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The End of the Road for Bulls, or Just a Healthy Correction?


Why it's not a bad idea to behave defensively.

Wednesday's session saw some fireworks, which we'll talk about in a moment. But before we get into that, let's recap the recent past, since this has been an interesting and important week for a number of reasons:

1. The Russell 2000 (INDEXRUSSELL:RUT) reached my long-standing target of 1000 (intraday high 1008.23).

2. The NYSE Composite (INDEXDJX:NYA) came within 1% of January's target (9695.46).

3. The S&P 500 (INDEXSP:.INX) reached May's target of 1680-1690 (1687.18).

Long-time readers know that I believe it's important to take at least partial profits and/or tighten stops in target zones, and then watch how the market reacts -- and react it did. These captured targets are thus made much more noteworthy by the dramatic intraday reversals that occurred afterwards. SPX plummeted 38 points intraday (as bears once again took the elevator almost straight down). In fact, just yesterday I wrote:

The only thing I'd warn here is that this is the type of market that can lull bulls into a deep complacency, and markets like this can become ripe for "an event." Always remember the old market adage: "Bears take the elevator; bulls take the stairs."

So, is this the end of the road for bulls, or just a healthy correction?

We'll cover the expectations of the wave counts in more detail momentarily, but there are at least three important factors that bear mention right now. First are the tandem facts that SPX captured May's target zone and reversed hard, and RUT captured my long-term target zone (for a 10% gain, I might add), then reversed hard. The second is the insane sell-off just experienced in Japan, as the Nikkei (INDEXNIKKEI:NI225) dropped more than 1100 points last night. And the third comes from Minyanville's own Todd Harrison. (See: Random Thoughts: A Signal that Bears Watching.)

Morgan Stanley (NYSE:MS) explains that among its equity long-short fund activity, the short activity (the net of shorts added and shorts covered) reached a minus-2 Z-score, indicating massive covering over the past 20 days.

The last three times this occurred were April 2010 (S&P then fell 13% in eight days), July 2011 (S&P then fell 19% in 23 days), and October 2011 (S&P then fell 10.5% in 20 days).

Normally, we would expect a high degree fourth wave correction to begin in this zone, and if that has indeed begun, it would be par for the course to see a trip into the mid-to-high 1500s. There is room within the wave structure for even lower prices. This market has defied gravity for a long time, which is going to make bears scared to short -- and ironically, that's exactly what the market needs to experience a decent sell-off.

We'll cover the preferred long-term count first, and then we'll take a look at an alternate, more bearish possibility. We haven't quite reached the long-term price expectation of the mid-1700s, and given the fact that it's far too early to confirm yesterday's sell-off as any kind of major turn, I'm left favoring the view that we're finally going to have an intermediate correction, but the market is likely to see another wave up afterwards. That said, SPX tacked on 176 points since I first published this chart -- so at this point the market reserves the right to do something unexpected. I think it's a mistake to assume any system can see "too far" down the road; nothing is foolproof.

Click to enlarge

The SPX hourly chart is unchanged from yesterday. Yesterday's chart expected the 1680-90 target to be reached, and the position of the wave indicated that it was likely to mark the end of blue 5/red iii.

So we're in a position where the market appears ready to correct, and we have a reversal from a key price zone. What we don't have yet is an impulsive decline that will allow us to refine targets, but the normal expectations would be for red iv to decline into the price territory of blue 4. Due to the length of wave iii, there is room for red iv to move lower.

The 65-35 margin refers to the near term. The big picture chart above, and the big picture chart beneath this one, must be considered at slightly different odds, which I will cover.

Click to enlarge

It's been a while since I've considered the possibility of a long-term top in this market, as to me it appeared that the long-cycle waves have been pointed up (and they have). At this juncture, though, there is finally some room for this to be a major top. Though that isn't presently my preferred expectation, as I mentioned, no system is foolproof. Beyond that, this is a bizarre market environment, and I would suggest keeping arrogance and complacency to a minimum.

The chart below shows a long-term bear count that I can finally consider as reasonable enough to be complete. At the moment, I still have to continue favoring the long-term count, which points toward the mid-1700s, because we don't reverse long-term counts after one day's price action. But we do have to stay alert to this as a potential. I'd presently put the odds for eventual higher prices at 60%, but be aware that the near term and intermediate term now both seem to be pointed down.

Click to enlarge

In conclusion, the long term presently remains pointed higher, but that may be irrelevant at the moment. We can't see around every bend in the market, but most times we don't need to: The near term appears to be pointed downwards, and the intermediate term, while too early to confirm, also looks likely for further downside. This is not a bad time to behave defensively. Trade safe.

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No positions in stocks mentioned.
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