Initial Stages of Global Stock Market Crash In Progress? http://www.thebullbear.com/profiles/blogs/initial-stages-of-global-stock
Last week SPX appeared to complete an abc sideways correction. By Friday the index was heading back towards its lows and ended the day and the week just above critical support at the confluence of the 200 EMA and the uptrend from March 2009. The setup is for a potential gap below this support zone on Monday, which could then trigger sell stops leading to a cascading decline.
Commodities continued to lead to the downside, with Crude breaking lower and the Agriculture and Grains sectors breaking key long term support levels. Gold and Silver also broke down from key support.
At the same time, US Dollar Index closed the week above long term downtrend resistance and above the key 76.00 level. VIX hovered just below long term downtrend resistance and has yet to register significant levels of fear in the market.
Technical indicators moved back from oversold and excessively bearish short and intermediate term readings while long term readings continued to deteriorate.
Overall the setup continues to be for a major break of support and a dramatic acceleration of the downtrend. Whether this entails a strong C wave decline to support, similar to the March 2011 decline, or an outright crash, remains to be seen. Either are distinct possibilities.
Late in the week, governmental and monetary authorities made transparently desperate attempts to prevent the breakdown of asset market prices. First, the announcement of a Greece austerity plan was timed to the minute to prevent a break of the 200 EMA and fostered a short covering rally. Next, Obama attempted to stimulate the markets by releasing strategic petroleum reserves to drive down the price of crude oil which would presumably give the economy an across the board "tax cut". Neither of these efforts were successful as corporate and sovereign debt related news triggered additional selling. In fact the net effect of last week's volatile correction and the efforts at keeping the markets above support was probably to exacerbate the situation by expending scarce buying pressure from "buy the dip" traders and investors and short covering in a minor corrective range.
The fundamental news cycle has now shifted into earnings warnings prior to the official onset of earnings season on July 11. Negative corporate news out of Micron (MU) and others hit technology hard and grumblings are heard that companies will be pre-announcing earnings disappointments going forward.
Although European authorities and the IMF would have investors believe that the Greece crisis has been contained, evidence is mounting that Italy is next on the hit list. The downgrade of the Italian banking sector is likely the first salvo in an ongoing attack on Italy's financial stability. No doubt other countries are set to show cracks in the facade of their solvency soon as well.
In the following video I detail the current basic technical picture for global markets. Before viewing it you might like to also review my prior videos and blog postings in this series:
As I have been saying for weeks now, the basic technical situation is quite precarious and even a cursory look at the charts of the major markets is enough to alert the open minded investor that there is major risk at hand. Yet even so, most analysts are focused on a perceived short to intermediate term "oversold" condition or an apparent "excessively bearish" sentiment picture.
The major breakout on the US Dollar Index chart is perhaps the most important indication of that a rapid, dramatic shift from risk to safety is under way.
VIX would be the next big indicator to make a dramatic breakout. It appears to be ready to move.
At the time of publication SPX futures are down .45% in very early Asian trade and have broken the 200 EMA. Dollar is rallying and commodity futures are down across the board.
Naturally, the market can prove us wrong at any time, and we should not get complacent or take our eyes off the ball. Any move above 1293 on the futures would be enough to get me to close my short positions and reassess the situation.
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I recommend that you read the prior blog entry before assimilating the information in this new report.
So far the core analysis presented in the last report has been validated by market action, technicals and ongoing developments in the fundamentals.
As suggested, markets around the world have tested or violated key technical levels. In this video, I follow up the prior video report with further evidence of an ongoing, global technical breakdown across virtually all world markets.
Tonight, India has plunged 3.3% upon breaking the support line indicated in the video.
Nasdaq 100 has closed below its 200 EMA for three consecutive days and is challenging its long term uptrend:
It appears that Crude Oil and quite probably the commodities complex in general is leading the next break lower in a repeat of the May top. The geosynchronous technical weakness is not likely to be an anomaly or a false signal and is already in a sufficiently advanced stage of development that a reversal and re-initiation of the bull market are unlikely.
There are significant signals in the current market that a crash or meltdown scenario could unfold sometime in the next 1-2 weeks. Crashes are rare events and nearly impossible to predict, but many elements that could combine to produce a financial market calamity appear to be present at this time.
This video reviews the current technical condition of the major world stock markets. In it I examine each index in terms of the relationship between price and the uptrends from March 2009 and August/September 2010, the April 2010 top and March 2011 low, the 20, 50 and 200 Exponential Moving Averages and areas of significant horizontal support/resistance.
Here's a direct link to the video: href="http://www.youtube.com/watch?v=OGVv2ODBQ-E">http://www.youtube.com/watch?v=OGVv2ODBQ-E
Every major stock market in the world is either hovering just above or directly upon or has already broken a critical area of technical support. Ordinarily this might represent a major buying opportunity. But the current market setup may be anything but ordinary. In fact it may be quite extraordinary.
By moving dramatically ahead of the markets and leading price lower, the market's underlying technicals tend to indicate that a sharp break to the downside is imminent. Many indicators have led the market lower and now price will likely play catch up to the underlying technical condition of the market. Here is just one of many examples:
In spite of a very modest 7.5% decline over 6 weeks of trading (1.25% per week), Percent of Stocks Above the 20, 50 and 200 EMA have declined to precipitous lows usually associated with huge selloffs. This is a prime example of the technicals leading the market lower.
