Bad Prospects for Extension of Stock Market Rally

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 - SPX has made a triple top, which is a bearish pattern. It has now given a strong indication that an intermediate correction is underway.

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

After several days of resisting the downtrend, the indices finally started to rally on October 26. The SPX tacked on 31 points from Wednesday's 1403 low, but met with heavy selling on the next day after nearing its top declining channel line, and retraced .618 of its advance. The Dow and NDX suffered the same fate.

I had warned that the SPX would reach a resistance level at the opening and to expect at least a consolidation. However, what started as profit-taking became more intense as the day progressed and, by the close, the index had lost all of its previous day's gain, and filling the gap which had been created on Thursday. In the process it came to rest on the support level created by the base which had formed prior to the rally. Now the question is whether this was only a severe but normal correction of the uptrend which started at 1403, or if the counter-trend rally is already over. With cycles expected to start making their lows as early as next week, the uptrend does not have time on its side.

There is also a matter of an unfilled P&Fcount to 1395 and Fib projection to 1386. While (near-term) the election may play a role in the background uncertainty and resulting volatility, we know that the odds favor a continued decline of intermediate proportion into January 2013.

Because of its influence on the market (especially the NDX), AAPL has to be considered a key -- if not the most important -- short-term indicator. On Friday it made a new correction low, losing almost 20 points, and was definitely partly responsible for the overall market weakness. There was relentless selling until, by the close it had reached what could be an important Fibonacci projection. That projection taken from the high of 705 has already proved its effectiveness by producing several temporary holds on the way down: at 626, 613, at 591 - all of them important Fib measurements -- and finally, at 575 on Friday. It may also have completed 5 down-waves from 603 and could be ready to bounce, at least over the near-term. That, combined with the support level reached by SPX, could lead to at least a hold and, more optimistically, to another attempt are continuing the rally. Breaking below 575 would take AAPL down to an even more important Fibonacci projection at 555. The P&F analysis by StockCharts.com has a price objective of 565 -- exactly in the middle.

Chart analysis

This is a daily chart of the SPX. I have drawn two important trend lines: the green trend line which connects the lows from 1267 and which has already been broken, and the blue trend line which goes all the way back to October and connects with the 1267 low. That trend line has not been broken and it looks like it is currently providing support for prices. Long-term trend lines can vary slightly depending on the way they are drawn and on the data provided. The data provider that I use for everyday use shows that trend line at 1385 as of Friday. On this chart it appears to be much higher, more like 1405. That's quite a bit of difference if you are going to depend on the trend line to tell you at what level the support is.

We look for that intermediate trend line being broken to confirm that we have started the intermediate decline which has been forecasted by cycles. Fortunately, there are two more criteria that can assist us in making this determination: breaking below 1396, the level represented by the red horizontal line drawn across the early September lows and, for good measure, the SPX should also decline below its 200-DMA which currently stands at about 1378. Should the index decline below all these important levels, we would be able to say with certainty that we are in an intermediate decline. However, because all three of these support levels are capable of arresting the decline (at least temporarily) we can probably expect the kind of market action that we are presently getting to continue for a while longer. The decline from 1474 has been halted and our job is to decide for how long!

The daily indicators at the bottom of the chart (enhanced by the McClellan oscillator positioned below) should help us evaluate when the SPX will be in a position to break below all these support levels and confirm the intermediate downtrend. Right now, it is not, and this is why: All the indicators -- including the NYMO - have turned up after showing some positive divergence. As a result of Thursday's rally, they moved a little higher, but not enough to give a buy signal, and the NYMO failed to turn positive when it could not get past the blue downtrend line.

Since we mentioned how critical AAPL is to the market trend, let's analyze this 4-hour chart. The arithmetic scale trend lines shown on the chart vary substantially from those shown in last week's newsletter which were in log scale. Friday's decline has brought AAPL to what could be some significant support. Besides meeting the Fibonacci objective mentioned above, the stock is at the bottom of the small red channel and of the large green channel. It has also entered a zone of support created by the May/July price action. Also (not shown here) Friday's close was slightly below the 200-DMA. EW analysts might also conclude that the stock has possibly completed 5-down waves from its 704 top. These various factors could conspire to give the stock the support that it needs to reverse course over the near-term, something which would aid the market immensely.

On this chart, the indicators are showing positive divergence and the least up-move in the stock could lead to a near-term buy signal

Cycles

There is a cluster of cycles due in mid/late November which could put some additional pressure on the decline into that time zone.

