Stock Market Correction Continues

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 (after this bull market is over), there will be another steep decline into late 2014. However, the severe correction of 2007-2009 may have curtailed the full downward pressure potential of the 40-yr and 120-yr cycles.

Intermediate trend - SPX continues to progress according to its structure. An intermediate reversal is probably on the way.

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.

CORRECTION CONTINUES

Market Overview

Until last week, it could still be questioned whether an attempt at a new high would be made before a larger correction took place, but the way the SPX and other indices closed on Friday nullified that possibility and defined the market condition: a correction has started, but what kind is not clear. The various indices and leading indicators are pretty much of a mixed bag.

Structure: As sometimes occurs, there is some ambiguity about the EW structure and this does not help us to decide how much of a correction to expect, so we will need to turn to other indicators for enlightenment. The correct labeling should manifest itself over the next couple of weeks.

Cycles: I repeatedly stated that a cycle cluster would bring prices down into the first week of June. It looks as if the forecast was dead on! A short-term bottom could be established on Monday or Tuesday. However, another cycle low is due around the middle of the month which should take us to lower levels, with the possibility that it could bring the correction to an end.

P&F projection: Combining P&F, pivot, and Fibonacci projection, we arrive at several potential targets for the decline. The ultimate one will be signaled by the various indicators. Specifics will be given in daily updates, including interim phase projections.

Support zone: There is major support at 1536. If the SPX continues to decline beyond the middle of June, this is probably where it is heading before finding its footing, but that would only happen if we have started an intermediate-term correction.

Sentiment: The sentiment figures remained neutral for all but the last couple of weeks of the rally, warning of a top only recently. As the decline progresses, they would be expected to recede until they are back into a "bottom" warning zone.

Chart Analysis

This is how I classify the market trend:

Monthly: Bullish. Weekly: neutral. Daily: bearish. Hourly: bearish. We'll look at a daily chart of the SPX (courtesy of QCharts) and point out why it has turned bearish.

I have drawn a channel of the main trend since 1075 in dark blue. Also of the important trends within trends using different colors. The strength of the SPX can be seen by its topping action. It rose as far as it could go within the major channel, and ended its upward trek with a climactic move which briefly took it outside of its intermediate channel from 1343 and ended with a key reversal ("outside") day. In candle-speak, this is also known as "bearish engulfing".

Price action of this type normally ends a trend temporarily, and brings about a correction. But this has to be confirmed, and that confirmation came on Friday when the index closed below a short-term support level. It had already broken outside of its short-term (pink) channel from 1536, had a failed attempt at resuming its uptrend, and finally, on Friday, closed below its 21-DMA and made a new short-term low.

While we were waiting for price confirmation, the indicators (led by the A/D oscillator) were giving us plenty of warnings. They showed negative divergence, a loss of momentum, and then started rolling over with the A/D indicator going negative and making lower and lower lows.

Looking at the overall trend in retrospect, it started from 1343 with a breadth thrust and ended with a climactic top. As a result of Friday's 24-point decline, we are quickly approaching the first projection and support level with an oversold A/D oscillator. This should bring about a brief respite in the downtrend which should continue after taking a breather. The indicators need more work before being able to signal an end to the correction.

Cycles

Last week's newsletter stated: "Several cycles identified in previous letters should make their lows in the first week of June. If so, continued pressure should bring prices down into that time frame." My cycle crystal ball gazing proved to be very helpful.

What I did not mention was, now that we have identified the beginning of a significant correction, that these cycles might only briefly interrupt the decline and be followed by another selling wave into the 8.5-wk cycle low which is due in the middle of the month.

Breadth

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

The McClellan Oscillator broke below the level which normally marks shallow corrections, indicating that something more negative is taking place this time. It will give us a hint when the correction is over by changing its pattern to an uptrend. We can get a better feel for that by looking at the Summation index, specifically its RSI. Deeper corrections normally require the RSI to become oversold and to remain in that state for a while. Currently, the RSI is still declining but has not yet reached the oversold level. That tells us that a turn is not likely for at least a couple weeks (judging by previous comparable patterns). This is supported by the MACD which is just turning down and is still positive. Incidentally, the MACD did signal an approaching top by showing negative divergence to the NYSI.

Sentiment Indicators

On a daily basis, the SentimenTrader (following chart courtesy of same) reached a medium-negative reading of 70 for several days in the past week. Since it had remained neutral for a long time, this told us that something had changed in the nature of investor sentiment which finally turned bullish enough to suggest that a top was fast approaching. Sure enough, they did it again - and so did the SentimenTrader, adding to its impressive record for being accurate.

Past behavior suggests that it should drop back to neutral or lower before the correction ends.

VIX

VIX has responded to the market weakness by moving up, but it is a long way from suggesting that a significant correction will take place. As we will see, this is also the case with other leading indicators.

The P&F chart of VIX has not built a large base and does not look capable of projecting beyond the former short-term top. There is still some room on the upside, but it appears limited.

XLF (Financial SPDR)

Of all the leading indicators, XLF is probably the one which least confirms the weakness developing in the SPX and DJIA. At important tops, XLF historically has led the market on the downside. This is clearly not the case here. Notice the red line at about 19.50. That comparable level was broken decisively by SPX on Friday. XLF, on the other hand, remains well above it. That should caution us not to expect a protracted correction unless the laggard "leading" indicators (XLF and others) do some catching up.

BONDS

TLT continues to decline and is now challenging its March low. The indicators of the various time frames are not showing signs that it is ready to reverse its course. It has now moved outside of its long-term rising channel and could be heading for the bottom of its current declining channel and the major support level around 110. This is also the approximate level of the 200-wk MA and it should, at least, temporarily arrest the decline. However, with the end of QE in sight, the bond market may have started a long-term decline which will eventually see much lower prices.

GLD (ETF for gold)

Last week I posted a long-term chart of gold which showed that it had declined to the vicinity of a 7-year trend line. As would be expected, this should provide temporary support. Also, the chart below shows that GLD has reached the bottom of its correction channel which is providing support as well. This is confirmed by the action of the stock which is now building a base and may continue to do so until the 25-wk cycle has bottomed in a couple of weeks. After that, the index could have a rally to the level of its broken support -- around 149.

UUP (dollar ETF)

UUP may be stalling in its advance from (ca.) 21.60 and could need additional consolidation before meeting its ultimate short-term objective of about 23.30, which coincides with a long-term trend line drawn across two previous tops.

Recent strength in the Euro has stymied UUP's advance, but it should prove to be only temporary. In fact, it is very possible that the dollar started to form a large base beginning in May 2011 from which -- when it has been completed -- it will be able to rise to significantly higher levels. Should that be the case, gold should eventually have a much bigger decline.

USO (United States Oil Fund)

USO has made several attempts at moving out of its converging trend lines on the upside, but they have all failed. It may try again and be more successful IF it is building an inverse H&S pattern. The indicator suggests that it has more correcting to do. More of a pull-back could nullify the possibility of being engaged in building a right shoulder for that potential inverse H&S formation.

Summary

SPX has given all the appearances of having ended its move from 1343. If that is the case, the following correction should be of intermediate nature which could eventually take it back to 1536. However, several leading indicators are not leading but following -- even reluctantly -- casting some ambiguity on the nature of the correction.

We shall let the indicators do the speaking and follow their advice.

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