Friday, September 3, 2010

The Bear Slaughter Continues

So a big gut punch to the EWP bears was issued today with the break above key resistance in the S&P at 1100.14. As I've said before, I feel that the break above that level makes the decline from early August a clear 3 wave drop. I know some folks count the decline as a 5 wave move, and they certainly can do so without violating any EWP rules, but it certainly does not have EWP's guideline for the "right look", and doesn't follow enough guidelines to give me high confidence in the count. And in my opinion, counting it as an impulsive decline is like trying to shove a round peg into a square hole. It's really just forcing the issue. An objective viewer of the structure would conclude that the move is most likely 3 waves, a correction.

So most likely this means that the S&P will now exceed 1129.24 before we can consider looking for another top. I'm not a buyer of this market at this point since it's just gone way to far too fast and feels too much like a "panic-buy". Internals are stong but more like yesterday's and not like Wednesday's. So I'm just an observer right now. It just doesn't seem like a nice smooth healthy move higher. I think if the S&P had dropped 500+ points and then the market acted this way, then perhaps I'd be a buyer. But the market hasn't really fallen that much and yet the economy and credit and employment and housing are all still weak and yet the buying frenzie is so fierce. Smells a lot like a panic rally that will soon fizzle and reverse. But we need hard evidence in the charts, not just "a feeling".

So where do we go from here? I talked a bit yesterday about how in late 2008 we had a similar choppy sideways structure with a 3 wave drop in it that eventually gave way to the big October 2008 massive selloff. That wave ii of 3 occurred August 11, 2008 and so far we currently have a top on August 9, 2010 almost two years later to the day. So it's still possible later this month and into October we could get a massive selloff as well. Another element of support for this is the action in the XLF and Russell 2000 which I discuss below.

Above you can see the daily of the Russell 2000. It looks that perhaps a leading diagonal kicked of its major selling phase and now it's declining impulsively.

The problem here is that the 590 support level has held very well over the past few months and perhaps a major double bottom was put in recently and it will be in a big rally phase now. But that has not been confirmed with any bullish evidence, mainly that means a new high needs to be established to break the downtrend and eliminate the impulsive decline implication it currently has.

The impulsive implications I'm talking about are shown above. You have a clear 5 wave impulsive decline from 672.16 with a sharp bounce off support at 588.58. However notice that this 5 wave decline followed a 3 wave rally that started at 587.67. So the Russell rallied in 3 waves from 587.67 and then declined in 5 waves and did not make a new low beneath 587.67. A 5 wave move down that doesn't make a new low almost always means the larger trend is STILL down. So this would suggest that the recent high at 672.16 will hold and that at least one more new low beneath 587.67 will occur in the near future.

Looking at the XLF we have a similar picture. The financial sector appears to be decline impulsively and the current rally is simply a small wave ii that will top before making a new high and rollover soon. However unlike the S&P and Russell, the XLF's key support is being severely eroded at $14. We've had quite a few breaks beneath that $14 level to make it less and less significant to where very little support is holding it up anymore. It won't be able to withstand many more blasts down at that level before it finally completely caves in and gives way. Here we can say that $15.09 should hold since that's the start of the most recent 5 wave drop.

So what does all this mean and what do I do? Good question, I'm glad you asked, and I'll be pondering this more in depth as I float around in the pool and sob in my beer this long weekend. The bottom line is that in the bigger picture, this market and our economy just look broken. The toxic assets, over-optimism and excesses in our economy have not been fully flushed out yet. Until that occurs, I cannot comfortably sit on a long term bullish position, nor buy individual stocks for the long run. Looking at the technical picture above of the S&P I see a market that is topping and on the verge of a big swoosh lower, and I see that the 1040 level's stand against the bears will eventually give way. Unfortunately it's not making it easy for elliotwavers in the short term structure because of the way it's unfolding lately.

I can easily see the S&P breaking out to a new high above 1130 while perhaps the Russell 2000 and the XLF do not. The evidence from an EWP standpoint for those two to hold their recent highs is still compelling. So I'd still feel comfortable shorting the XLF and/or the Russell with stops above the key levels I cited above. The Russell 2000 can be shorted through it's ETF (IWM), or with an inverse fund that shorts it 1 for 1 (RWM) or double (TWM). I would still hold long term shorts though. This market and our economy look broken, and I see little upside potential in the years ahead, but major downside risk in the years ahead. In the short term I'm neutral the S&P and will look to establish a short or long position in the short term as soon as I get higher confidence of direction in the foreseeable future.



Rob said...

Hey Todd, thanks as always for the interesting posts. Good point about the potential parallels with August 2008. I still have no convictions about what the stock market is going to do in the coming days or weeks, but I agree with you that the economy is FUBAR and this market is eventually going to fall hard.

I think the VIX has been the most interesting thing about today's session. It dropped below its early August low, even though the SPX is still 25 points below its early August low. The VIX also broke below its lower Bollinger Band -- looks like the first time that has happened since April 12. These make me think that either (a) SPX's upside is very limited from here, or (b) the market is about to slip into a complacency coma a la Feb-Apr 2010 as the stock market puts in some kind of double top in the neighborhood of the April highs.

PrincipleAnalysis_Blogspot_Com said...

Hi Rob, glad you mentioned the VIX because I too noticed that it's really close to a daily close beneath that lower bollinger band. A close beneath it today would be the final confirmation I'd need that this market has moved way to much way too fast, and that a reversal is just around the corner. Do you trade currencies Rob? Some good setups coming about........should be confirmed early next week.

Rob said...

I don't trade currencies (although I may buy some long-term puts on EUR:USD and AUD:USD), but I try to follow them. The set-ups you point out look good indeed. Have a great Labor Day weekend, and here's hoping for a big sell-off when it's over!

PrincipleAnalysis_Blogspot_Com said...

Same to you pal. Have a good one!

Blankfiend said...

"A 5 wave move down that doesn't make a new low almost always means the larger trend is STILL down."

Unless that five wave move is the c of an expanded flat, which seems quite possible in the RUT.

Another currency pair that has yet to confirm that this rally has any legs is EUR/YEN, which looks to be painting some sort of triangle after a five wave down reversal on Friday. IF it is a triangle, it must be a b wave of a larger correction that would be followed by another leg up of larger degree.

PrincipleAnalysis_Blogspot_Com said...

You're confusing "rules" with "guidelines". The theory of alternation is a "guideline", which means it's preferable but not required. The RUT can in fact be a leading diagonal from the April highs although leading diagonal are rare, so I'll admit it's not highly likely. But no rules are being broken here and it is in fact possible.