I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Saturday, August 29, 2009

A Massive Chart Dump - P2 Analysis Wrap-Up

.... And by "Chart Dump", I don't mean all these charts belong in the toilet :)

So like I said on Friday, I wish Primary 2 was done, I *want* Primary 2 to be done. I just don't think it is done. But I do think it is very close to being done, next week looks very likely for the top.

But the whole point of this post is to look at a whole host of indices, sectors, asset classes, and sentiment indicators to show that there are some very substantial divergences taking place. Some of the "leader indices" show that they have already potentially topped (are not making higher highs with the broader markets). The Dollar and the VIX may have already bottomed. Volume is drying up (or at least substantially declining) in most of the indicies. In short a lot of the signs that we expect to see with Primary Wave 2 have occurred, and things are more or less "on track" for a large trend change in equities.

The other reason for this massive update this weekend is that our first born child is due any day now, and my blogging and chart updates will drop off dramatically next month. binve's life is about to get a lot more interesting :)

This post contains a lot of charts that I show often, but every chart is completely updated with new annotations and analysis. I believe it is a useful post and tells the picture of the markets from a macro view. Enjoy!

The Primary Wave 2 Checklist

There are several signals that we should see that help to let us know we are at the end of Primary Wave 2. There are some characteristics that Elliott (and then Frost and Prechter later) put forth that would describe some of the technical, fundamental and sentiment aspects of Wave 2. Here are some of those (modified to be bullish, as this Wave 2 is bullish):

From EWP: “Second Waves often retrace so much of Wave one that most of the losses endured are gained back by the time it ends. At this point investors are thoroughly convinced that the bull market is here to stay. Second waves typically end on very low volume and volatility.”

Additionally, bullishness sentiment returns, and is often as high as it was at the peak, despite the technical long term damage that was done by Wave 1.

So here is my P2 Checklist:

- X -    VIX Low
- X -    BPSPX (and other bullish indicators) at higher highs than 2007 peak
- X -    CPC at uber-bullish levels
- X -    Investor Sentiment above 80%
- X -    Economists declaring "end of the recession"
- X -    Analysts upgrading everything
- X -    "Speculative Leader" indices showing weakness / bearish divergence
-    -    Clear end count for P2

.... And almost on that last one. Things are certainly in place.

Who wants a snack? (thanks MissMalibu !!) :)

Let's Start at the Beginning: SPX Long and Short Counts

The SPX looks like it is in the final move of the triple zigzag. We have a smaller converging wedge within a larger converging wedge. And as per my preferred count, I think we have an ending diagonal (another wedge) happening at the end. I will talk about this more in a minute.

Looking at the Daily Chart, we see lots of negative divergence across the board. We see volume declining and the move slowing down at the 1044 resistance level.

The next set of charts discuss the Ending Diagonal count option. Here is the ending diagonal count that Columbia and I have been working (discussed the possibility a week ago) and mentioned in these posts:

It looks like the bulls and bears want to fight it out just a bit more before heading down.

This first chart is the count from last week where I was exploring the possibility and giving some Wave A, B and C comparisons:

Next is the updated version of the count. I think Wave C (final) will be different from Wave C (first) in that the diagonal will not be as drawn out. But that makes sense with the exhaustion that we are seeing at the end of this rally.

I believe the RSI divergence will be greater in this final diagonal

Here is the Ending diagonal count option that Columbia and I are carrying. Mine looks just a little different than his, because I do not believe the C Wave of the diagonal is done yet. C Waves in diagonals are typically the longest (in duration) and the most complex. Again these are guidelines, not rules. But I think based on the bounce off the bottom trendline on Friday, Monday could give us some surprising upward complexity

(Then again, we might get a -300 point "Black Monday" open. P2 could be done as of Friday morning. There is a valid count option there. But read this post as to why I don't have that as my preferred count: So the Diagonal Walks Up to the Two and Says...)

Same count on the NDX


Next, let's look at a major "canary in the coal mine" sector: Financials. There is still a lot of "un-bullish" developments occurring in financials right now.

XLF is sporting a nearly complete 5 wave for it's final C. And the last wave is also shaping up to be a diagonal.

BKX is hitting its head on major resistance

Goldman-Sucks, errr.. Sachs. This is **very** interesting. GS not only has not been making higher highs like I was observing last week, it is also beginning to break sideways through the wedge support line. GS is undoubtedly the leader of financials, and the fact that it is not making higher highs should be particularly distressing to anybody who is bullish on the sector

BAC "Death Wedge" is still in play. Apex right in the middle of huge long term resistance.

