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Saturday, September 26, 2009

Another Massive Chart Dump / P2 Analysis Wrap-Up

I wrote the first iteration of this post here (A Massive Chart Dump - P2 Analysis Wrap-Up) on Aug 29. There are three main reasons why I wrote that post at that time, saying that the end of P2 would be soon:

1) There was a 5 wave count up from the Aug 18 low that could possibly have served as a C wave to finish P2 (obviously it didn't)
2) There was a possible ending diagonal setup the I identified here: So the Diagonal Walks Up to the Two and Says..., that had a possibility to pan out (obviously it didn't)
3) Our first born child was due any day (was actually born on Sept 3) and I knew I would not have time to watch the market anytime around then. So I figured I might as well write a post calling for the top soon, because I might not get a chance while it was actually happening :). LOL!

Well, as we all know, Mr. Market does not do anything obviously. And since then we had a big pullback, then a big rally, then a dramatic and confusing spike with a large pullback. ... which brings us to now.

So what is up?

That is what I will explore in this post. I will most assuredly not be getting this 100% right (I make mistakes in my calls just like everyone, I just admitted to several in the paragraph above). But in the past few weeks we have received a few glimpses of what Mr. Market's intentions may be. And I will give my interpretation for all who are interested. Hopefully it is useful, or at the very least, an entertaining read :)

... On to the analysis!

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

I wish Primary 2 was done, I *want* Primary 2 to be done. Why? Several reasons. Mainly because this rally is "fake". It is a countertrend rally in a overall secular bear market. And countertrend rallies are fine. In fact, they can be fun! Traders can make money on the volatility. And even swing traders and short term investors can make money in strongly trending markets. However, this rally has gone on so long that economists are declaring end of the recession, and Wall Street is advising everybody to jump back in before it is too late! What does this mean? The individual investor will get screwed. Tell me if this describes you or someone you know:

From the 2007 peak, we had a huge meltdown during 2008. Many people held during 2008 and in the middle we had the biggest selloff. Many still held through that. We plateaued in December and even got a little rally. Ravaged investors began to feel a little better. Then January and February came and the selloff continues. Gun-shy investors still remembering the stomach drop feeling of Aug-Sep 2008 sell during the Jan-Feb selloff not wanting to "live through that again". Basically they sold at this bottom.

Then after months and months of still being gun-shy and not buying into this countertrend rally, investors are starting to pour in. Recession is over the economists say. New bull market Wall Street says. And so finally after months and months of waiting, individuals investors are buying ... at the top.

Maybe you believe in P3 and maybe you don't. But I don't think that anybody who seriously watches the market and seriously follows the economy, thinks that this rally has much left in it, or this the market has a chance of making new highs this year, or even in the next several years. Most likely, the next major move in the market is down. There are debates over how much down the next major move will be. But I contend (and many will agree) that the upside from here is very limited and the downside risk is great for equities.

This is the main reason why I want P2 done. Because it will be suckering a lot of people (turning them into bag-holders) who have already had their retirement accounts decimated. My parents, your parents, maybe even yourselves. And if this does make one more wave up before the plunge (which I think it will, and more on that in a minute) it will sucker even more investors. ....

.... end rant.

So is Primary Wave 2 done?

I just don't think it is done. But I do think it is very close to being done. There is a count option, that is possible, that shows it could be done (the spike to 1080 on the SPX last week), but I don't think it is. I think there is one more wave up left in it that will make a higher high (up to about 1100) somewhere in the beginning of October. (more on that in a minute)

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. And not just volume drying up (since the rally has gained in price, you need less shares to transfer the same amount of wealth), but Money Flow is declining. Additionally, money flow has lately been showing distribution, not accumulation for most issues. 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.

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 (with a possible end count showing completion). 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 one more wave up to finish Primary 2.

But let me show you a few options for this count, because there are a few ways it could be interpreted.

The one I think is mostly likely is Option 1. This is my preferred count and the one I will be showing through most of this post.

Option 2 ... yeah. I am throwing it in there because it is a technical possibility. However, I have no expectations right now of this rally extending to 1200 in the current wavecount without a *major* correction.