Here's a closer view of NYSE Percent of Stocks Above the 200 EMA:
Only 55% of NYSE stocks are trading above their 200 EMA after a minor 7.5% correction. Even though market price has yet to take out the March low, the indicator has plummeted below its March low and is not far from its August 2010 low. It's moving averages have crossed into bear market mode. So on a long term basis nearly half of the stocks traded on the NYSE are trapped under long term resistance in a market that is showing historically weak buying pressure and significant and rising selling pressure.
Many analysts are calling this a signal of an oversold market. I think they are wrong. An oversold condition requires some capitulation selling and some fear and we have not seen that. Remember, crashes and capitulations generally come from oversold conditions. An oversold condition is also only a buy signal under bull market conditions and there are many reasons to believe that we are no longer in a bull phase.
There is very little fear in this market. VIX has barely budged:
Near market bottoms when fear is strong, traders switch to the use of ETFs instead of individual equities in order to insure that there will be adequate liquidity to exit the market in a hurry if things should turn ugly. This is represented in the SPY Liquidity Premium indicator:
In spite of everything we have discussed above, where is this indicator in relationship to its March low or April 2010 low? Not even close to showing the fear usually associated with a bottom.
This technical evidence tells me that the selling HAS NOT EVEN STARTED YET. And it is likely to get started soon. There is MUCH more technical evidence that supports what I am saying here which has been published in a full report for href="http://www.thebullbear.com/group/bullbeartradingservice" target="_blank">BullBear Traders members.
When you have a situation where price needs to play catch up to the underlying technicals and market participants are not fearful and are still buying the dip, you have the recipe for a selling panic of some kind.
Today's weak bounce is probably just another selling opportunity. Early action in Asia, US futures and the Dollar suggest that the correction may be over already:
This is wave C as I see it at this time. 2 of C was a large abc flat and (ii) of 3 of C may have been a smaller version with c falling short of a, making it a bearish running flat.
Breadth Thrust Indicator FELL today, a particularly ominous sign, since if this were a real bottom of any kind there would be a breadth thrust signal of some kind:
Many other indicators, such as Bullish Percent Index, did not even register a blip. From what I can see the technical quality of today's rally was very poor.
Also, Dollar rallied into the close and Euro and Aussie gave up almost all their gains. This has continued in the Asian session and Dollar is once again near 75.00. Looks like iii of C down may have begun in Euro. I am short more EuroDollar.
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In the introduction to this report, I detailed many of the non-technical elements that should have happened and could have happened and almost happened--but that ultimately failed to happen--leading to a non-confirmation of an ongoing bull market. Let's reiterate: I gave the bull the benefit of the doubt and argued its cause to the extent that it gave a cause to argue. But when reality departs from argument I will have to go with reality. Let's look at some technical factors which failed to confirm an ongoing bull market and give substantial cause to anticipate a renewed bearish environment.
First let's examine a long term chart of SPX:
Since the August/September 2010 bottom, we have been operating under the thesis that SPX was probably in a bullish Wave 3 advance. If this is the case, there are some technical characteristics which should be present and some which should not be present. Separately, the persistently declining volume over the course of entire run and the successive RSI divergences are not necessarily troublesome, but together they add up to a technical non-confirmation and make the move much more likely to be a C wave. If the 50 MA of volume starts to turn up and volume levels persist above the 50 MA during an ongoing decline, that will probably be a long term bear signal. If RSI declines below 30 and breaks its March 2009 low, that would also be another confirmation of a bearish shift.
The 50 EMA of Advances-Declines is testing its key support zone from which intermediate term rallies have been initiated many times since March 2009:
Of course, it's possible that it may rally sharply off this support zone again and the market may reverse. But there are some signs that that is not what is going to happen this time. First, note that the indicator has made lower highs as the market made higher highs--a bearish divergence. Second, note that the indicator recently bounced off of support but failed to attain a new high before heading back down again. Also note that the indicator is now nearly at its support level after a minor sell off in the market. This means that if the market breaks support this week the indicator is likely to also break through support and head back down to its May or July 2010 lows or below. This would likely represent a bearish range shift for this indicator and the markets.
Percent of Stocks Above 200 EMA has broken down badly:
This is just one example of the many indicators that are leading the markets lower. The indicator has declined to readings well below the March and November lows while market price has not yet even taken out the March lows. Generally when technicals lead a market lower it is a good signal that market price will follow soon.
While the situation described thusfar could certainly reverse and propel markets higher, the important point to be grasped here is that on every count there have been significant attempts to move in a direction that would be bullish for stocks and general asset prices that have FAILED badly and REVERSED strongly in the opposite direction. What makes this even more inauspicious is the total failure of the trading and investing community to come to recognize and come to terms with the situation. Trapped in attachment to to established views they may be forced to reckon with reality all of a sudden, producing a steep, sudden decline in prices as everyone heads for the exit at the same time.
In the short term a minor rally is possible as there may be a bit of short term selling exhaustion and a bit too much bearishness creeping in to the markets. if there is a rally, the next minor high should be a good shorting opportunity for the next wave down, which will likely be the strongest move down seen yet this year.
In the last BullBear Market Report, I called for a significant correction to begin and announced that I had closed all long positions and initiated a short position. My current analysis suggests that that continues to be the correct view of the market, but that the topping process is still in progress and that substantial downside may yet be a few weeks away. I'm back to 100% cash and awaiting a good shorting opportunity. I've changed my market stance from Bullish on all time frames to long and intermediate term Neutral and short term Bullish.
