Saturday, October 31, 2009

Technical Update – Bulls Turning a Whiter Shade of Pale…

The Goldman orchestrated bear massacre of Thursday quickly turned into a bull slaughter on Friday. The S&P 500 now resides 5.9% lower than its 1101 wave B peak, the DOW resides 4% lower, the Transports a divergent 11.1% lower, the NDX has fallen 6.3%, the RUT 10.0%, and the XLF is off 10.8% from it’s recent highs, still a whopping 60% from its ’07 peak.

Fundamentally the stimulus has gone to banks and not into the hands of the consumer who are still rife with debt. The banks and your government are hiding bad debts and derivatives that render our financial system insolvent many times over. Wave A down failed to cleanse the system of the debts or derivatives, it has failed to reign in the criminals, the fraud, the deceit, the printing press, or the government. Wave C will take care of all that.

In Elliott Wave terms, the descent from the September ’07 highs to the 666 bottom was wave A down. The rally from that point this March to the recent highs was wave B which is very likely now complete (the count in some of the indices still allows for higher). Next comes the very destructive wave C down, a wave that will carry with it the seeds of CHANGE that has failed to happen so far. History shows that wave C’s are long and grinding affairs full of volatility and psychological oscillations between hope and despair.

As is the tradition when there is a collapse of credit, wave B retraced nearly 50% of the losses incurred during wave A – 48% in the S&P 500 to be precise.

Friday’s action pretty much drove a stake into the notion that we are going to be setting new highs this year… it’s still technically possible, but not likely. On the very short time frames we are now oversold but the long term divergences are still in place, the decline being confirmed with increases in volume.

The rising wedges across the indices have all broken cleanly and convincingly to the downside, the only exception being the Dow Industrials when viewed on a non-log chart – on a logarithmic chart, it too has now broken the uptrend. These wedges are a very high probability pattern, the target of which is the base of the wedge or lower. That means that we are very likely to revisit the lows shortly. The patterns were not overthrown before breaking, the final leg up failed to reach the upper boundary – a bearish development for sure, especially when confirmed with volume as these have been. In fact, the divergence in volume on Wave B’s rise was HISTORIC, much larger than prior to topping in ’07, and much larger than prior to the crash of 1987.

Let’s look at the charts…

The DOW Industrials are the strongest index so far of this decline. On the log chart they have broken the rising wedge and now sit just under the 50 day moving average. Volume is coming up on the decline and the daily fast stochastic has now reached oversold. The lower Bollinger band is rising steeply to meet prices, that will provide resistance to the decline.

The Industrials have yet to make a new low that’s lower than the previous low, that is a divergence from the Transports that have, and it sets up the possibility of a bullish non-confirmation of a Dow Theory sell signal.

That said, the declines of this bear market have started just like this one with the Transports, then the RUT, and then the NDX leading the decline and eventually pulling the defensive large caps with them. That’s part of the psychological process and yet another myth propagated by Wall Street that big caps will protect you – they won’t. Here’s the simple truth… Stocks do NOT return the historically touted 8% annual rate of return, they never have! Stock INDICES, on the other hand, did in modern history up until about the year 2000. That’s because the indices replace failed firms with younger ones in a process known as substitution bias.

The Dow Industrials are a great example of substitution bias with GE the only survivor of the original companies, and even it is technically dead. No, STOCKS have a life cycle, just like you and me. If you seek growth, get them while they are young (Microsoft being a terrific example). They then mature and their stock plateaus – again, Microsoft is a great example. Once they get too big and too fat they fail – again, GE is a good example, as are all the other Dow stocks that preceded it into the dustbin of history (GM is another good example). A healthy economy and market let the dead die… the undead, the zombies (like GM and all the big banks), are nothing but a barrier to progress. Wave C will place a much needed stake in their undead, blood sucking, vampire like hearts.

The Transports are bearishly diverging against the rest of the market - they have already given back the past 3 months of gains! The are leading… they tell us that the engine of the economy is slowing in the supply chain, again, a slow down of historic proportions. I don’t use the word historic lightly! You are a witness to a very rare economic event, one that in Elliott Wave terms is on the next HIGHER level of order than the Great Depression. No one alive has seen or experienced this level of correction if the Elliott Wave experts I follow are correct.

