11/01/11 BullBear Market Report

The market got spooked by the collapse of a minor brokerage firm, MF Global. Perhaps an appropriate Halloween reaction of -2.5% occurred as the firm's demise was at least partially linked to losses stemming from the European debt crisis. Just two sessions earlier, markets spiked on news that a deal had been struck on Greek debt and the "recapitalization" (bailout) of European banks. At this time all of that spike move has been given back.  News that Greece is planning a referendum on its debt deal has also sparked a wave of selling since a popular referendum is not likely to pass, raising the specter of a disorderly default and the explosion of the derivatives bomb.

US markets have followed closely the roadmap I set out back in June/July. We completed a first leg down of a bear market in August (Wave A), made a slightly lower low and are now in the process of completing a corrective move higher (Wave B). At the top few believed it was possible for the market to crash so hard; at the bottom few believed it was possible for the market to rally so powerfully. I called for both moves (though the extreme volatility made exact timing difficult).  At this time we are seeing mostly skepticism regarding the rally from the mainstream financial news media and the blogosphere alike. That may be one indication that the move higher is not over yet. We'll probably need to see the rally reach heights sufficient to engender widespread speculation that a new bull run is in progress before a real top is in place.

Having said that, there is a setup that allows Major C to begin from here.  There is certainly an Elliott Wave structure which arguably completes Major B and most intermediate term indicators have readjusted to a neutral or even overbought condition.  Any hangup to the beginning of Major C comes from longer term indicators which in most instances are still hovering near levels frequently associated with major bottoms, not major tops.  At this time I am looking for an intermediate term correction of the move off the low (in progress now) which backs the intermediate term indicators off from their neutral to overbought/excessively bullish condition and sets up a final run back at the highs to complete Major B.  Ultimately optimism that somehow world monetary and governmental authorities will be able to contain the debt crisis will prove unfounded and a series of Lehman-type events will likely unfold, catalyzing the Major C down in a five wave decline.

I'll start our review of the technical condition of the markets from the very long term and move towards the shorter term. (NOTE: some technical analysis charts are dated one or two session prior to the 11/01/11 close)

On the very long term chart we can see that the market is closer to an upside breakout than it is to a downside break.  After over 10 years of bear market action and repeated calls and widespread expectations for a market catastrophe, price is not far from the all time high and the recent interim bull market high:

My current view is that we are seeing the final stages of an ABCDE triangle corrective pattern that began in 2000.  I've indicated a major long term support zone between 1000-950 on SPX which could be a good target for the final decline.

Note the yellow box around the volume spikes.  We should see a fourth similar capitulation volume spike to put in a final low.  A spike that matches or exceeds prior spikes accompanied with a higher price low would be part of a setup for a long term bottom.

Here's a view of the proposed triangle:

The proposed E wave could terminate as indicated or could head all the way down to the lower red rail.  There's no way to know at this time.  No matter where the low comes, it should be accompanied by apocalyptic fear similar to or even greater than that seen at the March 2009 low and by vomitous capitulation volume.

Another way to measure the performance of the equities market is via its performance relative to it natural competitor for capital, the 30 Year Treasury Bond.

SPX to $USB is showing a triangle pattern as well.  The long term bull market uptrend is clearly in jeopardy and there is nearby resistance from the monthly moving averages, which appear set for a bear cross.  A sharp decline in the ratio is likely.

The daily chart shows the current setup:

It's possible that the recent European Bailout spike was the top to the C wave of Major B and that Major C is already underway.  However, the tone of the financial news media and the blogosphere over the last few days has turned very bearish after a tone of skepticism towards the rally off the low, so sentiment may not be set up for a major C down.  In addition, we have seen fractal patterning on numerous flat corrections in which the C wave of the flat was a pronounced 3 wave zigzag.  This would also square with the incredible volatility that we have seen since the February high.  Later in this report I will show that many longer term indicators are at levels associated with bottoms and are not positioned consistent with the beginning of a Major C leg down.  At this time I'm looking for a distinct 3 wave ABC pattern to complete the C of B.