It's important for readers to note that I am not a permabear. In fact just a month ago I was 100% long and firmly bullish in my outlook. But I think it's crucial for traders to practice non-attachment to views. Rigid self identification as "Bullish" or "Bearish" is a major hindrance for any market participant. It's important to be able to let go of an established view when the market reality changes. Zen master Thich Nhat Hanh says:
"We must not be attached to a view or a doctrine, even a Buddhist one... The Buddha said that if in a certain moment or place you adopt something as the absolute truth and you attach to that…then you will no longer have any chance to reach the truth. Even when the truth comes and knocks on your door, and asks you to open the door, you won't recognize it. So you must not be too attached to dogma - to what you believe, and to what you perceive." Thich Nhat Hanh
That doesn't mean we should throw out an established view casually either. But views should be constantly tested and probed for weaknesses using objective criteria and analysis. During solid market trends, such probing finds confirmation of the view. But during the process of a market trend change, eventually probing reveals weaknesses and soft spots which over time develop into a reversal. It's very possible we are already well into that process now and that a trend change is looming.
Markets are fundamentally driven by the dynamic between buyers and sellers, supply and demand. That includes the capital markets. So ultimately it is a game based on liquidity. Whether liquidity flows into a market depends upon the available pool of capital as well as the psychological willingness of participants to risk that capital in the given market. When the pool has run low and most participants are already in the pool, the trade is crowded and it will inevitably reverse. The extent and duration of the reversal depends on depth of the imbalance. Eventually the pool will become relatively full and will look enticing and market participants will start to dip their toes in the water once again, eventually climbing back in for a swim.
When I analyze a market, my process proceeds from the What and then to the When and lastly the Why of that particular market. What is the market doing, when is it going to do it and then finally why is it doing what it's doing. I first concern myself with What a market is doing: is there an identifiable trend or is there a topping or bottoming process? Then I focus on When: is the market likely to continue its trend for a given time frame or is due to reverse or consolidate sideways? In the process of doing what it is doing when it does it, the market eventually reveals why it is doing it. As that process is unfolding I try to identify the motive forces for the move to evaluate its durability and potential extent.
When I turned bullish in March of 2009 and again in September 2010, I put forward a set of criteria that could both explain the apparent bull market and potentially underly its perpetuation. Evaluating these criteria now I find that they are, at this time, unverified by market action. This, together with the technical action of the markets at their current state of development, forces a reevaluation of my market position.
My set of criteria for a continued bull market at this stage of the game:
Emergence of a leading economic growth sector, most likely Green/Clean Technology and other Tech
Leadership from BRIC and Emerging Market sectors
Re-initiation of currency carry trades, most likely Yen carry trade
Flight of capital from low yielding bonds to risk assets
Eventual, gradual broadening of participation in the bull market from professionals and institutions to the general investor population and eventually the general public.
Technical condition of the market remains healthy
At this time I am not seeing any of these criteria being met. Recently, most of the above were approaching or exceeding levels in keeping with a bullish view or were at least showing signs of moving in a bullish direction. But all have effectively reversed or aborted at this point. In this report I will detail and evidence this with research and analysis. Here's a brief synopsis of my findings:
1. NO LEADING GROWTH SECTOR: If stocks are in the third wave of a bull market, at this stage we should expect to see certain effects in the underlying economic fundamentals that confirm that price action. One of the criteria I was watching for was a Green/Clean Technology investment boom. Any sustainable economic recovery and concomitant bull market in stocks would require a leading growth sector. That sector should add value to the economy, increase productivity, produce real job growth and stimulate activity across the rest of the economy while also providing leadership in the general stocks bull market. The Housing industry and associated stocks served this role in the 2003-2007 bull run. This time around, we were promised by government and Wall Street that the road to economic renewal would be paved by Green investment. So far there are no signs of a broad based move by the private and public sectors to invest in such technologies and infrastructure. The ETFs that track Green investments have recently broken down after repeatedly threatening to break out, indicating that a stock investment boom in Green Tech is not happening at this time. Absent a leading growth sector, the move off the March 2009 low then becomes a purely liquidity driven rally.
3. NO YEN CARRY TRADE: After the Japanese Yen spiked to an all time high in the wake of the recent earthquake and tsunami and world monetary authorities initiated a coordinated intervention, many speculated that the Yen would then reverse and become the target of the carry trade once again. The Yen carry trade had been a major funding source for risk trades in prior bull phases. This hasn't really come to pass yet, and the Yen is not far off its all time highs.
4. NO BOND BEAR MARKET: In a protracted, sustained bull market in risk assets, bonds should suffer as investors leave the perceived safety of the debt markets for riskier plays. While the 30 Year Treasury and other sectors of the bond market has flirted with significant intermediate and long term levels, the Total Bond Market is back to a new all time high.
5. NO GENERAL INVESTOR PARTICIPATION: While professionals are totally committed to the bull, the general investor community remains reticent in spite of some positive stock mutual fund flows in the early 2011 time frame. The general public is still completely out of the markets. While this is theoretically bullish since that means there is still a large untapped cache of buying power on the sidelines, it may not work out that way if psychology is so damaged that non-professionals simply will not take on risk at this time and there are insufficient contingent circumstances that will force them to do so.
6. DETERIORATING TECHNICAL CONDITIONS:SPX is either well into the major 3rd wave of a bull market and in the process of an intermediate term correction or it is approaching a completed C wave top. The emerging underlying technical conditions suggest that a C wave top of the move off the March 2009 low has either been achieved or will be shortly. The first warning shot across the bow was the Commodities Crash of early May. Breadth deterioration began in February and now significant divergences between market price and breadth indicators have emerged. Sentiment has turned broadly bullish for the first time, generally a contrarian indication.
