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Advanced Technical Analysis - SPX



Note: the following analysis is formulated as an assimilation of Fibonacci, DeMark, Elliott Wave and other technical indicators. It is offered as education and not intended as advice in any way.

We're updating our SPX long term technical note from 11/5/04 in which we presented what we believed to be the most probable Elliott wave interpretation of the price action off the lows from October 10th 2002. Where most observers are calling this entire move up an impulsive "5" wave advance and thus the "A" wave of a larger A-B-C upward zigzag toward 1300-1400 in late 2005/ early 2006, we have been of the view that a more probable interpretation is that the move up from October 2002 is itself a nearly complete A-B-C zigzag to the 1200 area. For details of both the count and the underlying technical logic of it, please see our note dated 11/5/04.

Today we are doing two things: (1) filling in the short term action of the SPX from the 11/5/04 piece by citing the divergences in momentum, breadth, ticks, and volatility (the VXO made a new low 45 days ago while the SPX has continually made new highs, a very large divergence) and presenting what appears to be a clean and potentially complete "5" wave move up from the 10/25 lows. (2) We are also presenting three possible paths forward from current prices: one is immediately bearish positioning a decline from around these price and time levels (the original SPX 1200 +/- analysis from 11/5/04) and suggesting the restart of the secular bearish trend, one is more short term bullish to SPX 1250 +/- before a restart of the secular bearish trend, and the final one is the most bullish analysis: the ABC upward zigzag to 1300-1400 toward the end of 2005.

There are any number of all-time record or many year record extremes being made right now: single day daily sentiment index is 93% bulls, the highest level since 2001; the SPX put in 15 straight higher lows yesterday, the first time in the price records history; MBH commodity advisors (traders, short term read) registers 83.3% bulls, a figure only equaled or exceeded on February 20th, 2004, January 27th, 2004, and August 31, 1993 in its 17 year history; Market Vane's bullish consensus too, remains at the highest level in 6 years at 72%, a figure greater than the bullishness when stocks were reaching their bubble peaks in 2000; and the 5 day relative strength index for the DOW is at 94.5, a level last seen in November 1996.

As we see it, there are three possible, most probable "paths" for the SPX given our analysis of (1) the long term Elliott wave count, (2) the Demark trend exhaustion indicators, and (3) the underlying technicals (breadth, momentum, ticks, sentiment, etc.). As we have stated in the past and want to reiterate today, technical analysis of a complex, 'many-bodied' system like the stock market is about developing probabilities. Given the mix of linear and non-linear forces at work at all time frames within the equity markets, our goal is to use phi-based technical indicators to determine a most probable path for future prices from, literally, an infinite number of them. We use Elliott wave analysis, Demark indicators, and underlying technical health indicators (sentiment, breadth, volume, ticks, volatility, and momentum among others) to winnow the potential list of possible paths down to some workable number. And from there we then choose among the remaining options to determine a set of most probable. It is important to realize that we are dealing with probabilities and not certainties; such will always be the case when dealing with complex, many-body systems. Below we present these three paths with strengths and weaknesses for each.

First, the immediately bearish scenario which we highlighted in our 11/5/04 note in which prices take a final 3 wave movement off the 8/13/04 lows toward our window of SPX 1200 (+/- 5 pts) between 11/12/04 and 11/18/04 (+/- 1 day). This peak could then restart the secular bearish trend from the 2000-2002 period in an increasingly impulsive fashion to the downside, in time going below the 2003 and 2002 lows. The technical 'strengths' of this count were highlighted in the note dated 11/5/04 so we won't recount them here. We would add to that note's conclusions however that, in comparing the internals of the impulse waves off the 3/12/03 lows, the volume, breadth and momentum data still suggest this is the best count. Specifically, wave i (dated 3/12/03 to 6/17/03) has the following daily averages: volume of 1.44 billion shares, and breadth of +490 shares and a meaningfully higher internal momentum (MACD). Wave iii (dated 9/30/03 to 3/5/04) has the following daily averages: volume of 1.39 billion shares and breadth of +312 shares, a meaningfully lower internal momentum (20% less in MACD) and registered a higher peak sentiment reading (average daily sentiment index). Lastly, to date, wave v (dated 8/13/04 to present) has the following daily averages: volume of 1.36 billion shares and breadth of +420 shares, an internal momentum that is nearly equal to the peak momentum registered in wave iii (MACD), and a still higher average daily sentiment index. Note that the current wave v has lower volume and more extreme sentiment than wave iii but better average breadth and a nearly equal momentum profile. In an ideal world, the wave v internals would be uniformly weaker (save for sentiment which we would want to be more extreme to strengthen this count.)

However, this count does have its weaknesses specifically having to do with the move off the August 13th lows for the SPX. Under this count, the current terminal wave 5 up (itself composed of a 3 wave zigzag pattern) from the 8/13/04 lows would be expected to be weakening as it progressed. For example, the initial wave up from 8/13/04 to 9/21/04 should be stronger (volume, breadth, momentum) than the second wave up (the 10/25 lows to present). Is that the case? No: the second wave up from 10/25 to present is stronger than the first wave (8/13 to 9/21) in terms of volume (1.56 billion shares vs. 1.2 billion), and breadth (+706 vs. +571) and momentum (on both MACD and ROC measures). The 'strength' of the latest impulsive move up (10/25 to present) relative to the first impulse is not ideal if the count for an imminent cycle degree peak is valid. So net/net this count still has many of the long term strengths we highlighted in our 11/5/04 note as well as the above average daily volume and breadth plus the momentum and sentiment profiles. But the short term move up from the 8/13/04 lows at the very least clouds the long term picture.

