Stock Market Short-term Top Forming

By: Andre_Gratian

Current Position of the Market

SPX: Very Long-term trend - The very-long-term cycles are down and, if they make their lows when expected (after this bull market is over) there will be another steep and prolonged decline into late 2014. It is probable, however, that the steep correction of 2007-2009 will have curtailed the full downward pressure potential of the 120-yr cycle.

SPX: Intermediate trend - The intermediate uptrend is still intact, but a short-term top is forming.

Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which discusses the course of longer market trends.

Market Overview

The title of last newsletter was "TARGET AREA REACHED" and, indeed, during the past week the SPX could only trade within the projection range, strongly suggesting that it might have attained the momentum peak of the rally from 1159. It did, however, accomplish something significant; it joined the ranks of those indices that have overcome their May 2011 highs on a closing basis. This is an indication that, even if we have arrived at a short-term top, the bull market which started in 2009 (what else would you call a 3-year rally?) is not likely to be over.

We'll let the long-term trend unfold, but for now, we'll focus on the short-term since there is every indication that the SPX and other indices are ready for a pause in the form of a short-term decline to correct the overbought condition. Already there are signs that we could retrace to about 1322 for a start. But first, we need to make sure that Friday was the high of the move. EW analysts are waiting for an initial small impulse wave to signal that the decline has begun. If my rudimentary EW knowledge serves me right, this could be accomplished on Monday with a slightly new low -- in conjunction with the bottoming of a short cycle due in this time frame.

This, in itself, would not be a confirmed sell signal but if, after a small bounce, we drop below 1353, it would open the way for the first meaningful pull-back since 1159.

Chart analysis

The following SPX Daily Chart has another index added for comparison. It's the XLF financial index which, fortunately for us, has the habit of acting as a lead indicator. It is particularly effective in signaling the market's long-term reversals. In 2007 it warned of a top several months ahead of time, and also at the May 2011 high. Today, the time span is only a few days which does not forecast a protracted decline.

There are two more factors that point to a top. The first is the indicator below the chart which has been declining while the price was advancing, causing negative divergence. The red arrow indicates that the oscillator has, for the first time since August 2011, broken through its uptrend line, and is about to go negative. The other, the structure of the move is an ascending wedge, a negative pattern which normally resolves itself to the downside.

The fact that the price has continued to progress so close to the apex of the wedge is actually a sign of strength, suggesting that the pull-back should not be severe. 1285 to 1288 is a possible area where the correction could end, since there are two Fibonacci projections to that area. When the top is confirmed, we can better arrive at a target with a P&F count.

On the Hourly Chart, instead of creating a wedge pattern, we can build a channel (blue lines). Actually, another, shorter wedge has formed in the upper half of the channel, but more interesting is the second parallel from the bottom which is drawn from the first low of the corrective pattern at the left bottom of the chart and which, when extended, proves to be the trend line which has acted as support for all the minor pull-backs of the rally. Needless to say, when it is finally penetrated, it should move prices to the bottom of the blue channel.

After that is broken, the next support will come at the red 200-hr MA, and if we keep on going and drop all the way to the bottom of the wider, green channel, at the point where it coincides with the blue horizontal line, we come to a strong support level consisting of two Fibonacci projections; the channel bottom line, and the former 1292 peak of last October. Sounds like a good place to look for the end of a correction.

The odds of the supporting blue trend line being broken over the next few days is not only enhanced by the weakness displayed by the oscillator which has been showing a steady loss of momentum and is ready to go negative once again, but by the fact that an important P&F count has been filled. This in itself normally results in a reversal as savvy traders take profits.

Cycles

A 9-10 td cycle is due to bottom on Monday and could bring about the completion of an initial 5-wave pattern from Friday's 1368.92 high. If it is destined to be a high instead, it could push the index a little higher before it reverses.

A more important nest of cycles is due in the first week in March. It could also be either a high - if the market needs more time to complete its topping pattern and drive all traders who are looking for a correction a little more crazy in the process - or a low which could bring about the first corrective wave of the rally.

Breadth

Here is another sign that a correction is about to start. The NYSE Summation Index (courtesy of StockCharts.com) has begun to roll over, and so has its oscillator. This pattern of deceleration in the A/D confirms what we see in the price structure. Since it is the custom of the RSI oscillator to go to the other extreme of its range when it starts down, we can look for signs of a possible reversal in price after it gets there.

Sentiment

There is little change in the SentimenTrader (courtesy of same) long-term indicator this week. It remains in a negative position which is compatible with a market top.

VIX

The VIX may have re-tested its low successfully on Friday. The SPX made a new high, but the VIX did not, and it had a decent re-bound by the close. This is the kind of divergence we look for to warn of a market top. Similar action occurred in February, May and July of last year.

Besides that, the oscillator is showing much stronger divergence and has gone positive. That does not necessarily mean that we are ready for a major decline in equity markets. On the contrary. The VIX is still crawling at the bottom of its long-term channel and it will have plenty of work to do to get out of it. This appears to confirm the prospects for a continuation of the bull market, and places a long-term top weeks if not months down the road.

If we are to have a bona fide reversal in the SPX, the VIX will also have to reverse and overcome its former short-term high. We can estimate how high it should go according to the P&F base it has built.

