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SPX and Crude Oil Update: Rally Ready to Roll Over for Good?


The market has followed the script so far; if it continues, this next leg down could be nasty.

I'm going to keep this update short and sweet. Yesterday, the charts looked muddled, and to some extent, they still do -- I've noticed over the years that this almost always happens in the charts when the market is making an important top. I was looking for a reversal yesterday, but I usually tend to be a day or so early for those, at least when I'm calling tops before they actually happen. Did the same thing on October 27; I was a day early. Maybe one day I'll figure out how to compensate for that.

Anyway, as a result of yesterday's action, there are really two main counts I'm focused on now: The preferred count I've stuck to since late October, which says October 27 was a major top, and the alternate count, which suggests the S&P 500 could make a slightly higher high for the move.

In both cases, I am of the view that this is a bear market rally; and it should get ugly fast when it rolls over, as hoards of Johnny-come-lately bulls will be jamming the exit doors trying to get out. If you're just joining the discussion, it's helpful to review my big picture outlook for the market (see The Big Picture: SPX Long-Term Count and Projections). Note that I haven't updated that article's long-term chart since October 3, largely because I haven't really needed to.

Over the past few days, I have presented several indicators regarding sentiment, and discussed how these indicators were arguing that a top was being made. In the market update for Monday, we examined Rydex bull funds (retail investors), which had reached record money flow levels. In Tuesday's update, we looked at the ratio of money flowing into the NASDAQ vs. the NYSE, which had also reached record levels.

The point I really want to stress here is that this level of extreme bullish sentiment is simply not consistent with a bottom in the market. Let me repeat that: Bullish sentiment is not consistent with a baby bull market. Remember March 2009? People were convinced the market was going to zero. Even at the October 4 low (Remember way back then? Like a month ago?), most were convinced the market was going to crash, not put together a monster rally. Compare that with today, when there's more money going into risky stocks and bullish funds than ever before. This type of sentiment is consistent with a top, not a bottom. The market is all about fear and greed. When the market reaches extremes of either emotion, a reversal is usually nearby.

This first chart shows my preferred count. With the additional puzzle piece of Monday's price action, I am now about 70% convinced that this latest countertrend rally is over. There could be one more quick drop followed by a marginal new high (see blue "or (c)?" label), but I'm not favoring it. However, the level on this chart that is critical for the bulls' first defense is 1,238 to 1,240. Until bears break those levels, new highs can't be ruled out. But if those levels go, that will almost certainly leave the bulls in trouble. And if this formation is an ending diagonal, those levels will probably get tested pretty quickly when it breaks.

Click to enlarge

One reason those levels are so critical is because breaking them will eliminate the option that this formation is a leading diagonal. A leading diagonal would be consistent with the bullish alternate count (shown below), which considers the possibility that the market is in the beginning stages of Wave c up to new highs (early targets are for 1,305 to 1,330). If the bullish alternate count is unfolding, then this diagonal is Wave 1 of red c on the chart below.

I should also note that breaking 1,238 to 1,240 still can't eliminate the bullish alternate count. I don't know that it would help to launch into a huge and confusing explanation as to why, so you're just going to have to trust me on this: 1,197 is the level that eliminates the bullish alternate.

Even though the market has pushed up close to the knockout level for my preferred count (above), I continue to only give 30% odds to this bullish alternate (below).

Click to enlarge

One last chart to add; I'm sharing this primarily because a number of readers have requested it. The chart is an update to my long-term count of crude oil. The last chart I posted was on September 9, but if you check the old chart, crude has played out pretty closely since -- however, the old chart did require some slight adjustments to the labeling.

From the looks of it, crude is currently in the process of back testing the broken blue trend channel, in the mid-$90 range. If the preferred count shown on this chart is correct, I expect this back test to fail, since crude is forming a nested series of first and second waves, and could collapse dramatically when it turns.

I am currently favoring the preferred count by a 90% margin, based on my analysis of other markets, such as the dollar, copper, and equities. However, the black alternate count cannot be ruled out yet, and, strangely, results in the exact opposite effect from the preferred count. So, one way or another, crude is likely gearing up for a monster move.

Click to enlarge

To sum it all up, I think this rally is almost certainly over... but pay attention to the levels listed above for confirmation. The next leg down could be brutal. Preliminary targets for the first leg of the next move down are in the mid-1100s, but that could change as it unfolds. Once we get some confirmation, I'll start refining the targets. Ultimately, the larger-degree wave should take the SPX into the 800s or lower, although that will take some time, and there'll be rallies along the way. Trade safe!

This article was originally published on Pretzel Logic's Market Charts and Analysis.

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