Longer-term, the 66-wk cycle should lead prices lower into early January.

Breadth

The McClellan Summation Index (courtesy of StockCharts.com) changed very little in the past week. It is still in a downtrend but may be trying to turn. Its RSI is oversold and shows the same flattening pattern. The MACD is still declining and its lines have not crossed.

A reversal could be triggered by the McClellan oscillator (shown under the daily SPX chart, above) if it goes positive.

Sentiment Indicators

The SentimenTrader (courtesy of same) continues to be perfectly neutral.

VIX

Last week, when I posted this chart, I mistakenly showed it in log scale. That created a long-term downtrend line which was still unbroken. What a difference with arithmetic scaling. Here, the VIX has definitely broken out of its downtrend and has started to make a series of short-term higher highs and higher lows. That puts it in an uptrend until it reverses. I did warn that we should not get too excited because it was still contained by the 200-DMA which pushed back its first attempt at getting above it.

For now, at least, the incipient uptrend has only had a normal pull-back to the bottom of its channel as it back-tested the long-term trend line. Its next accomplishment -- to show that it is in a true uptrend -- should be to overcome the moving average. Doing this will surely be accompanied by the SPX breaking below its multi-support area described above.

XLF (Financial SPDR)

If there is one index that says that the market is not quite ready to capitalize on its initial decline, it is the financial index. It has had as good a rally as any in the past three days and, even though it had a sharp pull-back on Friday, it is still in a near-term uptrend and remains near its high of the move.

It may be making a H&S pattern which would be complete if it dropped below 15.75. That would probably put the nail in the coffin of the stock market and confirm the intermediate downtrend it is trying to initiate. Conversely, if it is able to rise above Friday's high and move back above the green trend line, it would tell us that the market is not yet ready to follow up on its initial weakness.

BONDS

TLT continues to correct after making an all-time high in July. It is trying to hold just below an intermediate trend line which was penetrated in September but which did not cause much subsequent weakness in the index. TLT is trading in a small triangle formation and the direction in which it breaks out will determine whether it is able to reverse or continue with the correction. The longer it takes for TLT to reverse its downtrend, the more likely it will become that the bond market has started a significant correction.

GLD (ETF for gold)

GLD has broken its first level of support - the lower channel line - and is now challenging the next - its 200-DMA. As a result of last week's action, the chart is now looking a little more bearish. If it breaks below the moving average, it should find more support at 159.

The weakness in GLD coincides with a renewal of strength in the dollar which reacted favorably to the positive jobs report. I discussed in previous letters that GLD's 25-wk cycle had given all the appearances of having peaked and that the index was vulnerable until the cycle had bottomed in December/January. The odds of GLD having a significant reversal to its downtrend before then are slim.

UUP (dollar ETF)

UUP tried twice to break below its strong support level of 21.75, but found willing buyers and rallied above, forming a small base which is capable of taking the index up to 22.70, but perhaps not before it has more preparation.

There are two potential obstacles directly ahead: the first is the top channel line of its correction, and the second is the 200-DMA. Both are capable of putting a halt to the advance for a few days and perhaps even send it back down into its base to do some additional accumulation.

There is another short-term impediment to the uptrend: the extension of the green intermediate trend line which will offer resistance when it is reached. These levels will not necessarily keep UUP down for long. They could be met and delt with one at a time as the uptrend develops. What is certain is that if UUP starts an uptrend, it will result in additional downward pressure for the market for gold and for the euro.

USO (United States Oil Fund)

USO continues to perform as expected, continuing its inexorable long-term journey to 28, and then 22.

Summary

The anticipated counter-trend rally has, so far, netted 31 SPX points. On Friday, the index retraced .618 of its gain and returned to a support area which could halt the decline and turn prices back up if this is only a correction in a short-term uptrend. In that case, the index would then have to choose between filling its 1444/1449 projection or, if stopped once again by the top channel line, create a range-bound sideways pattern from which it would eventually emerge -- most likely on the downside.

As pointed above, prospects for an extension of the rally are not very good, based on the cyclical configuration directly ahead.

The immediate future action of AAPL will play a significant role in deciding the market's near-term direction.

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Disclaimer - The above comments about the financial markets are based purely on what I consider to be sound technical analysis principles uncompromised by fundamental considerations. They represent my own opinion and are not meant to be construed as trading or investment advice, but are offered as an analytical point of view which might be of interest to those who follow stock market cycles and technical analysis.

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