Is the Stock Market Correction Over?

By: Andre_Gratian

Current Position of the Market

SPX: Very Long-term trend - The very-long-term cycles are in their down phases, and if they make their lows when expected, there will be another steep decline into late 2014. However, the Fed policy of keeping interest rates low has severely curtailed the full downward pressure potential of the 40-yr and 120-yr cycles.

Intermediate trend - Correction could be over.

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.

IS THE CORRECTION OVER?

Market Overview

In order to provide continuity, I can't think of a better way to start this week's newsletter than by reproducing last week's Summary:

"Last week, SPX had its first significant correction since April. It will soon come into important support around 1900. This is expected to be tested next week and provide at least a pause in the decline. Part of that support is an intermediate trend line going back to November 2012. The level of this trend line will be a decision point for the index. If broken, we could see the decline continue into the October lows."

The projection was met on Thursday when SPX made a low of 1904.78 in the last hour of trading and closed near 1910. Overnight, futures sold off lower, but rebounded by the Friday opening so that Thursday's low remained intact in the cash index. The rest of Friday saw a 22-point gain by the close which, in the process, overcame the first significant resistance level that was in the way of the advance. It's therefore a safe bet that the index has made a short-term low, especially when it met the stated target which happened to lie on a significant trend line.

The question now is: "Are we on our way to making a new high?" That remains to be seen! There are a lot of overhead hurdles that will have to be overcome before this becomes a realization. And although a significant projection was met which, judging by the market reaction, was obviously valid, it will take more than a rally of one day to guarantee that we have made and created a solid bottom. With the SPX closing on its high of the day, it's likely that it will continue its advance on Monday, but it will soon meet with significant resistance around the 1940 level. We'll discuss these prospects in the chart analysis, below.

Chart Analysis

Let's start again with the SPX daily chart (courtesy of QCharts.com, including the following chart).

The trend line from 1343 is shown in dark blue. You can see how close the cash index came to meeting it before rebounding. If the index keeps going on Monday, it will face a level of resistance at the high of our first rally in a downtrend (1942.92), and if it should go through it, it will reach the underneath of the broken trend line from 1738. Chances are pretty good that the current rally will not go beyond doing a back-test of that trend line.

Now I want you to focus on the dashed trend lines that are drawn on the chart. The bottom green one is the support line which was first pointed out back in May when I discussed the value of drawing trend lines across the daily closes, as they often provide a better perspective than connecting the highs and lows. If you recall, this trend line had 8 points of contact from February to May, and that made it a strong support line. With Thursday's close on its extension, it now has 9 points of contact!

Just for the fun of it, I was curious to see if its (red) parallel also served as a resistance line and, indeed, it did. For six months, starting on December 31 of last year, it kept prices in check until it was finally overcome this past June. You can see that the same red dashed line was re-tested and held after it was broken to the upside. I expect that it will also create some resistance for the move that we have just started if and when we get to the area of that trend line. The range between these two lines may decide the direction of the next important move in the market. Should there be an extension of the move to the dashed red line, a pull-back, and then a move through it, we can be pretty well assured that we are on our way to new highs. However, if the current rally reverses course and prices.

plunge below the green dashed trend line, then a longer and deeper correction can most likely be expected. There are other parameters that can determine the SPX's future intentions. This is only one of them.

In spite of today's strength after meeting the projection and reversing, this is, after all, only one day from the low and we can't state with certainty that we have a valid reversal until it is confirmed by some follow-through next week. Also, on the chart, I have drawn the channels which I suspect will encompass the corrective pattern - a small one within a larger one -- and which will have to be penetrated on the upside before we can state definitely that the correction is over and that the SPX is likely on its way to making a new high. This provides another parameter to watch.

The third and simplest one is if the trend line from 1343 holds! A break of that trend line, if not immediately reversed, could lead to more protracted selling.

Now let's look at the indicators. Here also, in spite of the stellar performance of the A/D oscillator which started to move up a full week ahead of the low, it is the only one which has actually reversed. The other two are just beginning to turn with the MACD just barely doing so, suggesting that more work will be needed before we can make much more headway. If we complete the initial break-out move on Monday, we could (should) have a re-test of the low before moving higher.

Let's see what the hourly chart looks like.

