Stock Market Rally is Suspect But Larry Summers Comes to its Rescue!

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 and some other indices have formed a H&S top which was confirmed with last week's sell-off. An intermediate term correction is under 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 IS SUSPECT, BUT LARRY SUMMERS TO ITS RESCUE!

Market Overview

Last week, I suggested that we could be approaching the top of the B wave of the correction, but that confirmation was needed. Instead, the rally actually intensified with the SPX tacking on another 34 points. That has market analysts wondering if we have not started another uptrend. That could be, but this rally is highly suspicious. By the end of the week there were some important pieces missing to the technical picture, suggesting that, instead of heading higher, the SPX was more likely to roll over and continue its intermediate decline.

The index formed a clear Head & Shoulders pattern when it topped out at 1709. I had mentioned earlier that very often the first penetration of the neckline is followed by a rally back up to the neckline before the decline continues. There is a strong possibility that this is all the SPX is doing and that it is not starting a move to a new high. Last week, it came within 5 points of reaching that neckline and, interestingly enough, this move has a P&F projection to 1696 which, if realized, would take it to the exact level of the neckline. On Thursday, the hourly indicators became oversold in spite of the fact that prices only pulled back slightly and, on Friday, these indicators started a weak uptrend which continued into the close. An extension of that move could easily give us the additional five or six points needed to fill the projection and touch the neckline as well. That, of course, would be perfection, but who knows? It would not be the first time that a projection has been met perfectly!

By the end of the week, there were also other occurrences in Sentiment and in some leading indices which are strongly pointing to the end of a move rather than to its beginning. Some of these will be discussed later on in this newsletter. Considering the total technical picture, it is best to be cautious if you are bullishly inclined.

Chart Analysis

The daily SPX chart (courtesy of QChart) appears below. The first thing to note on that chart is that there are two trend lines drawn from the 1343 low, one brown and one green. The brown one first held when touched at 1598, causing a brief rally, but subsequently gave way when tested for the third time. The SPX then rallied back above that trend line until its extension (dashed lines) was also broken at a higher level (1687), bringing about a decline which found support at 1627.

Note that the green trend line -- also drawn from 1343 and connecting with the 1560 low - provided support for the decline which started when the H&S neckline was broken. The rally from that level has exceeded most expectations causing some confusion about what the market is doing. As I pointed out in the introduction, a rally back to the neckline is not uncommon and there is a P&F projection to 1696 so, what is taking place technically valid. I am expecting the rally to top in this area and resume its decline, this time breaking below the green trend line. Only if 1700 is exceeded with good breadth support would we be able to state with a degree of confidence that we are heading for new highs - but probably not before another pull-back.

Let's now turn our attention to the red trend line which was drawn across the tops and the various parallels to that line, all of which, together, form a large, mostly sideways pattern. Besides connecting the two tops, that trend line is an exact parallel to the neckline of the H&S (dashed red line) and, if we look below, we see that the decline from 1709 not only ended on the trend line from 1343, but also on a parallel to the neckline drawn across two prior support levels. Finally, the lowest trend line of that broad pattern is drawn as a parallel to the neckline starting at the former correction low of 1560. If, in fact, we start another decline from where we are (wave C if you will), it would not only make a new correction low, but would most likely complete somewhere outside the lowest parallel. The (red) 233-DMA would be a good level at which to end it.

There are other features on this chart which could be discussed, but they are of secondary importance. Let's instead, turn to the indicators. The two lower indicators became oversold on 8/19, when the first low of the ongoing correction was registered at 1639. The lower indicator began to lift immediately afterwards so that, by the time the 1627 low of the correction was reached, it was showing significant positive divergence. The middle indicator just kept on hugging its lower parameter and, when it turned up, the rally was underway.

Now, both indicators have become overbought and have started to roll over. At this stage, they may hold off giving a sell signal for a few more days, or do so suddenly, depending on the market action. Any decline from the current level would probably find temporary support on the red horizontal line at 1670. A decline decisively beyond that point would most likely be on its way to breaking the green trend line and making a new low.

Because this was a rather long analysis, I won't bore you with the hourly chart which only enhances the probabilities discussed in the daily chart. Let's, instead, move on to the other aspects of the whole market which are also issuing strong warnings that we are at, or near, the top of wave B. I do want to add that the weekly chart is in the process of weakening and this could influence the daily trend in a negative manner.

Cycles

The low of the 7/8-wk cycle is due any day! As you can see on the chart, its normal phase length is 33 to 36 trading days. It has occasionally gone beyond that during its 8-week extended phase.

