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Is This The Heart Of The Hurricane?


The markets are poised to move from the eye of the hurricane to the heart of the hurricane as a two to three week counter-trend rally ended last week.


All down the line, we'll be watching out for trouble, yeah.
All down the line, we'd better keep the motor running, yeah.
All down the line, well, you can't say yes and you can't say no,
Just be right there when the whistle blows.
-All Down The Line (The Rolling Stones)

Sometimes clichés are called clichés because they are many times so true. One such cliché that comes to mind as the market sits on the precipice of a test of the August low, or a new fifth wave down, is "the bigger they come the harder they fall".

The markets are poised to move from the eye of the hurricane to the heart of the hurricane as a two to three week counter-trend rally ended last week.

The bulls are looking for a blowout low and successful retest of the August 16th low, which holds 1400 S&P. The bears expect a new leg down, a fifth wave down.

Click here to enlarge.

Many pundits frequently offer that the market is at a critical juncture. But what happens this week in the market has the potential to truly determine three courses for the financial markets over the immediate term:

  • Confirmation that a bear market has begun.
  • A test of a classic 10% correction.
  • A panicky plunge – a deep correction – that will end sometime in September or October that takes the S&P down by as much as 20 to 25% of its high will play out.

Why do I say this week should determine the course of events for the equity market for some time to come? In a word, cycles. Despite the skepticism bordering on venom regarding cycles theory by many market participants in the fundamental fold, fear and loathing aside on Wall Street, all historic cyclic patterns indicated a top for the seventh month of a year ending in 7, i.e. this July, that is exactly how things played out just when the market looked its strongest. But isn't that usually the way it is?

Consequently, is there sufficient evidence to doubt that these cycles, according to their historical precedents, will cease to exert their downside influence into September and as far as October – assuming this is not the beginning of a bear market? Here is a line-up for a possible cascade setup in the market.

  • As you know and as I have offered over the last month, the steepest part of waterfall decline in the past, such as 1987 and 1929, erupted precisely where the market found high last Monday, and accelerates this week. The financial panics of 1987, 1990, and 1998 lasted 55 Fibonacci to 89 Fibonacci calendar days.

  • September 11/12 is 55 Fibonacci days from the July 19 high. So it will be interesting to see what happens to price over the next few days. The next week or two are the potentially devastating part of the near term cyclical outlook.

  • Tuesday is also a solar eclipse, which as in 1987 showed a propensity of heightening the volatility.

  • With a prospect of a recession in the U.S. economy looming large on the heels of the worst jobs data in four years on Friday, the vulnerability of the market to a washout cannot be overemphasized or discounted. As my father used to say, "The market can go down in earnest for two reasons – a recession, or the perception of a recession." Friday the perception of a recession crystallized in the minds of investors after the U.S. reported jobs data for the month of August which unexpectedly slumped by 4,000 against expectations of an increase of 100,000 new jobs created. Many analysts now feel that a recession in the world's largest economy is imminent.

  • A potential cascade that lines up technically, which is backstopped by a lineup of cycles, recent economic data points, September's redemptions songs, and continued sub-primal fear. Is there sufficient reason to step in where angels fear to tread, until we see what is wrought during September's un-serene season given recent market turbulence?

  • Friday's weakness broke below a trendline coming up from the August 16 low which tagged the August 28 Pullback low.

  • The price high of 1556 S&P in July conjuncts and aligns with the date of August 16. Additionally one full square of 360 degrees in price down on the Square of Nine Calculator from that 1556 high is the price of 1402 S&P. That is why I identified the potential for a reversal on August 16 prior to it occurring. To paraphrase, I offered at that time that if the March lows were tested on August 16 a reversal could be carved out and that a close above the key 1402 pivot should confirm the deal being sealed. On August 16 the S&P skidded below 1400 to 1370.60 (coming within six points of the March low at 1364) before reversing to close above 1402.

  • Now, after two to three weeks of a counter-trend rally, the S&P is on the brink of a test of this key 1402 level. It is important to note that in fast moves the markets usually don't give more than two to three days against a trend on the daily time frame; just as on the weekly time frame strong downtrends typically do not see more than two to three weekly bars against a confirmed downtrend.

  • The big wheel of time, the Quarterly Swing Chart, turned down on August 15 on trade below April's low of 1416.35. In keeping with the Principle of Reflexivity, when a big wheel of time such as the Quarterly Swing Chart turns down there is typically reflexive price action, i.e. a snapback in the opposite direction of the turn. The Quarterly Swing Chart turned down on August 15 on trade below the August 2 low of 1416.35 (the low of the second quarter), in keeping with classic swing chart behavior when the Quarterly Swing Chart turns, the market found low in price and in time quickly after this Quarterly Swing Chart turndown.

    In this case, a significant low occurred the day after, on August 16. It is important to understand that in the bull market of the 1990s every single turndown in the Quarterly Swing Chart in the S&P defined a significant low in terms of time and price within a few days, and a percent or so, from the date the Quarterly Swing Chart turndown occurred.

  • Consequently, a move back below 1416 for the quarterly pivot at this time would be the sign of the Bear. In other words, going back below this key level would issue a Time Turn Trend Signal. Put another way, going beyond the price of an important period in time – the Quarterly Swing Turndown – will be out of character with bullish behavior and will demonstrate a change in the primary trend to bearish.

  • It is critical to observe that a possible cascade setup exists. Why? A break of what Hoofy is hoping is the right shoulder of an inverted Head & Shoulders pattern will occur at 1432 S&P.

  • If such acceleration penetrates 1416, a Time Turn Trend Signal will be issued.

  • If further downside continuation plays out below the critical 1402 level, which roughly coincides with the low close for the move down in August at 1406.70, the house of cards could fold. Interestingly, these levels roughly coincide with the weekly close at the end of December 2006 at 1418.30. Consequently, panic could be brought to bear amongst money managers if the S&P benchmark goes to a loss on the year and remains there.

    Click here to enlarge.

  • These are the levels to watch if this cascade setup begins to unfold. A measured move that parallels the first leg down from the July 19 high (or a fifth wave down) projects to a minimum of 1350-ish S&P.

  • September 5 is the average annual high of any year. Consequently, downside risk may have reached critical mass suggesting the August low is likely to be broken.

  • The dollar went off the cliff on Friday, putting further pressure on U.S. assets. This is one of the keys to the potential for a global meltdown, just as was the case in 1987.

  • A ten minute chart of the S&P for last week shows two 30 point S&P legs down. A third 30 point leg down from the last swing high at 1466-ish counts to 1436. Consequently a break of 1436 may indicate that the key level of the recent low at 1430/1432 may buckle.

    Click here to enlarge.

  • Additionally, because the S&P closed on its low last week, there is every reason to believe that the weekly chart will turn down on Monday morning. The behavior on this turn down, i.e. if the market accelerates, will suggest a minimum measured move to the mid-1430's.

  • Finally an hourly chart of the S&P from the August 16th low shows that the three point trendline was snapped on a gap on Friday. This left an Angular Rule of Four Sell Signal on Friday, which argues for lower prices in keeping with the Friday weekly close by the S&P below its 200 day moving average.

    Click here to enlarge.

Editor's Note: Want more of Jeff's insight and trading ideas delivered to your inbox daily? Minyanville is proud to announce that we have launched Jeff Cooper's Daily Market Report, complete with Jeff's day trading and swing trading setups. Email Josh Sander for more details and how to sign up.

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No positions in stocks mentioned.

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