Here's an intermediate term view:

There should be considerable new driven volatility over the next few days to a week that will have most traders tied up in knots.  It's been an exceptionally difficult time to trade since February with incredible volatility, and we are likely to continue to see that in the near term.  If and when we get a setup for the proposed B of C bottom, I might want to take a small long trade for the trip back to the top, which could last 2-4 weeks.

I'll briefly note that there is an argument for a fully bullish resolution of the current setup, but I'm not giving that much weight at this time.  The move off the low has been strong and swift but it does not show anything like the clear bullish impulsive wave characteristics that would be evident at the start of a valid bull run.  I'll also note briefly that there is no evidence in the Elliott Wave count or the technical charts that validates the move off the February or May highs as a bearish impulsive start to a five wave major bear market.

The competing scenarios, as I see it at this time is a continuation of the rally after an intervening correction to a high from which the Major C leg down will unfold VS. an immediate commencement of Major C.

Nasdaq 100 is showing a somewhat different pattern but it should also resolve into a 3 wave C of B:

If markets do resume their upward move, the break to new highs by technology stocks will no doubt feed into the bullish psychology necessary to put in a top.

Let's look at some ratio charts.  Ratio charting is one of the most effective technical analysis tools we have at our disposal.  By measuring the performance of one market by another we can observe relative performance over time and infer bullish or bearish underlying conditions.

Here are some ratio charts for SPX:

While SPX Equal Weighted index has bested its August/September highs, the ratio charts have not.  They are lagging.  SPX Equal Weighted to SPX should be leading the move higher in a broad based, bullish advance.  The broader SPX should be besting the narrow Dow and it is not.  The high beta Russell 2000 should be outperforming the SPX and it is not.  These are indications that the rally is a bear market move and not the beginning of a new bull advance.

If the markets do make new highs above the February high, I will be looking for bearish divergences to confirm that we have a setup for major C down.  Here's a long term chart of $SPXW:$SPX:

Note that in 2007 as the market made a new recovery B wave high, the ratio made a much lower low.  We are certainly set up for a repeat performance should the market make a new high.

If we were bullish we'd like to see technology firmly in the lead.  Let's see what the Nasdaq 100 Equal Weighted ratio chart have to tell us:

$NDXE bested its August/September high, but not by much.  Despite some initial strength hasn't been outperforming SPX or the Dow or the Wilshire 5000 for over a month now.  And it is seriously underperforming the capitalization weighted NDX.  None of supports the commencement of a real bull run and instead tells us to regard the rally as a selling opportunity.

I we are to be bullish long term, we'd also like to see high beta stocks such as the small caps outperforming as well.  Let's look at the Russell 2000 ratio charts:

While $RUT did barely manage to get above the August/September high, none of its ratio charts were able to do so and are lagging badly.

Wilshire 4500 Completion Index ($EMW) is comprised of the total market excluding the 500 big capitalization stocks in the S&P 500.  In a bullish scenario, we'd like to see $EMW outperforming as an indication of solid market breadth:

Once again, the ratio charts are not confirming the rally.  If, after a correction, the rally were to resume and these ratio charts were to show dramatic improvement going into the high, we might take note and consider the long term bullish argument.  But I suspect that we will not see much improvement if any and instead we will see some solid divergences leading to an excellent short setup.

If a new bull run were in progress, we might also expect to see Emerging Markets and BRIC showing leadership over US stocks.  We're not:

SPX to Bond ratio charts are showing similar poor performance:

In spite of the spike in equity prices, risk appetite relative to the urge for the safety of bonds has not been performing well.  We'd need to see a big move out of bonds and into risk instruments in order to be sold on a bullish long term case.

This ratio chart shows that the safety of long term Treasuries is preferred over the risk of junk corporate bonds:

While stocks have rallied sharply off their lows, commodities have not:

CCI is no where near February-August lows let alone the highs.  Copper has also been performing poorly during its bounce:

The Copper:SPX ratio is showing a clear long term break and a weak recovery:

Let's move on to look at some of the technical indictors.  Most of the indicators have shown definite bullish divergences at the recent bottom, a sign that there would be a sharp rally and also a sign that the rally will not likely die without an additional upside push towards the former highs.

McClellan Oscillator reached an extreme overbought condition that begged for a short term correction, and we got one.

