Thursday, October 21, 2010

There is Still no Evidence of a Top, All Short Term Signs Point Higher for Now

The action today was interesting since we made another slight new high with diverging momentum and then a sharp reversal in price and internals.  Early this morning on the rally I noticed that internals were strong with well over 400 S&P stocks trading higher and NYSE volume coming in solidly higher than declining volume.  But notice how the internals closed today.  Down volume ended up exceeding up volume and a big wave of S&P stocks ended up moving into the negative.  Also note that the Nasdaq Composite, XLF, small caps and NYSE were all significantly weaker than the Dow.  So again, although the bulls are still in full control, their climb higher continues to weaken.  And remember the strength and conviction the bears brought to the internals of the market on just one down day Tuesday.  When the bears finally gain control and take advantage of the opportunity to strike, they will be fresh and strong and going against an exhausted and stretched bull run.  The result should be a fast and ferocious decline.  The challenge is not “if?” it’s “when?”

If the wave count is correct in that Primary wave ((2)) topped in April, and Minor wave 1 completed in May and the action ever since then is Minor wave 2, then we’re not looking good as far as probabilities go.  The daily chart of the S&P illustrates what I’m saying.  The proposed Minor wave 2 rally is extremely stretched in both price and time.  And with it now trading well above the maximum comfortable retracement level of 78.6%, it’s time to start considering other counts to apply to our overall strategy in my view.

My current daily count is quite simple, which is how I always start my counts… keeping it simple and working it more complex only as required. The rally from August has been quite strong and somewhat impulsive looking, so it most likely is a 3rd or C wave.  I would think that a 3rd wave would be a little sharper and more impulsive looking, although it’s not required.  But it’s all about probabilities.  And I think it’s more probable that it’s a wave C.  Of course this would mean a Minor wave C of Intermediate wave (Z) of Primary wave ((2)).  It means that new highs in some, or all, of the major indices are coming in the near future, most likely for the rest of 2010.  If the bulls do not push the market down in a sustained correction to work off the severely overbought condition before it makes new highs on the year, then I think I can state with high certainty that those new highs would be short lived, and probably be accompanied by various intermarket and momentum divergences when it tops and reverses sharply.  So although we could certainly top and reverse at any time, the Nasdaq 100 has already made new highs on the year, and a few others appear to be on their way there as well.  But with that said, the risk is still to the downside and I personally would not be long equities unless I had 100% put protection.

Going back to the basics, I labeled the 15min chart to show what we’re dealing with at the current time.  You can see we’re still in an uptrend because declines are 3 wave moves and the recent rally is a 5 wave move.  Today’s reversal was nice, but there is still only a 3 wave move down in place.  It needs to continue downward and subdivide into a 5 wave move to even consider a top possibly being in.  And the bigger long term picture suggests higher levels to come.  So without any definitive evidence that a top is in, the proof lies with the bullish argument and higher levels until the bears can produce evidence that the uptrend is broken.

The 6 month daily chart of the S&P and XLF continue to paint a very bearish picture for overal equities.  The financials are not only sustaining their multi-month divergence from the S&P, but it seems to be accelerating it as it’s making more and more lower highs consistently while the S&P makes higher highs.  Eventually, one of these markets has to give way and join the other one.  The larger big picture evidence suggests that it will eventually be the S&P that drops and joins the XLF.  But again, the “when?” is the key question.  Right now, I see no signs of it happening.  So we have to continue to wait.

The break above 1.4005 last night in the euro busts the impulsive decline count I've been tracking and leaves a 3 wave move instead, suggesting new highs are on the way.  Although I can't be certain this will occur since this rally is stretched in sentiment, price, momentum and the wave count.  It's possible a truncated 5th wave will occur, or other currency majors will make new extremes and not the euro.  I just don't know for sure at this point.  But right now, the evidence suggests the euro uptrend is still intact.  Until I see something different, we have to assume the euro will move higher, for now.

Lastly, a look at the gold ETF (GLD) shows a nice clear 5 wave decline from the high, and there’s also one arguably in silver as well.  Of course this suggests that the trend in the metals has turned down.  It would be bearish for stocks as well as the euro, so we’ll have to watch these metals since they are the only short term bearish pieces of evidence I find compelling.

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