There are other minor cycles which are associated with the 7/8-week cycle but, looking a little farther ahead, there is an 18-wk cycle bottoming in the second half of October which would be perfectly in sync with the above technical discussion of the daily chart and the other red flags that are appearing.

Breadth

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

Similarly to my own A/D indicator, the McClellan oscillator has turned down after reaching an overbought condition. It may do more work at the top before starting a decline. Dropping below the zero line would be a red flag.

The degree to which the Summation Index has been helped by the Oscillator is not very impressive. The pattern of the former is one of lower highs and lower lows, with the last high merely a blip from its last low. That is certainly not a sign of returning strength which would lead the market to make a new high right away. This is also a red flag which supports a resumption of the decline!

Sentiment Indicators

The long term indicator of the SentimenTrader (courtesy of same) has moved up a notch back to 60 from where it had been for several weeks. That's the level at which it was at the former market high during the first week of August! That's another negative, and an important one!

VIX

The pattern that VIX is making on a weekly basis provides us with another negative which is just as important to the one appearing above.

We know that VIX moves in a contrary direction to the market. Therefore, just as the market prepares to move down by showing some deceleration in the price pattern, and distribution which shows up best on a Point & Figure chart, VIX should show that it is preparing to move up by displaying a pattern of downward deceleration which results in positive divergence to the SPX.

There are two ways to perceive that this is now happening: the first is by looking at a weekly price chart. Positive divergence is indeed taking place in the VIX versus the SPX. While SPX made new highs, VIX has resisted making new lows. On 3/14, VIX made a low of 11.05 while the SPX made a high of 1563. When the SPX reached its peak of 1687, VIX was at 13.05, significantly above its previous low of 11.05. This was followed by a decline of 127 points in the SPX.

At the most recent top, VIX repeated the same pattern of divergence, but with even greater positive divergence! When the market reached a new high of 1709, VIX did not go below 11.83, well above its 11.05 low of mid-March. And with the SPX now only 20 points from its former all-time high, VIX remains at a comfortable 14.16.

Another, simpler way of demonstrating visually what precedes a decline is by looking at the VIX weekly MACD behavior over the past 4 years. Significant market tops have been preceded by a prolonged period during which the weekly VIX MACD was making a series of higher highs and higher lows as it rose toward the zero line. At some point, the MACD popped above the line, sending the market in a downward spin. It looks to me as if, after 18 months of preparation, we are about ready to complete this behavioral pattern.

XLF (Financial Index) (One more red flag)

How many times in the past have I mentioned that XLF is one of the leading indexes that would give us ample warning when the market is in the process of making an important top? Lots, and it would be downright silly for me to ignore this warning when it is actually taking place! So let's take a look at XLF! Like the SPX it broke the brown trend line drawn from the November low, rallied above it, and broke it again. But then, it bettered the SPX by also breaking its green trend line instead of finding support on it. Also, if you look at the rally which it has experienced from its recent low, it is showing considerable relative weakness to the SPX!

The MACD pattern is reminiscent of the McClellan Summation index which we've already labeled as a weak pattern. One more red light flashing!

BONDS

TLT is now in a well-established long-term downtrend and is searching for a support level. The primary one has already been broken and it is approaching a secondary one (not seen on this chart but identified by the lower green line). It has also reached the secondary level of its long-term downtrend channel, which may hold it for a while. However, looking at the weekly MACD which is making a series of new lows, it is obvious that any rally it might start from here will be of short duration.

GLD (ETF for gold)

GLD is also in a long-term downtrend which is now two years old, during which it recently broke a long-term uptrend which goes back almost ten years. After finding support at the bottom of its long-term channel, it had a strong bounce which attempted to back-test the broken trend line, but fell short of doing so. Two weeks ago it resumed its decline and may be on its way to fill the afore mentioned 110 projection, perhaps in conjunction with the next 25-wk low due around late November.

UUP (dollar ETF)

Recently, UUP re-tested its long-tem uptrend channel and generated a near-term buy signal. Its indicators suggest that it may be ready to extend that incipient uptrend. Next week will test that theory.

USO (United States Oil Fund)

A few months ago, USO also found support at the bottom of its intermediate uptend channel and had a good rally. It now looks as if that rally was only phase 1 of a longer uptrend, and that it is time for USO to rest and consolidate.

Summary

After pointing out the various technical negatives that have developed in the market, the sudden announcement that Larry Summers is withdrawing his name as a potential Fed Chairman candidate is sending SPX futures through the roof and changing the short-term dynamics of the stock market.

Some of these negatives - such as the SentimenTrader reading of 60 -- can only be made more negative by this action, so it will be interesting to see just how lasting an impact this news will have on the market action.

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