Overall, the circumstances outlined above together with a number of other factors--end of QE2, summer seasonality, waning bullish economic news, bearish news items out of Europe--combine to set the stage for a significant correction or even the resumption of the bear market. We'll have to see how the market actually performs in the weeks ahead, but I am actually leaning in the direction of calling the March 2009-Februrary 2011 move a three wave ABC bear market rally. In that context the next probable move would be a three wave partial retracement of that rally to put in a final bear market bottom.
Traders should keep in mind that topping is a process and SPX may be in the early stages. False breaks, false starts and sharp counter rallies may be common as shares are gradually distributed. I'm leaning towards a week or two of mild, grinding upside pressure with a top in the 1340-1380 zone. Then again, the market is set up such that the wrong news out of Europe could break support and initiate a cascade of selling pressure.
I've been long SPX since the September 2010 bottom and an aggressive buyer on pullbacks. Today I exited all long trades and went to 100% cash and then even took on a small short position. My current analysis shows ample reason to conclude that stocks and commodities are in the early stages of a significant correction. Here's my SPX trading record for 2011:
I've just completed a review of recent mainstream and alternative financial media. Bears are virtually nonexistent. Almost no one is looking for any kind of a top at this time. For over two years, even the slightest sign of market weakness and every bit of bearish news has been greeted with a cascade of calls for the end of civilization. Apparently sentiment has turned fully bullish for the first time, just as the markets are signaling the potential for a deep pullback. The traders on CNBC Fast Money were completely unfazed by recent market action:
”The market feels vulnerable but it's felt vulnerable a number of times,” says Fast trader Guy Adami. Largely Adami and the other traders aren't terribly concerned by Wednesday's sell-off; they expect a bounce. "On the dip you can buy," says Pete Najarian. "I'm with Pete," echoes Joe Terranova.
And in an environment like this, the Fast Money traders always suggest looking for pockets of strength and putting money to work.
I had called for a Crude Oil, Silver and Commodities top and a temporary bottom the the Dollar to the very day and expected to see a significant correction over a period of weeks or months. But I was somewhat surprised by the ferocity of the market action. I'd been quite bullish on equities, as I said, and the commodities action caused me to reevaluate my analysis of equities. Experience has shown that a market event like the commodities crash is often a harbinger of further selling, particularly when its significance is universally dismissed as has been the case in this instance. It seems to me that complacency reigns supreme at just the wrong time and that most market participants are about to be caught on the wrong side of the markets.
My long term view remains bullish on both stocks and commodities, but there is a clear chart setup for a major correction at this time. The chart setup is supported by negative divergences spanning the February to May time frame between SPX and many breadth and momentum indicators.
The fact that this condition is almost universally ignored by traders and investors is coupled with very high bullish readings on a number of sentiment indicators and very low cash positions among funds and individual investors creating an excessively bullish intermediate term sentiment environment.
Earnings season is largely behind us, so the late buying power that enters the market on news has been largely disbursed. The Fed is winding down QE2, so that font of liquidity is drying up. Another round of European Sovereign Debt crisis appears to be gearing up. Next week the US government debt ceiling issue is also on the front burner.
Markets tend to correct this kind of scenario sharply and suddenly and there is good reason to believe that process is under way now.
Here's my current view of SPX on the futures chart:
There are quite a few alternate scenarios, and I've presented them all to BullBear Traders members. But at the moment, this is my preferred scenario.
What is being corrected? The Wave 3 of (3) move from the September 2010 bottom.
What kind of correction is it? An ABC flat correction for Wave 4 of (3)
Where are we in the correction? Apparently starting iii of C of 4 of (3)
What is the target for the correction? Strong support should be found in the zone of the lower rail (blue) of the entire move from March 2009, the 200 EMA, the April 2010 high, the November 2010 high, the March 2011 low, and the 38.2% Fibonacci retracement of 3 of (3).
Is the correction shortable or should a trader stay in cash? That depends on your style of trading. The magnitude and timing of the likely correction should make it shortable for the intermediate term swing trader.
Could this be wrong and could the uptrend continue? Of course! A wide variety of factors would seem to indicate that a significant correction is imminent. There's no guarantee at all that support will not hold. Although the risk/reward picture favors the downside for the first time since August 2010, this is still a countertrend trade, which is always a dangerous proposition. There is significant risk that we will be caught out of position when and if the bull market resumes its upward trajectory. Cash is largely a countertrend trade (and short certainly is) in this environment. But this should be as good a setup as we can hope for to either take profit and re-enter at a lower level or even make a little money on the short side. The correction actually began in February with a three wave move down for wave A. The move off the March low was also a three wave move for wave B. That wave ended with the "Bin Laden Is Dead" spike (a classic wave ending news event) and wave C began. We'll get confirmation that C down has begun with a move below the recent low. That could come as soon as Monday, but most likely by Wednesday.
We can see confirmation of the ABC corrective pattern by observing other markets and ratio charts which are showing similar ABC setups in even clearer terms since February:
Technical charts also show bearish divergences with underlying price that go back to January or February, confirming that the markets have been correcting in a sideways ABC pattern for the last few months. Here are just a few examples; there are many more:
These indicators are now showing signs of being ready to roll over into bearish territory as the market corrects. Eventually they should reset into a buy position (if the bull market is to continue) and we will look for bullish divergences to help us identify the bottom of the correction.
The correction should be fast and scary and should bring out the bears in droves. No doubt figures like Bob Prechter will be making the mainstream financial media rounds next week. The function of the correction, in the context of a larger bull market, will be to force cash positions higher and reset sentiment to bearish levels again, setting the stage for a renewed bull move.