International Equities

As I was discussing last week (A Look At Some of the Asian Markets), many of the Asian markets were the early beneficiaries of inflowing speculative money. They rose the earliest and the fastest. I was also pondering then, would the speculative outflow leave them first? First In First Out (FIFOs for us programming types). It would seem like the speculative MO, move into the most beaten down markets when investor sentiment is at an all time low, ride the wave up, and then bail when everybody thinks we are on the way to new all time highs.

HSI was looking particularly strong up until 3 weeks ago. It has not been making higher highs with the rest of the worlds markets the last 2 weeks. And now it looks as if it is about to start breaking down from the wedge. The Hang Seng is not only tied to China, but it has a huge weighting in Financials. This index is a double-canary (if you will), and should really be on everyone's radar screen.

South Korea is headed right into major resistance.

Shanghai. Wow, what a train wreck. Read the notes on the chart, they tell the story

The German DAX is also sporting a wedge within a wedge. Things are about to come to a head here too.

The NDX is a proxy for the leadership of the US indices. This wedge is also quickly converging.

The SENSEX is another *very* interesting chart. It has rallied like China, huge nearly 100% move off the bottom. But it has already broken down through the wedge support line. Moreover, on a retest, that support line as turned into resistance. Also we see some major RSI divergence showing up on the daily chart. Another canary worth watching.

US Sectors, Assets, and the US Dollar

Watching the sector participation / non-participation has been very interesting. And the last few week there have been some "dissident" sectors. It will be interesting to say how they all behave next week.

Among the major assets classes that drive the US Markets, since the Great Leveraging Event of 2008, we have seen some very strong positive and inverse correlations take place. Here is an excerpt of observations from this post (Market Update - Equities and US Dollar):

Short term is all noise. And the current dollar weakness is fueling the equity rally. Long term, equities will go down (due to poor fundamentals) and the dollar will go down (due to confidence crisis) together (such as 2007-2008 and numerous other occasions)

By and large, there is **far more** positive correlation between the Dollar and Equities than there is inverse correlation. They both go up and down together as evidenced in the chart above.

However, many others including myself, have observed that the "weak dollar" is currently fueling the the equity rally right now. So why the discrepancy?

Because you need to realize that we are still in the aftermath of the Greatest Deleveraging Event in History (2008)!

During the meltdown of 2008, everything was sold / redemeed for the relative "safety" (used exceptionally loosely) of Treasuries: shares in hedge funds, commodities, stocks, etc. As such there was a massive dollar repatriation. The dollar didn't gain value because it was strong! It did because it was "in the way" (you have to buy dollars in order to buy treasuries, it is sort of a necessity that way).

In the ensuing months we have seen the Fed ream bondholders through ever more massive QE salvos, intentionally destroying the "value" of US Treasury debt and the US Dollar. Since that time, money has been moving back out of Treasuries (putting downward pressure on the dollar) and into more speculative endeavors (the stock market). You can see here that there is not a "if the Dollar goes down then Equities must go up" relationship here. Money was leaving treasuries and equities were oversold so they were bought. That's it. Another force at work is the fact that the weak dollar and the oversold nature of equities a few months ago made stocks attractive to relatively stronger foreign currency holders, who could "get more bang for their Euro" so to speak.

You can see that the current inverse relationship between the Dollar and Equities is a product of a very particular setup and is not a given. In fact, the relative valuation of all of these asset classes (Treasuries, Dollar, Foreign Currencies, and US Equities) has shifted a lot the last few months. Anybody expecting this "status-quo" relationship to persist much farther into the future is going to be rudely surprised.

And so the game has been that gold, oil and equities have been positively correlated and Treasuries and the Dollar have been inversely correlated to that group. Now we are beginning to finally see some breakdown of this strong correlation. As this rally gets "long in the tooth", expect to see these asset classes begin to diverge even more.

As I have said just above and many times in the past, I am a long term Dollar Bear. But I think for the end of P2 and the first couple of months of P3, the inverse correlation between the Dollar and Equities will be maintained. But it will be getting weaker and weaker. Eventually they will both head down together. But my 3-6 month forecast is for the dollar to rally.


All sentiment indicators are still reading highly bullish - CHECK!

The VIX still looks like to me that it made a bottom and is consolidating currently in a Wave 2 before the next bigger Wave 3 up.


I am not going to discuss fundamentals in this post. But they are exceptionally important and I recently put together a huge post that discusses them in great detail: The Long View
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