In the 9 month daily chart of the Transports below, you can see a very clearly broken rising wedge that ended in a double top formation. They have now retraced 23.6% of the entire wave B rise, a possible location for a bounce and well beneath the 50dma. Note that the lower Bollinger band has turned down and away and that a lower low was just made:

The SPX came down and touched the rising bottom Bollinger and stopped just above it, well beneath the rising wedge and 50dma, but not yet at a new lower low. There was also an expanding top in play, the lower boundary of which is now broken as well. Note the horizontal purple line I drew in just below the 50% fib... that's a somewhat likely area of support for the first wave down, right on the 869 pivot, the bottom of wave b of B:

Here’s a weekly version of the SPX bear market showing the bear market downtrend line, the 48% retrace, and the now broken wedge on this week’s bearish candle. Both the weekly and the October monthly bearish candles are on higher volume:

Here’s a 3 month close up of the weekly candle. Note the fresh sell on the weekly stochastic:

Below is a 3 month daily chart of the XLF. It has failed to reach even a 38.2% retrace of the bear market, again a bearish divergence. This decline started when the XLF made a bearish island reversal. Yesterday’s down stroke ended EXACTLY on 13.97, the same location of the last low. That opens up the possibility of a double bottom here, something that I consider unlikely but is there. The XLF also closed below the bottom Bollinger, a place where bounces often start. Volume has yet to really come up here, I am always weary of the moves in the financial space as the games being played by the crooks is absolutely out of control and unchecked. Be careful or you will be robbed – even worse than we all are already:

Want confirmation that wave C down has started? Okay, let’s look at the VIX. Remember that I’ve been saying I doubt if that prior double top holds? It didn’t. The VIX rocketed 24% in one day on Friday to close above 30 for the first time since July. It closed above BOTH the daily and the weekly upper Bollinger band. This is somewhat dangerous as closing back below that Bollinger would technically be a market buy signal… we’ll cross that bridge if and when it happens.

Note on the VIX’s P&F chart that it sees the triple top breakout and reversed its previously bearish target of 12 to a now bullish target (bearish for equities) of 52. There’s money to be made here in options if that target is reached:

I think the relationship of oil to gold here is interesting. Below is a chart of oil futures (/CL) on the left and gold futures (/YG) on the right. Note that oil over the past couple of days made a lower low, but gold has not. In fact, over the past 7 sessions, oil has lost 6.2% and gold only 1.9%. On Friday oil fell 3.5% and gold lost .5%. I think this is illustrating well what’s happening in the economy.

Support for Gold resides in the $1,027 area, resistance at $1,050, and then $1,070. If I were trading gold short term, I would not hold it on a break below $1,027 as the rising trendline will be broken just below that level, then there’s a longer term trendline that currently resides at $1,000 even. The inverse H&S pattern is still targeting $1,325, but it can take some time to get there and if equities really crater, there is risk there.

Demand for oil and oil products is WAAAY down, inventories up. If overall monetary inflation were occurring then the year over year price of both would be zooming. Sure, oil has risen tremendously off it’s lows, but real economic growth is NOT occurring. The only thing that’s growing is the government’s debts, but that growth, as destructive as it is, is not nearly as large as the deleveraging that’s occurring in overall credit especially with the leverage of derivatives considered. It’s difficult to see, so again, I remind doubters that JPM’s derivative portfolio, despite acquisitions, has fallen from $92 horrific trillion to less than "only" $82 trillion. Of course this is a lot like having enough nuclear weapons in your arsenal to destroy the world 100 times over (insane), well, that’s JPMorgan in a nutshell. Gold, I believe, is responding to a lack of confidence due to governmental debt, not due to monetary inflation. Sure they are printing and attempting to create monetary inflation, but they are not succeeding in doing anything of the sort, but they are succeeding in destroying confidence in our system.

Like the VIX, the Put/Call ratio broke out to new recent highs, closing Friday at 1.21. Extreme readings well above 1 can be bullish for the market:

In the past 3 years, you can see that the P/C ratio has been well above this level as the bear market was progressing, tops above 1.5 were common and even above 1.6 occurred back in Feb ’07. This is an indirect measurement of market psychology that needs to be watched carefully now that we’ve broken out to a new range:

Support for the SPX is at 1018, the even number of 1,000, and then 990. The overhead pivot is at 1041. Next week will be a busy one, with the release Monday of the ISM Index, the FOMC decision on Wednesday, and the October jobs report on Friday.

Yesterday’s action definitely put a whiter shade of pale on the bulls, any further decline and it’ll get whiter still.

Procol Harum – A Whiter Shade of Pale:

*I do these reports because I like to educate others and hate to see the public get burned. I do them for free, all I ask is that you occasionally visit and click on a sponsor to help me cover my costs… As Elvis would say in a deeply lowered voice, "why thank you, thank you very much."