We're seeing some interesting divergences between market professionals and the general investing population. The data is showing that professionals are excessively bullish and heavily invested in stocks and are holding very low cash levels, while non-professionals are uninterested in stocks and invested heavily in bonds.
The following charts are from Sentimentrader.com. First, let's look at market liquidity as measured by cash levels:
Rydex funds are used by market professionals. Rydex fund cash positions moved sharply lower recently even as the market hovered near its highs:
Rydex Bull/Bear asset allocation is stretched far to the upside:
The use of leverage is running very high as well:
Mutual Funds are apparently totally committed:
Money Market fund levels are at levels previously associated with tops:
This survey indicates that professionals are heavily allocated to stocks and are holding very low cash levels:
The use of margin is quite high on the NYSE: Short interest ratio is very low, so latent buying power from short covering is weak:
The following four charts show that sentiment surveys of market professionals indicate a very high level of bullishness:
The AAII survey of the general investor population shows a low level of interest in stocks, however.
While investors are allocated to stocks, the levels are much lower than the professional segment and bond allocation is much higher, while cash levels are also very low.
Mutual Funds just saw the first big outflow in quite a while. I wouldn't view that as a contrarian indication at this time.
While professionals are heavily committed to stocks, they are also active in puts to a degree not seen since the 2007 top. They may be literally hedging their bets against a big decline. Overall the picture I am seeing is a setup for a surprise intermediate term decline that scares professionals out of their apparently overconfident complacency and forces cash levels up to a more sustainable level. If the general investor base joins in the next rally off the bottom with the professionals, that may mark the end of the long lateral bear market and the onset of a new long term bull phase.
If support does hold here the next leg up will likely be a 5th wave in a diagonal pattern that will set up a correction. Here's one potential bullish interpretation of the short term picture on a 4 hour chart.
The most bullish view places the market at the cusp of launching into (iii) of 3 of 5 after a sideways triangle abcde correction:
Both of the above scenarios are viable and represent risks to the current short position. A break above the upper boundary of the proposed triangle correction would have to trigger a stop loss on the position. We can also see that the market is perched precariously upon key support and the potential for a gap down below support on Monday morning is high. That could trigger a series of stop loss levels and initiate a cascading decline. Given that just about no one is looking for that kind of scenario, it becomes much more likely. And given the very heavy bullish sentiment and commitment of professionals to the market, there may be no one left to stop the decline once it has begun.
There is long term bearish potential in the current setup as well, but it would be jumping the gun to even speculate about a long term bear turn without first seeing a good size correction and a break of some key support levels. Then we would have to revisit the indicators and see what they are telling us.
A few times a year, I like to release the complete text of an edition of my BullBear Market Report. Here's the report issued on March 17th in which I called the bottom to the Middle East/Japan panic sell off (after having previously identified the February top). Following the report are some of my subsequent updates to the report with comments and questions from BullBear Traders members. I hope this helps you in your trading and investing.
In recent BullBear Market Reports I was able to successfully identify the apparent Wave 3 of (3) top at SPX 1344. I advised BullBear Trading members that I was taking 40% of my long position off the table and closing long positions in Nikkei as well as exiting short US Treasuries. I might have taken more of the position off but there was some doubt, until the Japan Panic hit, about the degree of the correction at hand. All in all, the analysis and timing were quite solid.
Yesterday I went long SPX, Emerging Markets, BRIC, Nikkei, Grains and Agriculture and short US Treasuries. I also have short positions in gold and silver from near the highs and a small speculative long position in DollarYen. The US Dollar Index and EuroDollar remains a conundrum but I am tilting bullish on EuroDollar and bearish on USD at this time.
In this report I'll examine the current technical condition of the markets and the probabilities going forward using a range of tools including Elliott Wave analysis, Trendline and Fibonacci studies, momentum, breadth and sentiment.
A quick perusal of the blogosphere and mainstream financial media reveals that the predominant sentiment underlying the markets remains bearish. Fear remains the primary driver of market participation. Many have been quick to call a major top and few are willing to view the current decline as a buying opportunity. In fact I have not been able to find a single analysis or opinion which regards the current market setup as a buying opportunity, but a plethora which expect further bearish outcomes. Here's a piece that hit my inbox:
This quote from a recent blog posting sums up the bear argument: "With an already failing economic recovery in the US, a black swan variable such as the Japanese quake, Tsunami and nuclear crisis may very well be the tipping point that sends the entire world into a financial and economic catastrophe."
Experienced, grounded traders know that panics in an entrenched bull trend produce bottoms and buying opportunities, not catastrophic declines.
Many technical gauges of market sentiment have registered levels of fear typically associated with intermediate term corrections. The reaction to the events in the Middle East and Japan appear to have quickly catalyzed the underlying bearishness into a healthy correction within a bull trend. It's impossible to say what might have been, but it's possible we would have seen a correction of a lesser degree had Japan not blown up. It really doesn't matter though, because eventually this larger degree correction would have occurred from slightly higher levels. News has simply hastened the inevitable. For those bullish on the markets, this is a fortuitous set of circumstances since it has most likely cleared the decks for a higher degree advance from here.
Assuming that the Japan nuclear debacle results in damage and risks as serious as those attending the Chernobyl disaster, would that in and of itself be enough to derail world economic growth or even the Japanese economy? This is highly unlikely and there is no credible evidence that this would be so. Markets have reacted emotionally as traders have sought to lock in profits and seek safety in the short term. Emotional reactions create opportunity.
