Trading the March 2011 Bottom
by Steven Vincent
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.
Steven Vincent
BullBear Trading
03/17/11 BullBear Market Report
INTRODUCTION
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:
Nasdaq 100 has also stopped its decline at the lower rail of an apparent channel:
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:
China's Shanghai Composite Index has looks set for a major breakout after an extensive Wave (2) triangle consolidation:
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
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 NYSE Advance-Decline Volume has moved to its support zone which defined 4 prior bottoms:
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:
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:
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:
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 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:
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. 
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%.
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.
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:
- 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
US DOLLAR INDEX
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.
Reply by Steven Vincent on
03/21/11 UPDATE:
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.
Reply by Mae Woo on
- Reply by J CHAN on
- Reply by Ricky Latham on
03/23/11 UPDATE:
So far we have a minor abc correction of the move off the bottom:
It may have already completed. A move above the blue downtrend should confirm that the next leg up is in progress.
03/28/11 UPDATE:
SPX futures is at a minor resistance zone which is causing some sideways churning and likely creating a wave iv flat:
The top of the first wave off the bottom will probably come this week at the confluence of two Fibonacci extension targets.
03/29/11 UPDATE:
SPX futures show a probable minor iv bottom:
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.
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