Right now, 26 looks like a good target.

BONDS

TLT is not only in a long-term uptrend, it is also trading in the upper half of its channel. That's a sign of long-term strength and designates the recent correction as a high-level consolidation. That seems a little odd, considering the fact that the equity market appears to be so strong. You'd think that the bonds should have been retracing by now.

A note of caution is warranted about expecting TLT to make a strong counter-move to the SPX as the latter starts to correct. Historically, bonds and stocks have traded in the same direction. It is because the Fed has kept rates so low that bonds remain in an uptrend. At some point, the two indices will come back together. The shift may be subtle and gradual, as a rise in interest rates will be foreseen by bond traders months before it actually takes place.

UUP (Dollar ETF)

I have been saying for the past six months that, according to the P&F base that it built between May and September of 2011, UUP (21.81) should go up to about 25. That would correspond to the dollar trading at 90. Fortunately, I was wise enough not to say "when" this would happen! Neither index is in a hurry to get there.

In spite of the short-term decline that it has suffered over the past six weeks, UUP remains in its intermediate up-channel. But we can question whether It can stay in it until it has decisively broken out of its long-term down-channel. It temporarily breached it in January, but it was not a decisive break-out and it has now fallen back into it.

The near-term trend is unclear. Short-term moves have been primarily guided by a 25-td cycle which has been amazingly regular. The cycle bottomed about ten days ago, but could only create a five-day bounce, after which is made a slightly new low. It does not look as if the index is ready to develop some upside momentum, but may simply go sideways (or lower) by the next cycle low which is due around March 20 (small asterisk).

The dollar is suffering from the Fed's low-interest policy and may not do much until that changes. For a real break-out, UUP would have to trade above 23.50. When it does, it will be interesting to contemplate if it has simply been enlarging its base all this time - which would result in a much higher projection for prices. Of course, that's unthinkable right now, but let's see where we are in six months.

What could make the near-term more predictable is if we do, in fact, get a correction in equity markets. That would most likely help the dollar - and UUP - firm up.

GLD (ETF for gold)

Gold bugs had a field day when gold was surging last year, but even the strongest uptrends need a rest and, after essentially reaching its projection at 186, GLD started an intermediate correction which is still ongoing.

It is true that after finding good support on its long-term trend line and coming just short of its downward target, GLD has had a good rally which "looks" like the resumption of its long-term uptrend. This may be, but it remains to be confirmed. In the past week, GLD has tried to extend its short-term uptrend, but it appears to be stalling at 173.

By going beyond 171, GLD expanded its near-term potential to 173-175 - this according to the small re-accumulation base that was formed at 167-168. That would curtail the current move and one should perhaps be looking for a pull-back rather than a strong up-move. This is born out by the action of the indicator which is showing a loss of momentum that has created negative divergence. It is noticeable in the price action which seems to have difficulty reaching the top of its small up-channel.

There are good reasons for this: the red parallel lines delineate a wide downward channel and the index has risen to the top of that channel where, naturally, it is meeting with resistance. It now has a choice to make. It can expand its move beyond the highest red channel trend line AND move decisively above its former high of 175.46, or it can pull back.

Under the current market condition which appears to be forming a short-term top, the latter may be the preferred course of action. Gold has generally been trading in the same direction as equities and a market decline will probably result in a decline in gold, as well. If GLD starts to pull-back right away, it would have a near-term target of about 161.

OIL

I cannot end this newsletter without discussing oil, the hot topic of the day. Everyone must realize that today's surging oil prices are the result of Middle-East tensions, especially concerning Iran. Of course, in an election year, this is the perfect political foot-ball for Republicans and they are making the most of it. Let's see if we can bring a touch of technical reality to what is happening, and analyze oil's potential in the short-term and long term.

What is interesting -- not only just about P&F projections for oil -- but for other stocks and indices as well, is that they all seem pre-destined to rise or fall to a certain price level based on the amount of accumulation or distribution which has taken place in the past. For example, in 2009 WTIC made a base which has a count to about 135-138. That projection shows up again in re-accumulation phases which have formed on the way up since 2009, thereby giving the projection a degree of credibility. This long-term projection could have been made 3 years ago. The point being that in 2009, there was no threat by Iran to close the Straits of Hormuz and yet, the price projection was already there. This is why one should not try to use "human logic" when doing technical analysis. The market has a logic of its own which one must learn to trust in order to be a successful trader or investor.

Short-term, the projection for USO is 44. This coincides with a resistance level just below the high of last May, as well as the 200-wk MA (43-44). That looks like a good place for USO to take a breather, but that's all it is likely to be since there is no trace of momentum loss.

Near-term, WTIC (109.45) may take a breather around 111-112.

Summary

Last week, SPX did not exceed the 1364-1370 projection that was made based on the re-accumulation phase completed at 1300.

The more recent minor re-accumulation phase established at 1356-57 does call for a potential extreme of 1375. Until a sell signal has been confirmed, we should respect these potential targets.

There are two cycles to watch for, consisting of a short-term cycle due Monday, and a cycle cluster due in the first week of March. Both of these have the potential of bringing about either a high or a low!

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By Andre Gratian
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