Tape reading is an important skill for the trader to develop. It takes years of careful observation of many markets under many circumstances. One of my favorite maxims: "When a market does not do what it should do when it should do it then it is probably about to do the exact opposite in a big way". In other words, a failed setup is often more powerful than the setup itself. With all the widespread, rampant talk of catastrophic market consequences stemming from "skyrocketing crude oil prices", food riots and revolution in the Middle East and the Japan earthquake, tsunami and nuclear plant crisis, the US equities market is currently trading a mere 5.5% off the high. Three moderately strong rally days could entirely wide out this deficit. There appears to be a significant gap between the talk and the walk here.
Of course other markets have not fared so well. Japan has essentially crashed in a few short days, and is currently trading about 20% off its highs. EuroStoxx 50 is off 12.5% from its high. On the other hand, during the course of the entire Middle East/Japan panic, emerging markets have actually held position or even edged higher. Emerging Markets (EEM) and BRIC (BKF) as a group have travelled sideways since the February 18 high and select markets are in fact higher now than they were then. Other markets suchs as Canada's TSX are only marginally lower.
A review of the technicals reveals that almost all of the indicators I track have reset to positions from which the bull has consistently rallied to higher highs. Generally the picture is of a market that has corrected from overbought conditions to set the basis for a renewed rally.
Having said that, it is important to note that there is a valid bearish setup at play and we do need to develop and be ready to implement a set of bearish trading criteria should the proper circumstances arise. I'll be starting that process in this report. At this time I would say we are much closer to fulfilling the criteria for a bullish continuation than we are to the criteria for a bearish reversal. But stuff happens and we need to stay on our toes and keep our minds open to the full breadth of possibilities.
CHART ANALYSIS
The primary US stock indices have channeled nicely, showing a nice four wave move, with a 5 of (3) likely beginning now. Here's the S&P 500 futures market daily chart:
The confluence of the 20 and 50 day EMAs and the A wave low will likely represent some resistance to any rally from here.
Nasdaq 100 has also stopped its decline at the lower rail of an apparent channel:
Dow futures also appear to be channeling nicely, with a slight throwover to complete Wave 3. Towards the end of the run Dow was leading, so the throwover makes sense.
World Leaders Index appears to be in a different wave count than the US indices. I'm seeing the completion of a five wave pattern off the August 2010 low.
The apparent Wave 2 of (3) correction has retested the April 2010 high after a slight trend channel break. and a better than 23.6% retracement of the Wave 1 move. Generally we want to emphasize our buys after corrections of a larger degree, so this is a signal that this time around we may not want to overweight US stocks.
World Dow Index shows very similar characteristics, further suggesting that on the whole the recent panic correction in world equities has been of a higher degree:
Emerging Markets has tested its long term uptrend from the March 2009 low as well as its 200 EMA:
As noted above, the EM sector has largely continued to consolidate sideways during the recent spate of crises in an apparent abc wave (ii) of (3) correction. If this count is correct, traders will likely want to overweight in this area to participate in the powerful (iii) of (3) move. And of course a break and close below the 200 EMA on good volume would be a signal to re-evaluate this position.
China's Shanghai Composite Index has looks set for a major breakout after an extensive Wave (2) triangle consolidation:
The daily EMAs are now in bull market alignment after a recent triple bull cross and there appears to be a 3 of i of (3) setup. The moving averages look like solid support, but should they fail then we would need to be on alert for a bearish outcome.
US TREASURIES AND BONDS
One of the keys to my analysis of markets over the last year has been the intermarket relationship between Bonds and Stocks. Generally we have seen a move out of the perceived safety of bonds, particularly Treasuries, and into the risk of stocks and commodities. Will this continue?
I went short Treasuries on Thursday at what appears to have been a C wave spike above the 200 EMA to the 38.2% Fibonacci retracement level:
The Dow Jones Total Treasury Index has broken a long tern uptrend and appears to be testing that break from below, a typical move before a continuation lower:
The SPX to 30 Year Treasury monthly ratio chart appears to be setting up for a iii of 3 move following a bull cross of the 20 EMA over the 200.
The weekly chart of the same ratio has seen a bull cross of the 50 EMA over the 200, which places all EMAs in full bull market alignment:
The daily chart shows a abc correction. Bulls would like to see the 200 EMA and 38.2% Fib retracement level hold:
The 2 Year Treasury Note has not yet broken above resistance, potentially indicating that investors have still preferred to keep cash on ultra low yielding short term Treasuries rather than risk their capital in the stock market. That may mean that there is yet a good amount of fear to unwind and a big cache of capital waiting to fuel the bull market higher. In the lower pane we have a ratio of SPX to the 2 Year Note. Bulls would like to see the indicated levels on these charts break out, signaling an influx of new capital into the markets.
Municipal Bonds have corrected and stalled at the 200 EMA in what appears to be a Wave 2, setting up this sector of the bond market for a Wave 3 decline:
TECHNICAL INDICATORS
Just about every indicator I can find has reset to levels which have been associated with a renewed rally after an overbought correction. So far we have no reason to think that this time is any different.
Percent of Stocks above the 50 Day EMA has declined to 30%, which produced bottoms in August 2010, February 2010, November 2009 and July 2009.
We can see the same for Nasdaq. The setup is remarkably similar to the November 2010 decline.
Percent of Stocks Above the 200 EMA has corrected back to its own 200 EMA and its breakout point.
50 Day TICK has reached a support level associated with 3 prior intermediate term bottoms:
The long term 200 Day EMA of TRIN is resting on its long term rising bottoms support line. A solid move lower would be a major signal that the bear market is over.
