Stock Market Rally in an Intermediate Downtrend

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 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.

RALLY IN INTERMEDIATE DOWNTREND

Market Overview

Lately, the market has been displaying some volatility, and this will probably continue while the correction from 1687 remains in progress. Last week, after reaching an extreme oversold level, SPX found good support at 1598 and had a sharp two-day, 46-point rally. While this looks like the resumption of the long-term uptrend, it may only mark the end of the first phase of the downtrend and a positioning for the beginning of the second one.

Structure: The market action is ambiguous. The indicators appear to confirm that intermediate wave III concluded at 1687 and that we are now half-way through the wave IV correction (B wave of an A-B-C pattern). Until confirmed, this pattern could turn out to be the first up-wave of minute wave v of minor 5.

Cycles: The cycle cluster low predicted for the first week in June certainly was effective in bringing the market down, as well as fostering a strong recovery after bottoming. The next cyclic pattern will be discussed later.

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." The 1598 projection was the one which was the most likely to signal an end to the decline, and it turn out to be perfect. We already have projections in place for the initial phase of the current rally.

Support/resistance zones: 1598 provided good support for the first leg of the decline. Friday's rally took the SPX to a resistance zone which should stop the trend reversal, at least temporarily.

Sentiment: Sentiment remains slightly bearish, suggesting that the overall correction may not be over.

Chart Analysis

As you can see on the daily SPX chart (courtesy of QCharts), the index had become extremely oversold when it hit the 1598 support level. This shows up best in the indicators, especially in the lower one (breadth) which achieved negative levels not seen in months! (We will see this better when we analyze the McClellan Oscillator later on.)

The chart shows the uptrend phase which started at 1343. It is part of a larger uptrend which has been in place since October 2011. The phase that is shown is all that is being corrected for now and, for that reason, the correction should be in proportion to the previous uptrend. A retracement of .236 has already been slightly exceeded. A more reasonable .382 would reach down to about 1555. Several channels and trend lines were broken, but the long-term trend line from November 2011 (not shown here) is still very much intact. It could be challenged by a larger correction from some higher level in the future but, for now, we are only dealing with a limited pull-back.

So where are we in this pull-back? Down 89 (Fibonacci) points from the top and perhaps only about half-way through the correction. In structural terms, we may have completed wave A of the correction at 1598, and we are currently working on wave B. When that is complete, we should start wave C to a slightly lower low.

Why can we not say with certainty that we are back in an uptrend now? The indicators say we are not! Look at them. Except for the MACD which is still positive (but correcting), all the others are still in negative territory, and not one of them exhibited positive divergence at the low. We would have to see more positive patterns in these indicators before we can say that the correction is over.

The price itself found support on the 55-DMA and the former short-term April peak but, in spite of the rally strength, it has only back-tested several trend and channel lines which now offer strong resistance to a move higher. Also, the 7-8wk cycle low may still be ahead of us, and could exert downward pressure on a short-term overextended index. After that, we could try once again to resume the uptrend and, if the attempt is unsuccessful, we should then start wave C of the corrective pattern. Briefly stated, we need to clarify whether or not the correction is over.

Cycles

It is not clear if the 7-8 week cycle has already bottomed or will do so next week. We must also consider that the 1-yr cycle often makes its low in July and could be instrumental in prolonging the correction.

Breadth

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

The McClellan oscillator shows how severe the correction was. Last week, it registered the lowest reading since April 2012 and, in spite of two strong days of rally, it has not yet turned positive.

Then NYSI tells us that the correction may not be over. For one thing, it has now developed negative divergence to price by going lower than its April low while SPX has not even gone halfway that distance. This action is perhaps more ominous for the next market high because now, the NYSI is almost certain to show strong negative divergence at the next top. Concerning the current correction with NYSI still dropping and its RSI and MACD doing the same, it's a good indication that the correction may not be over.

Sentiment Indicators

The SentimenTrader (following chart courtesy of same) longer term index retains an elevated reading, also suggesting that the correction may not be over.

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

VIX

As we approached the top tick, VIX, once again, reliably identified a market high with increasing relative strength. Then, it started to rally as the market corrected. It also warned us that the price decline would probably find support when it found resistance, right at a former short-term top and at a declining trend line from its October top. If the correction is not finished, the VIX should continue to rally with another push up and another attempt at moving through its downtrend line.

XLF (Financial SPDR)

The financial index continues to mirror the SPX with a nearly identical pattern. This makes it useful as far as the long term is concerned because, based on historical behavior, it tends to show relative weakness at important tops. As long as it does not, we can pretty much assume that higher highs are still in store for the market. But it does not give us a clue about the short term and whether this correction is over or should continue.

BONDS

There is no question that TLT's apparent attempt at reversing was nothing more than a rally in what is becoming a long term downtrend. It has reached the bottom of a channel, but there is some evidence of downward deceleration in the pattern it is making, and it could continue to decline to the bright red trend line before finding support. At best, we could predict some near-term oversold bounce, but there is no sign that it is trying to end its long-term correction and attempt a significant reversal.

GLD(ETF for gold)

GLD is also in a long-term downtrend with little hope of ending it anytime soon. If everything above the major support green line is distribution, gold is eventually going to see much lower prices.

Short-term, GLD is trying to form a base at the bottom of its long-term channel. This process could continue for a few more days until the 25-wk cycle (which is due in the middle of the month) has made its low. Afterwards, GLD could experience a good bounce.

UUP (dollar ETF)

UUP has been in a shallow uptrend since it bottomed in mid-2011. It is possible that it is forming a major long-term base from which it will eventually start a strong uptrend, but this is only a speculative possibility at this time. The current pattern does not tell us very much about its long-term prospects. The short-term is characterized by small moves in both directions with no discernible underlying trend.

USO (United States Oil Fund)

USO is also essentially trendless over the medium term. However, it is possible that it is gearing up for a good move on the upside if - IF - it has completed an inverse H&S pattern . As we know from experience, these patterns often fail and evolve into some other formation. If this is a genuine inverted H&S, the index is posed to break out of its neckline with a potential rally of 4 or more points. The next few days will tell.

Summary

Last week, after an 89-point decline, SPX experienced a trampoline effect and bounced back up strongly, recovering 50% of its loss in just two days.

In spite of this show of strength, the indicators remain unconvincing that the index has resumed its bullish trend and is ready to make new highs. The next week or so should clarify the market position. For the time being, we'll call this the B wave of a potential A-B-C correction from 1687.

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