What does the short term (8/13 lows to now) internals conclusion say about the next possible count? It implies that in fact we may not be witnessing a minor 3 legged abc terminal 5th wave off the 8/13/04 lows but rather a developing "5" wave move off the 8/13 lows where wave i is from 8/13/04 to 9/21, wave ii from 9/21 to 10/25, wave iii from 10/25 to present with a wave iv down (1137 to 1150) and subsequent wave v up to the next important Fibonacci target of 1250 in the January/February time frame. How would this minor degree "5" wave move up off the 8/13/04 lows "fit" into the larger pattern off the 2002 lows? In two ways.

If the move off the 8/13/04 lows turns into a "5" wave move one interpretation would still call for a cycle degree (major) peak to register but would likely do so in the 1250-1260 region (which would be the 61.8% retrace of the entire decline from 2000 to 2002) before finally succumbing to the secular bear market forces from 2000 to 2002. Such a minor "5" wave move up would force us to re-label the move up from March 2003 as a series of "5" wave moves up: a 5-5-5-5-5 pattern up from the March 2003 lows to present. This would differ from the current count as we now have it labeled; we have the current move from 3/03 labeled as a series of "3"s: a 3-3-3-3-3 move up from March 2003 to present. While both a "possible" the 3-3-3-3-3 labeling is ideal for a number of small reasons. Could it be a "5-5-5-5-5" move off the March 2003 lows? Yes. Is it "better" as a 3-3-3-3-3 move? Yes.

The other way to interpret a "5" wave move off the 8/13/04 lows that ended in the 1250-1260 area would be far more bullish long term. Specifically, such a "5" wave move up from 8/13/04 to the 1250-1260 area could be interpreted as the final impulsive wave of a larger "A" wave up from the 10/10/2002 lows. This "A" wave could then be expected to correct down to 950-1050 over several months (a "B" wave) before another large degree impulsive move (a "C" wave) up to SPX 1300-1400 in the late 2005, early 2006 time frame. We discussed the reasons we thought this was unlikely for the SPX in our 11/5/04 note so we don't need to recap them here, but we do want to make readers aware of the potential that this is a possible path for the SPX over the next year +.

Below we highlight each of these three "counts" for how one could expect such an interpretation to play out from current levels. In the final analysis however, it will all come down to price. If the SPX advances in the next few days into our 1195-1205 area and turns down impulsively, taking out 1110/1120, then we can reasonably assume that the secular bear market is back and that prices in 2005 and 2006 will sink to substantial new lows. If however the SPX holds the 1135-1155 area on any pullback over the next few weeks we can then expect a thrust to the next Fibonacci target in the 1250-1260 area to be imminent into February or January. What happens from 1250/60 will then be critical. We'll be looking for a multi-month decline (to 950-1050) no matter what the longer term secular or cyclical trend is. If the 950-1050 area holds prices in Q1/Q2 2005, then a move to 1300-1400 (1240-1360 is an initial target) would become the most probable interpretation. But if prices decisively (and impulsively) take out 950-1050 in Q1/Q2 2005 then it is entirely possible that the secular bear trend is back and that much lower prices in the 2005-2007 period would ensue.

Most of the above analysis is open to further refinement as price action dictates and indeed they are longer term forecasts that might not matter much to traders focused on their near term P&L. But make no mistake the price action over the next few weeks has massive implications for the trend in 2005 and 2006. If we turn down hard from 1200 and take out 1110, that would imply a secular bearish trend and very bearish prospects for 2005 and 2006. However, if we hold 1130-1150 we can then expect a move to 1250-1260 before the next multi-month 15-20% decline. After that we'll simply have to take it one step at a time.

For the short term, there is little to add to our yesterday comment for all three markets: the "5" wave bounce off the 10/25 lows is nearing its end (>95% complete) or perhaps even ended at yesterday's peaks. Either way, we think a decline of 3%+ is imminent for all three indices; hourly momentum, ticks, breadth, and volatility have all diverged along with very important peaks in sentiment. The market, as you know, tends to make the most people wrong most of the time. With bulls at 93%, it's not statistically probable that that many folks are correct about the near term trend of the market. Becoming one of them seems remarkably risky at this time. If you are bullish then, you'll want the market to correct 3% or so here before attempting a run at the 1250-1260 area in January- February.

Waiting for move down to get more folks bearish would be the wiser (risk-minimizing) choice rather than chasing prices here and becoming another one of the 93% bulls in my view (not advice). The short term bearish interpretation awaits one last thrust to a new swing high, preferably into our 1195-1200 area before a resumption of the bearish trend. If a "5" wave move down on the short term charts develops before that new peak, we could then assume the correction has begun and that technical weakness from any bounces would then seem to make sense. For now the bearish view awaits either of those conditions: a new swing peak in 1195-1200 or a "5" wave move down to confirm a trend change.

The INDU pattern is almost exactly the same as the SPX, so DOW traders can follow similar interpretations. The NDX is far less clear off its August 13th lows (it looks like a 3-3-3-3-3 pattern is tracing out with a 3 down and then 3 up needed to complete it but that is one of many acceptable interpretations), so for that index we prefer to await a clear setup: a small degree "5" down to signal a trend change for a move potentially back to 1470-1490. We'll highlight as the pattern/technicals become clearer.

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