The same channels have been drawn on this chart. Prices found support at the bottom of the larger one (staying well above the steeper one of the two) with Friday's prices subsequently managing to clear two-thirds of the latter one. If we can keep going until we get to the top of that channel on Monday, we can start a retracement process before breaking out of it on the top side. Of course, it is possible that more than a mere retracement will take place. Even with Friday's good action, until we clear the 1942 level decisively, we could still make a new low. Another important land mark to cross will be the 200-hr MA (red) which first evidenced the decline when it was finally broken.

What encouraged Friday's rally was breaking above the blue downtrend line. Closing above the first resistance level was another accomplishment. We were helped by good action in the hourly indicators, especially in the A/D oscillator (at the bottom), but also in the SRSI and MACD. Since the indicators are still trending up, it could help prices to move a little higher on Monday. However, they will run into some stiff resistance starting at the red horizontal line (which marked the last line of defense along with the 200-hr MA for prices to remain in an uptrend), especially since it corresponds with the top line of the secondary channel, with the 200-MA lurking just above. We'll have to see how the SPX handles all of that resistance.

Cycles

Monday should be the top of the 9-day cycle. This could also contribute to arresting the rally from 1905, at least temporarily.

Over the following weeks, we'll have a chance to see if the long-term cycles have in fact already topped, or if they are going to wait until the last minute to do so.

Breadth

The McClellan Oscillator and the Summation Index appear below (courtesy of StockCharts.com).

The McClellan Oscillator had a good rally from the low, but not as good as is shown by my own daily A/D index. I suspect that mine -- which simply uses an MACD of the A/D differential -- is a little more volatile, but still does a very good job. In fact, I have not noticed much difference in its predictability potential when compared to the NYMO.

The Summation Index has just barely begun to decelerate. Dropping to the level of its December low, it is very likely ready to break it in the next few days whether the market continues its correction or simply consolidates. It has already caused its RSI to make the longest and deepest correction pattern of the past year. Let's see where it stops and what kind of a rally it can muster. Whatever it does from here, its action already portends weakness for the intermediate term.

Sentiment Indicators

This time, there has been enough of a market correction to drop the SentimenTrader (courtesy of same) long term indicator to a neutral reading of 50. This may not be low enough to suggest that the market decline has been arrested.

VIX (CBOE volatility Index)

VIX has changed its behavior. Previous spikes have retraced immediately; but this time it remains in a congestion area near the top trend line of the correction channel. It's as if it is consolidating for a move outside of it. If this is the case, the SPX will at least retrace Friday's gain to re-test its low; or worse, to make a new low.

XLF (Financial ETF)

XLF is trading in a narrow range, stuck between a broken trend line and a support level. Just below the top of the support level, there is an intermediate trend line as well as its 200-MA. That's a lot of support! If XLF breaks below that trend line, you can be certain that SPX is making a new low.

TLT (20+yr Treasury Bond Fund)

TLT is trying, once again to make new highs in spite of the overhead resistance which pushed it back down earlier. It is still at the very beginning of an extensive resistance area and it may be a tough slog to rise through it, especially after (if) it gets to 118.

GLD (ETF for gold)

GLD is fighting to retain its uptrend! I am not much of a believer in the "golden cross" whereby, when the 50-DMA crosses the 200-DMA, this is supposed to be a meaningful technical statement. In fact, GLD just did it on the downside with no dire consequences. Nevertheless, GLD's ability to hold above the combined 50 and 200 DMAs shows that there might be some hope left for another attack of the top trend line.

In fact, this formation could be read as an important base in the form of a triangle with the "e" wave just completed. If so, GLD is ready for a forceful break-out of that pattern which could result in a 10 to 15 point move.

UUP (dollar ETF)

A potential break-out in GLD is enhanced by UUP coming to a significant resistance line from which it may have to pull back.

USO (US Oil Fund)

For the moment, USO has found support on the lower channel line and the 200-DMA combined. This is important support and, if there is any strength left in this index, this is the time to take advantage of it to spring back into a continuation of its uptrend. Failing to do so would only attest to the weakness that is developing in oil, with the long-term uptrend line (just below) most likely becoming the next target.

Summary

It is clear that the geopolitical situation is heating up all over the world. What were before mostly small skirmishes by terrorist groups have escalated into full-fledged conflicts in various regions. This may be the beginning of a new trend: a "cycle of violence" (a part of which is the fight against Ebola) which will grow in intensity before it subsides. Since this could lead to unforeseen economic consequences, the stock market, which has been slow to react, has begun to express some concern. To what extent it will do so, that is still unclear.

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