Stock Market Pause Nearly Over

By: Andre_Gratian

SPX: Very Long-term trend - The very-long-term cycles are down and, if they make their lows when expected, there will be another steep and prolonged decline into 2014.

SPX: Intermediate trend - After a pause, the intermediate uptrend is almost ready to resume.

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 market pause predicted in the last newsletter is now a week long. After meeting its 1265-1270 projection, the SPX only had a brief two-day pull-back of about 20 points before it rallied. The consolidation extended into Friday with some minor selling at the close. Next week, the index should attempt to extend its uptrend into the third week of January and reach the next P&F target of 1278 or 1293.

This should be followed by some additional corrective action, but how much is not clear at this time. Some Elliott Wave theorists believe that the uptrend from 1075 is a minor wave 2 giving way, when complete, to a very sharp decline as wave 3 unfolds. After the correction from May to October, I thought that there was a good possibility that we might have started a bear market. Since then, I have become more skeptical of that scenario for a number or reasons, some of which I have already mentioned. The long term cycles which are scheduled to make their lows in 2014 certainly are a strong argument for a nasty decline into that time slot. However, the timing for the beginning of a significant wave 3 decline at this time does not feel right.

The behavior of some confirming indicators also argue against it. For instance, the VIX is not warning of a major downtrend in the market. And bond indices -- which normally move inversely to stocks -- appear to be in the process of forming an intermediate top.

We will analyze these two contrary indicators toward the end of this letter as well as the dollar ETF: UUP. That third one is a little more difficult to fathom, especially since the dollar (currently at 80.17) has created a Point & Figure base which is capable of sending it to about 90, but this is not necessarily something that would have to take place over the short term.

These apparent contradictions do not guarantee that we will not start a wave 3 in the next few weeks, but they argue against it. We'll have to wait for the market to clarify its intentions. Let's look at some charts!

Chart analysis

The Daily Chart of the SPX illustrates how insignificant last week's correction was. Here, it looks like it is undergoing a minor consolidation after challenging the previous short-term top and the downtrend line from 1356, before it is ready to push beyond these obstacles to a new near-term high.

A couple of technical factors support this outlook. First, the P&F chart gives us a projection for this move to at least 1278, and perhaps to 1293. P&F projections have a strong history of being met before a reversal occurs. Second, negative divergence normally develops in one or more of the indicators before the end of a trend. This has yet to happen.

The MSO has reached an overbought condition giving us a warning that we are getting close, but this index can remain overbought for an extended time (as we can see at the previous top) and there are indications that this could happen again this time.

Let's now look at the Hourly Chart. We'll see that it confirms the analysis of the daily chart and that there is still no sign of a top!

The short-term uptrend from 1203 is delineated by channel lines. After becoming near-term overbought, the SPX entered a consolidation which just broke out of its light-green channel and is now traveling within a larger (chartreuse) channel. Even if it broke out of it before resuming its uptrend, it would not be a serious matter unless it made a new near-term low by dropping below the red horizontal line, followed by moving below its 200-hr MA. Should this happen, we could start being concerned that a short-term reversal had taken place.

This is not likely. The index has already breached its long-term downtrend line from 1356 and made a new short-term high. When it did, it was very over-extended and is now undergoing a normal consolidation before making a second attempt which will probably be successful.

Cycles

A minor cycle is due in the middle of the month, and another one towards the end of the month.

Breadth

The Summation Index (courtesy StockCharts.com) remains positive and continues to move up, but it is obviously telling us that the rally's momentum has waned and that serious negative divergence is forming. Adding this cautionary sign to the chart analysis above, we can conclude that a short-term top is not very far off.

Sentiment

The SentimenTrader (courtesy of same) long-term indicator has gotten a trifle more negative, but not yet enough to signal a big downturn in the market.

The VIX

I am going to keep showing the Weekly Chart of the VIX because it is one of the best indicators for forecasting future market trends.

The following chart is a compact illustration of the bull market which started in March 2009. Each up move started with negative divergence showing in the VIX vs. the SPX, and it did not end until positive divergence developed in the VIX indicators.

I have marked the beginning of each uptrend in the SPX with a green vertical bar and the end of each move with a red bar. Let's start our analysis with the early March 2009 period, at a time when the SPX was approaching the end of a vicious bear market. What was the VIX doing then? It was making a much lower top, resulting in strong negative divergence and sending a clear signal that the bear market in equities was coming to an end. It then kept on dropping for many months until, finally, its indicators started to show positive divergence, a sign that the SPX uptrend was ending. That phase of the bull market took 14 months to complete.

The same pattern was repeated in phase II of the bull market, and that lasted 9-12 months (to first and second tops). It started with negative divergence in the VIX on 7/04/10, and ended with positive divergence in its indicators which marked a top in the SPX on 5/01/11, and a second top on 7/03.

A third pattern, similar to the other two, appears to have started on 10/2, when the first divergence occurred in the VIX. Another even stronger divergence formation took place on 11/27. Both of these resulted in the beginning of a rally in the SPX, marking what I am calling "bull market phase III".

Now let's fast forward to last Friday which was 3 months from the time the first negative divergence appeared in the VIX, and let's compare the current patterns of the index and of the indicators to the previous phases. Does it look as if the present patterns are indicative of a stock market top? The answer is obviously No! Therefore, we can probably safely conclude that equity indices will continue to rise until the VIX and its indicators signal the end of the present "bull market phase III".

BONDS (TLT)

Let's now take a look at the Weekly Chart of TLT. This will be a much simpler analysis than the one I did on VIX. After re-testing its low of April 2010, TLT created a base which I have marked on the chart with a green horizontal bar. That base took about eight months to complete and, on the P&F chart, produced a target of 124 for the next uptrend. In fact, the index reached 125.03 on 10/02, and immediately had a sharp correction of almost 15 points while the SPX had a strong rally.

Since then, it has retraced most of its decline and touched 124 one more time on 12/19 in an apparent test of its former high. If this is the case, TLT could be making a large distribution top which, if a convincing sell signal is given, could result in a decline down to a minimum of 110, and perhaps even 104. The indicators, which are both showing negative divergence (with the MSO ready to go negative) may be warning us that this sell signal could materialize at any time.

Considering the fact that VIX is not seeing an imminent top for equities, if TLT were to give a sell signal in the near future, it would be a confirmation of what VIX is saying.

UUP (Dollar ETF)

Our third contrary indicator is stronger than the other two, and may not be of any help in signaling a continuation of the rally in equities. The MSO is overbought and could be warning of a coming correction, but the MACD is still strong and moving up. However, the index is up against some resistance and may need to pull-back before moving through.

The daily indicators are much more bearish and are clearly signaling the beginning of a short-term downtrend, so we may get some help from this index after all in confirming the bullish signs (for equities) which are being given by the VIX.

Summary

The SPX is just about ready to continue its uptrend with an objective of 1278, and perhaps 1293.

After reaching its target, the index should go into another corrective period of undetermined length. However, considering the position of the VIX, the odds that we are ready to resume the bear market appear to be slim.

Based on cycles, the next two weeks should be bullish. After that, we may have to wait until the end of the month before we get more clarity about the future trend.

I want to wish a happy, healthy and prosperous new year to all my readers and subscribers

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