The indicator produced a bullish divergence at the October bottom.  It may be near a bottom now, permitting a renewed rise for stocks.

The longer term version of McClellan Oscillator, Summation Index, also showed a bullish divergence at the bottom:

In spite of two days of heavy selling, the indicator has not rolled over and has maintained its breakout.  If the ratio charts were bullish we might take this as a long term bullish indication, but my take is that it means we can look for continued upside after this correction dissipates followed by a resumption of the bear market.

50 EMA of NYSE Advances-Declines:

We can see a clear, large bullish divergence and a test of the upper end of the former range.  This does set up a short to intermediate term correction but does not preclude a final push into resistance following the correction.

200 EMA of NYSE Advances-Declines almost broke down into bear market territory before finding support and rallying hard:

50 EMA of NYSE Advance-Decline Volume:

Similar performance, with a nice breakout of the downtrend.  We're seeing sufficient strength on these charts to warrant the view that the rally is not over yet, but the poor performance of the ratio charts warns us that when it does run out of steam the bearishness seen since February should reassert itself.

50 Day EMA of NYSE Down Volume:

The indicator did not make a higher high as the market made a lower low, indicating that downside pressure had been exhausted.  If the market tests its former highs yet the indicator does not test its corresponding lows, then we would have a bearish divergence.

50 Day EMA of NYSE Up Volume:

The explosion of upside volume off the August low was a clear warning sign to the bears that a rally was coming.  It's also another reason to think that the rally is not over yet.

Ratio of Down Volume to Up Volume:

Bullish divergences on this long term chart have led to strong rallies.  The indicator is likely to get back down into its support zone between 3-3.5 before a major top is seen.

Percent of Stocks with Bullish Point and Figure Charts (Bullish Percent) rallied very hard off the low and has yet to turn in spite of two days of selling:

If we were seeing other similar confirmations of bullish strength we might be more persuaded by the long term bull argument.  I'll note that this indicator did confirm the new low in October and so I will take this as further evidence supporting the orientation of looking for an eventual continuation of the rally before a  final high.

Similarly, Percent of Stocks Above 50 EMA rallied very hard off the low after a bullish divergence:

Here again we can certainly see that it has reached an overbought condition that needs to be corrected.  I'd look for a dip down to support between 75-60 before a move back up.  A bearish divergence (market makes higher high, indicator does not) is possible at that point.

Percent of Stocks Above 200 EMA has not rallied nearly as hard and the difference in performance between these two indicators is suggestive that the intermediate term bullish/long term bearish orientation is correct:

50 EMA of NYSE New Highs has barely rallied off the low after a bearish divergence at the top:50 EMA of NYSE New Lows has fallen sharply after confirming the new lows:

Note that new highs are new highs did not expand during this recent rally while new lows did contract.  This sets up a situation where there will be a very large divergence between New Highs and market price if the rally continues.

TRIN is a good measure of both selling pressure and sentiment.  After confirming the lows, 50 EMA of TRIN has fallen back to support during the rally:

In spite of the big rally, 200 EMA of TRIN is still at levels typically associated with a market low:

This is one measure of a high level of fear in the market. At the market top, this will probably have backed off to indicated support level between 1.2-1.25.

Put/Call Ratio has backed off its highs but is still at a high level:

This should continue to decline until there is a degree of complacency in the options market that matches levels seen at important highs.

21 Day Put/Call Ratio is still hovering at highs normally associated with bottoms, not tops:

A substantial retracement of this key measure of fear in the market is probably required before we see the Major C wave begin.

SPX to Put/Call Ratio has barely started to turn in spite of the big rally in the market, showing that there is still a substantial amount of bearishness and fear in the market:

Voltatility Index is still at a very high level in spite of the rally, another sign that there may be too much fear in the market to set up the Major C:

The 30 Year Treasury is trading at levels associated with market bottoms:

There has never been a bear move with the 30 Year trading in its upper band.  Is it different this time?  Probabilities favor a substantial retracement before the C wave begins.

In summary, the weight of the technical evidence supports an orientation of short term bearish, intermediate term bullish, long term bearish and very long term bullish.  We should expect continued volatility in the short term followed by a final intermediate term thrust at the former highs to set up a major bear market move to lower lows.

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