50 Day NYSE Advance-Decline Line has retreated to a support zone which has marked 5 prior intermediate term bottoms:
50 Day Nasdaq Advance-Decline Line has produced a setup nearly identical to the November 2010 decline:
50 Day NYSE Advance-Decline Volume has moved to its support zone which defined 4 prior bottoms:
20 Day New Highs-New Lows has also reached its intermediate term support zone:
5 Day McClellan Oscillator is at support identified with 6 prior bottoms:
Summation Index is at the upper end of its support zone:
VIX has tagged its long term downtrend and a horizontal level frequently associated with bottoms.
21 Day Put Call Ratio has risen to a resistance level often associated with bottoms:
5 Day Equity Put Call Ratio has exploded well above levels previously associated with bottoms:
Let's look at our ratio charts. In general they are acting healthy and there are no divergences which suggest anything like a major long term top.
Russell 2000 Small Cap to Dow Industrials ratio chart has actually edged higher during the correction:
Dow Transports to Dow Industrials has moved higher during the correction and Transports have not moved significantly lower in spite of high oil prices:
Wilshire 5000 to Dow Industrials has consolidated sideways during the correction:
SPX Equal Weighted Index to SPX ratio chart has moved to new highs during the correction:
Here's the view of the same ratio since the March 2009 bottom. This is a picture of a raging bull market:
The above charts suggest that the stock markets have now corrected to technical and price support levels which should produce a renewed rally to higher highs in the context of an ongoing bull market.
Here are a few indicators which may tell a slightly different tale. SPX to Nasdaq 100 ratio had broken above its downtrend and above its 200 EMA. Bulls would prefer to see tech stocks continue to outperform big cap stocks:
Nasdaq 100 to Dow Industrials ratio chart has continued to decline during the recent bounce, nearly testing its 200 EMA:
The long term chart of the same ratio shows a break above the rising tops line followed by a failure back below that line and the trendline off the March 2009 bottom:
The relative weakness in tech stocks may simply be some sector rotation out of tech and into other areas of the market. Small caps and other higher beta sectors are not showing similar deterioration. But it's worth noting and keeping our eye on this.
THE BEARISH SCENARIO
There's enough bearish potential in the current setup to warrant an in depth look at the bearish scenario. Let's start with a look at the long term bearish wave count for SPX. Here we have the move since March 2009 counted as a nearly 78.6% abc three wave correction. The C wave rise could be over since its uptrend has been broken:
Here we can see that today the market failed upon contact with a clear resistance zone defined by the proposed A wave low, the (iii) of 3 high and the confluence of the 20 and 50 EMAs:
Today's failure from the high sets up the distinct possibility that the decline from the February high may turn into the first 5 wave bearish structure since March of 2009.
It's highly important to study and understand the following chart:
It's critical that the market continue to push higher above the proposed A wave low early next week. If a lower low is made on the hourly chart then we would then have a clear 5 wave bearish pattern. We would have a failure at resistance and a failure out of the proposed blue uptrend channel. The minor fifth would then mark either the A wave low of a much larger degree correction OR the first wave down of a bear market. In either case, I will want to exit all remaining long positions on the subsequent wave 2 or B rally to resistance, which would likely test the broken trend channel and the black downtrend, and go short. This should then be followed by a five wave decline to either a wave 3 or C low. The following rally will either come out of a bottom similar to the July 2009 low OR it will produce a wave 4 rally to resistance followed by a wave 5 down, confirming the onset of a bear market.
The specific levels on the above chart are not relevant; this is just a pre-visualization. If we do get a lower low then I will start looking at actual support/resistance, moving average and Fibonacci levels to chart the actual decline.
This is the ONLY significant POTENTIAL bearish setup I have seen since the July 2009 low. If the technical indicators were giving me cause for alarm I would be 100% in cash right now and waiting for a shorting opportunity. I will continue to monitor the technicals so that if the charts and the technicals conspire to produce a bearish setup we will be ready to take appropriate action.
Let's look at some other bearish factors at play.
India's SENSEX has been largely bouncing during the recent panic. A break above the moving averages would be encouraging, but we must note that it has been consolidating just below the EMAs following a bear cross of the 50 below the 200 in what appears to be a corrective pattern off the low. There is some chance that proposed waves a, b and c are instead waves i, ii and iii with the recent rise a wave iv of a bearish impulse. Should SENSEX go on to make a lower low then this would become a bear market. We definitely want to keep our eyes on this because if it fails, India, which is generally thought to be an engine of world economic growth, could end up being the canary in the coal mine that tells us that there is general trouble ahead. Today as most markets rallied India closed down better than 1%.
Big cap European stocks broke their weak uptrend from the Flash Crash low with a significant decline. Is this another canary? A failure to get up below that broken support line would be bearish. The 20 EMA has crossed the 50 to the downside. Today European stocks were down in spite of strength elsewhere.
Germany's DAX has been among the strongest indices in the recent run, but it has violated its uptrend from the March 2009 low. It's decline was stopped by a cluster of Fibonnacci targets, the 200 EMA and the uptrend. A strong close below these support levels could also be a canary indicator. RSI hit a low not seen even during the prior Financial Crisis.
Here on the hourly chart we can see that DAX clearly has the potential to produce a 5 wave bear structure very soon:
Japan's stock market crashed below its prior major low in a matter of days. Is this a major wave (ii) buying opportunity after a long term abc correction or a break of key support levels ushering in more bear market for Japanese equities. I tend to think the latter at this time, but we shall see.
What are some of the technical indications that would put us on notice that either a larger correction or a bear market are in progress?
