just noise at this point -- so we're still in a bit of limbo regarding short-term direction. 

The market has been sitting in the target reversal zone for what seems like forever, and I'm starting to feel like a broken record everyday with "either the top is in, or there's one more thrust higher still to come."  Well, you'll be happy to hear that... nothing has changed yet.  If I didn't have to actually update the charts (and didn't feel obligated to provide my readers with new info), I could just do a form-letter for the updates until the market actually reverses.  That would save me a lot of time.  Trade safe!

Of course I'm only kidding.  Sort of.  Anyway, for today's new info, we're going to talk about the historical tendencies of this week.

The market started closing for Martin Luther King, Jr. Day in 1998.  Going back to 1998, this has historically been a pretty bad week for the markets, with the S&P 500 (SPX) ending the week negative 71% of the time for an average loss of 1.10%.  The worst loss was 2010, when the SPX shed nearly 4.5% for the week.  Couple that with the fact that January options expiration also tends to be negative -- the Dow Jones Industrials have suffered heavy losses on OpEx Friday in 10 of the prior 13 years -- and you have the makings of a week that favors the bears.

It is also likely that the bulls are running out of time on Minor Wave (2), if, of course, they haven't already.  Friday may have finally marked the turn, but there's still enough play in this ugly, ugly wave that there may be another thrust higher left in it yet.  It pays to remember that the absolute hardest thing to do when predicting the market is to call a turn before it happens, be that turn a bottom or a top.  When you predict a turn, you are betting against the trend.  And as they say, the trend is your friend... at least until the end, when it bends.

The first chart we're going to look at is the intermediate chart of the SPX, which shows the long-ago-reached Wave (2) target box, which the market seems intent on sitting in until the cows come home to roost (or whatever that saying is).  The expectation remains that once this wave reverses, the October lows will be broken. 

 
The next chart is the short-term SPX chart, with one possible count that suggests the market may have suffered a failed fifth wave on Thursday, in which case the top is in.  I'm favoring this count, but only by a slight margin.  Any significant downside follow-through on Tuesday would likely seal the deal; conversely, any upside beyond the recent swing highs would invalidate it.  If this count is invalidated, consult the second chart below.

We'll follow that chart immediately with my alternate count, which suggests wave 5 didn't fail, but actually started on Friday.  The short term wave structure of this rally is maybe the ugliest I've seen in about 6 months, and has really kept me guessing.  Remember the two week decline in December when every target zone I published was hit like clockwork?  That was an ugly waveform too, but nothing like this rally.  This current rally is the Ernest Borgnine of waveforms.

Also note how the market bounced right where a perfect new trendchannel could form (in red).  This is a very common occurrence, and it's one that veteran traders know to watch for.  I strongly suggest drawing channel lines whenever two swing highs or lows allow it during the day, to help anticipate potential reversal levels. 

The target for wave 5 would still be the 1300-1310 zone under this count, though that could change with new input from the market.  I still think it's unlikely the market will hold above that zone for more than a brief moment, if at all.

The last chart is the updated US dollar chart.  The correlation between the dollar and equities has uncoupled lately, but will almost certainly recouple at some point in the future.  In any case, the dollar is the one market that hasn't let my predictions down even slightly since my first published dollar update on September 3, when I predicted that a major bull market was starting in the dollar. 

I'm updating this chart because the dollar corrected right into target zone suggested on January 9 and reversed higher -- and the waveform out of the reversal zone looks impulsive, meaning it seems very likely that the nested third wave-up is about to break higher in an explosive way.  Since it seems to have completed five-waves up, a short-term correction is likely to occur first.  After that, it strikes me as probable that even though equities have been ignoring the dollar, a big move like this may get some attention -- from the algo-bots, if nothing else.  Note the blue melt-up channel.

In conclusion, I continue to believe that a top in equities is at hand; and that the dollar is going to continue markedly higher.  It's worth mentioning that I've had an excellent record at calling tops and bottoms, and hit both the October turns, and December turn, pretty darn well -- however, the market hasn't yet fulfilled my prediction that it will break the October lows.  So I haven't been too terribly early when calling tops (nailed the October bottom, but major bottoms are easier), but I have been too early in projecting where those prior tops would ultimately end up. 

Sometimes it's hard to see ten steps down the road, and traders may want to remember that although Elliott Wave allows us to make these predictions, often with a high degree of accuracy, there are always multiple paths the market can take to reach conclusion.  The lesson I hope to convey with this is that traders who protect their profits can do very well just hitting the turns, even if the market doesn't go down that road as far as one hopes it will every single time.  Trade safe. 

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX Update: 12-year Study of Investor Sentiment Points to a Top

The latest American Association of Individual Investors (AAII) sentiment survey numbers were released yesterday, and amazingly, were virtually unchanged from the week prior.  For the second week in a row, bearish investors remain at 17%, still near decade-long lows.  This struck me as a rare situation, so I decided to investigate further.

