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Last Market Rally Before the Bears Take Over

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The current market rally will likely last through Christmas before we see the big leg down.

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Back on October 3, I penned a public article (see Expect the Unexpected: The Market Could Soon Bottom) forecasting a major low in the S&P 500 to occur around 1088. The S&P 500 had been declining from the 1,370 highs this May and was in the 1,130s and nearing its final descent in a corrective pattern. The next day, the market bottomed intraday at 1,074 and closed north of 1,100. Since that time, we have rallied impressively to a high of 1,292, with a strong pullback to 1,215, and now what I believe is the finally rally to a major top formation.

This current rally is part of a normal retracement of the 1,370 highs to 1,074 lows that similarly occurred in the 2008 rally off the first major market drop. One would expect this rally to take a few months to complete from October 4 and likely peak sometime between now and Christmas in the 1,292 to 1,320 ranges as outlined below.

First you must understand that my forecasts are largely based on human behavioral patterns and not economic news or European headlines. The crowd commonly buys and sells in the same fear and greed swing patterns over and over again throughout history. Once you understand these patterns, you can make pretty strong educated guesses on the direction and pivot highs and lows within a few percentage points. Other than those wave patterns, there are other indicators I use to confirm what I think I'm seeing, so let's review:

1. The Bullish Percent Index readings are now at 72%, which typically is an area that marks a rally high in the markets. These indicators tell you how many of the S&P 500 stocks have bullish point and figure charts. Typically a reading over 70% is way overbought and all bulls are on board, and a reading below 30% is the opposite. The market bottomed twice on August 8 and October 4 as these readings were sub 30%. The market topped in July at 1,356 as this reading was over 70%. With my wave patterns and this reading now again over 70%, it's a strong warning of an imminent reversal.

2. Sentiment indicators are now back to full on bullish. In the most recent AAII survey, we have nearly 46% of those polled bullish, up from an extreme low of 24% in early October near the market lows. In addition, the bears in this survey are at a near extreme low of 24% of those polled, leaving the ratio at almost 2-to-1 bulls. This is another warning flag.
The Bullish Percent Index chart is below with some notations:

Click to enlarge

Longer term, my best view right now is that this is a countertrend bounce off the 1,074 lows that will give way to another big down leg.

Here is my reasoning:

First, look at the S&P 500 chart. I show the congestion zone from 1,275 to 1,300. My Fibonacci and wave targets have been 1,292/93 to 1,306 for a few weeks; we hit 1,292/93 once and fell hard. The market is trying to work back up there in this final E wave up, I think. So far 1,274 to 76 were hit (one of my targets), and we will see if it can run to 1,292/93 and the final is 1,306 to 08.


Click to enlarge

This is a B wave rally or wave 2 rally off the 1,074 lows. We are in a bear cycle bounce.

From March 2009 (I forecasted a market low on February 25, 2009), the market rallied from 666 to 1,370 in three clear waves, ABC. Those are corrective patterns of a bear market. The market topped at .786% of the 2007 highs to 2009 lows at 1,370 with Osama Bin Laden's death, a seminal event.

Since then -- five waves down (impulsive) to 1,074 marked a 38% retrace of the bear rally that went from 666 to 1,370.

This is a countertrend rally from 1,074 to three potential pivot areas: 1,292 (which I forecast and already hit), 1,306 to 1,308, and max 1,320; 1,306 to 08 is probably the max in my views.

Why?
A wave: 1,074 to 1,233 wave A from October 4 lows. (I forecasted a bottom on October 3)

B wave: 1,233 to 1,195 wave B (A mild .236% retrace of A wave)

C wave: 1,195 to 1,292; 1,308; 1,320 wave C (Where wave c is either .618, .71, or .786 of wave A (159 points 1,074 to 1,233))

This recent pattern in a more microcosmic view is much like the ABC rally from 666 to 1,370. There the A wave was huge and went from 666 to 1,221. The B wave 1,221 to 1,010, and then the C wave 1,010 to 1,370. That C wave was only 64% of the A wave. All of those pivots, 1,010, 1,221, 666, 1,370, etc., have Fibonacci relationships to prior market highs and lows.

I'm looking for this current countertrend rally to mimic the nature of the 2009 to 2011 ABC rally. That means this final pattern up now we are in from 1195 pivot would be much less substantial than the rally from 1,074 to 1,233. That is why I look for 1,292 to 1,306 ranges (same forecast I had weeks ago) as a top between now and Christmas at best. At any time this market could top and crack, so I'm laying it out as best as I can.

Bottom Line: Market is trying to complete a countertrend rally which so far peaked at 1,292/93 and is struggling to get back up there or maybe a tad higher before the markets lose strength. Many indicators short term are peaking as well, and everyone should be on guard.

Editor's Note: David Banister is the chief investment strategist and co-founder of ActiveTradingPartners.com, a small-cap portfolio and market advisory service.

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No positions in stocks mentioned.

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