If the long term chart of Summation Index were to break below the black horizontal support level it would probably be sending us a bearish signal:
If the 50 Day Volume of Declining Stocks continues to rise even as the market rallies or moves sideways next week we might have cause for concern:
Here's a few more things to watch for:
VIX breaks above the previously indicated resistance levels and stays there
Treasuries move above the 200 EMA and stay there
Emerging Markets break down below the 200 EMA and the recent proposed C wave low
The group of indicators show above do not find support at current levels normally associated with intermediate term bottoms and instead break lower
NEXT WEEK MAY BE THE MOST CRITICAL WEEK IN THE MARKETS SINCE APRIL 2010! THINGS ARE AT A CRITICAL JUNCTURE AND VIGILANCE AND THE ABILITY TO TAKE QUICK, APPROPRIATE ACTION IS REQUIRED. RE-READ THIS REPORT SEVERAL TIMES AND MAKE SURE YOU UNDERSTAND IT!!
US DOLLAR INDEX
The US Dollar Index has broken down from a four year pattern. There is every indication that it will continue lower. There is not much on this chart that gives a bullish indication at this point and it strikingly resembles the pattern in USD.JPY before the recent panic breakdown, but on a much larger scale:
The best wave count here is that a Wave iii is now underway. This is coming even during a period of substantial selling in risk assets. While AUD.USD and NZD.USD have shows some significant weakness, the European currency pairs have been strong against the dollar (Euro, Swiss Franc and Swedish Krona). Canadian Dollar is also at multi year highs.
What does this mean for markets? Generally a weak dollar has been associated with rising asset prices. A 6 month correlation grid shows an almost across the board negative correlation with other asset classes. (UUP is the US Dollar Index ETF):
Stock and commodity bulls should be encouraged by this technical failure in the USD...unless there is some critical economic or financial dislocation that is associated with such a failure. Is there some as yet unknown crisis associated with a falling dollar in the wings?
CONCLUSION
This is the most important edition of the BullBear Market Report that I have written since the July 2009 bottom. I remain bullish but for the first time since then I am on alert for a bearish turn. Much depends on the action in the markets early next week. With a decent thrust through resistance we can be confident that a move higher has begun. New positions should be kept on a tight leash and monitored.
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Good luck and good trading! Ask questions and comment below in the discussion forum!!
Very nice rally to take out several resistance levels and the A wave low:
Penetration of the A wave low makes a 5 wave bear structure much less likely and makes a 3 wave bullish corrective structure much more likely.
Once again, we nailed both the top and the bottom virtually to the tick!
The upside potential of this 5th of (3) wave remains unclear. We will have to see how far this wave i goes and take a Fibonacci extension from there. So far it looks like an very powerful wave, since the A wave was taken back in just 3 sessions.
SPX is also back above the 20 and 50 EMAs:
A close above those levels would be very bullish.
I didn't find any other analyst who utilized the basic technical analysis technique of channelling to identify this bottom. Drawing a trendline from proposed 1 to 3, make a parallel line, drag it down to 2 to create the channel. Instead there was generalized panic, extrapolating further declines from the very short term downtrend instead of trying to see the long term uptrend. Bearish expectations and bearish mentality still prevails, which means the bull market is not likely near its end.
Gaps are frequently but not always filled. I think that if today's gap were filled it would probably come as a minor ii pullback and make a great entry opportunity.
Volume was lower than previous day on quadruple witching Friday. Unusal. Volume was even lower today than Friday. I really can't buy into this without a retest and a up day with confirming volume. Spy is now right below the top of the Ichimoku cloud and heavy resistence. If it is to reverse lower, tomorrow will be the starting day. Guess what, America has started any other war. Stocks always go up when that happens ???
Reply by Ricky Latham on March 21, 2011 at 11:29pm
I was concerned about lack of volume also. Does not seem too convincing at the moment. Took some profits off the table. 10d EMA < 20 and <50 and 20d EMA seems poised to cross below 50. Isnt next couple of days pivotal to declaring a continued surge up or rollover in momentum? If we fail to exceed the peak of around 7Mar does that suggest a change in upward momentum?
Dear people, your comments are all highly reflective of the "Wall of Worry" that bull markets climb. You feel you need to worry about something and it keeps you on the sidelines waiting for some kind of confirmation that never comes. Waiting for everything to line up perfectly so you can feel safe in entering a position. The safest time to enter a position is when there is panic and we had a panic bottom last week. I spent many many many hours compiling pages of technical data showing you that a buying opportunity had been produced. This is solid, real world technical data in this report that has been PROVEN over the entire course of this bull market. Yet you are focusing on things that have been entirely DISPROVEN like volume. If volume is your criteria then you have been out of the market or short since March 2009. Is that the right side of the market? In a bull market you must AGGRESSIVELY buy the fear dips like this obvious overreaction to the Japan situation. Particularly when the panic aligns with the technicals, as I have show clearly in this report.
Furthermore, I have given you a clear set of criteria under which we should turn bearish. A real, solid, actionable set of criteria that you can monitor and measure.
Yes, this current move is at a resistance zone, which I have defined for you. If we break higher, then we are looking good. If we turn down from resistance, it may be a pullback to fill the gap and give us a second chance entry. I would buy then, but on a penetration of the prior low I would stop out of the position because at that point we would have a five wave bearish structure and I would have to re-evaluate the situation.
I'm not trying to be harsh with you, my friends, just trying to give you the benefit of my experience and knowledge which has cost me so much time and money to acquire, in the hopes of saving you some time and money.
Chances are pretty good we will be back down here on the Wave 2 correction to retest the breakout, a possible 23.6% retracement level and the 20 EMA. That would be a good intermediate term buy point.