I set out to uncover how the market reacted when there were two or more consecutive weeks of bearish investor percentages this low, using bears below 19% as the control figure (thus allowing for roughly 12% standard deviation in the data figures). After combing through 562 weeks of AAII data by hand, I discovered that since the 2000 market peak, there have only been twelve other occurrences of this scenario.  Interestingly, the current back-to-back reading of less than 19% bearish is the first occurrence we've seen in almost six years.  So indeed, this is a rare set up.

After locking down the dates of prior occurrences, I went on to chart each example on the S&P 500 (SPX), in order to visually coordinate how the market responded to the excessively low bearish numbers.  What I found was that two or more consecutive weeks were always associated with some kind of peak in the market, even during bull markets.  In bull markets, the peak was sometimes minor, but it was still a peak.

There is another very interesting finding in my study.  Without exception, when bearish investors disappeared during bear markets, it was due to a technical breakout on the indices.  In other words, the shift in sentiment was due to market technicals, and not due to an improvement in the fundamental backdrop.  Conversely, this was not the case in bull markets, where the sentiment shifts didn't seem to correlate to any particular technical levels.  This has important connotations regarding the market's position now.

It seems we may be facing a similar situation today, as the market staged a technical breakout in December, yet the fundamental backdrop seems to have improved very little.

As I present the charts, the question investors need to answer for themselves is whether they believe the current market is a bull market or a bear market, because the implications of this data are quite different for each type of market.  If one believes this is a bull market, then these numbers correspond to a coming correction, which may be minor.  If one believes this is a bear market, these numbers correspond to a major top. 

I personally believe this is the start of a major bear market, and that this sentiment data is part of the "calm before the storm."  I am, of course, always open to the market proving me wrong at some point -- there's no bull side or bear side, only the right side. But at the moment, I see far more evidence for a bear market top than for an ongoing bull market.

The first chart I'm presenting shows what happens when sentiment reaches these levels during a bear market (hint: not pretty), as last occurred five times during the 2000-2002 bear.

 
Note how in every single instance, the sentiment numbers shifted in response to a technical market breakout, just as they have today.  One thing bears may want to keep in mind is that during bear markets, these extreme sentiment readings sometimes went on for a third week -- which can only happen if the market isn't falling too much.  Historically, that would suggest the current consolidation/rally could continue for another week  My current expectation is that it will not, however that could always change with new price action and data from the market.

The next chart shows how this sentiment corresponds with bull market peaks from 2003-2005.  Again, two consecutive weeks of bears below 19% hasn't occurred since.  Worth noting is that the very first shift in sentiment for the last bull market did correspond to a technical breakout above resistance (as has occurred now) -- however, it also corresponded to the 50 day moving average crossing up through the 200 day (known as the "golden cross").  So there were actually two strong technical signals to shift sentiment in 2003.  This golden cross technical signal has not occurred in the SPX today, so current sentiment seems to be "jumping the gun" as it did in 2000-2002 with each upside trendline break.

The next chart is the daily chart of the SPX.  Under Elliott Wave Theory, this bear market should unfold in five waves.  It appears the market is in the process of completing the second wave up, which should be followed by a very strong move down in the third wave.  My expectation for the next wave is that it will first carry the SPX below the October lows, and then ultimately much lower.

We remain on the hunt for the top of Minor Wave (2), which has thus far been sitting in the target reversal zone for the entire month of January.  This is not unexpected, as tops generally take time.  Second waves are particularly difficult animals, since they are able to retrace 100% of the prior move without violating any rules.  This makes them difficult to invalidate, and therefore more difficult to predict.  My expectation remains that the 1300-1310 zone should put the brakes on this rally.  This is not to say that the market can't break above this zone briefly, however, I wouldn't expect it to stay above that zone for long.

The short term wave structure remains very messy, which is another factor that adds credence to the idea that the market isn't going to suddenly launch into a sharp rally and break overhead resistance.  Strong impulse waves have certain characteristics early on which usually gives away their intentions. This rally has, so far, not displayed those characteristics.  Instead, it seems to have struggled higher, and burned off much of its energy in the process.  It's a bit like a marathon runner who sprinted his way to exhaustion just as he's approaching the steepest hill in the race -- which, in this case, is the overhead resistance at 1300-1310.  It sure looks like the rally doesn't have the required energy and momentum to break through this zone right now.

My expectation in this regard has remained the same since a week ago on Wednesday.  Assuming that a major top is indeed under construction, the exact penny of the top will probably only be apparent in the rear-view mirror.  The market continues to keep its options open in this regard, and as I stated yesterday, my stance remains that the reversal could begin at any time, if it hasn't already. 

The next level the bears need to take, and hold, is 1285.  The critical levels for the bulls are 1300 and 1310.  At this point, everything that happens in between these two levels is just noise.

In conclusion, I believe the preponderance of evidence points to a major top in formation, or complete -- and we can now add strong historical sentiment data to that collection of evidence.  My expectation remains that after the market finally turns, the October lows will be broken in short order.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com