Option 3 is the one where P2 has already ended. There are a myriad of issues with this count, and many reasons why it is not my preferred count. See this post for the reasons why: EOD Count Sept 23. In short, by my preferred count, and the issues I show with the P2 ended count, I think we are still in Primary 2 with one more wave up to finish it

Option 4 .... out of left field. Actually I have a count for it, and it is not too dissimilar from Option 1. It is an ending diagonal, and I will show the count for it in a minute.

Looking at the Daily Chart, we see lots of negative divergence across the board. The RSI is showing weakness as we made the next two highs. The MACD is losing steam and forming a wedge pattern itself. CMF is showing that the last main rally is being sold into. The "easy money" by going long and staying long on this rally has already been had. The last few points are the territory of nimble traders. Anybody who is going long here as an investment should have their head examined (fortunately I run a trephine shop in my garage. So please stop by if you need to release any excess bullish pressure from your brain!)

The next set of charts discuss the Ending Diagonal count option. Here is the ending diagonal count that Columbia and I had been working at the end of August and mentioned in these posts:

Obviously the short term smaller Ending Diagonal was a red herring. But recently the price action has made this a possibility again (diagonals are never obvious from the beginning, and usually show themselves after a lot of agonizing price action. After all, an ED represents a near even fight between bulls and bears).

Also here is the price action as it has unfolded that only recently showed the ED as a viable possibility again:

Next lets look at some wave comparisons and RSI comparison between the first Wave C ending diagonal and this last Wave C ending diagonal. The first obvious comparison is that this last one is significantly more stretched and exaggerated. But beyond that, there are some striking similarities in the Wave B behavior in relation to Wave A and the RSI trends between these two Wave C's:

Now, myself and many others have already observed that this current Wave C can be counted as a valid 5-3-5-3 impulse so far. Wave 4 does not go into Wave 1, and so this does not need to be an Ending Diagonal at all! However, I submit that while technically it does not have to be one, there are many characteristics that it shares with an ending diagonal.

Regarding the Ending diagonal, from this post of mine: http://marketthoughtsandanalysis.blogspot.com/2...

This does not have to count as an ending diagonal.
1) The count so far is a valid 5-3-5-3 for Minute 1-2-3-4. However, the count could easily be interpreted as a 3-3-3-3 based on how exaggerated wave 4 of 1 was and how Wave 3 has very much the shape of a zigzag (the biggest correction comes right in the middle)
2) Minute 4 does not go into Minute 1
3) Minute 3 is the longest wave

However it certainly does *act* like an ending diagonal
1) Minute 1 was the technically strongest most impulsive wave of the run
2) We see a large amount of negative divergence in the RSI during the whole run.

It is really just a matter of semantics whether we call it an ending diagonal or not. Either way, they both point to one more wave up to complete Primary 2.

So lets go back to my preferred count: Option 1, the "clean" impulse up from the Aug 18 Wave B low:

We still have a valid impulse up with one more Minute degree (Orange on my chart) Wave 5 up to come to complete Primary 2.

Also here are my current microcounts. I am showing a valid Wave C move down to complete Minute 4 and we are now in Minute 5. I am also showing the alternate count (Option 3) which is that P2 has already ended. The count so far supports both options.

If we break 1039, then Minute 4 goes into 1 and we *have* to be in an ending diagonal to support the bullish case. If we go below 1033-1035, then the trendlines for the ending diagonal become an expanding ED (which I don't buy).

So, in my opinion, a break of 1033 means that the bullish case is done and we are in Primary Wave 2

.... Now wait a minute, I said I don't buy the P2 done count because it requires an expanding Ending Diagonal. So why would I go back to that if we break 1033, which means an expanding Ending Diagonal. What gives? Isn't an expanding Ending Diagonal an expanding Ending Diagonal?

**NO** !!

I do not like expanding Ending Diagonals. I think they are, for the most part, red herrings. I think, 9 times out of 10, when something is labeled as an "expanding ending diagonal" it is usually proven incorrect by later price action.

But if there really are two count options with expanding ending diagonals, then I would believe the one at a smaller degree first. (e.g. I would believe the eED at the subminuette degree vs. the eED at the Minute degree).

This is because of what an expanding ED means. It refers to a fight between bulls and bears that is so manic / frantic that instead of coiling up like a spring, which it usually does in a normal (converging) ending diagonal, it is more like a tug of war with bigger and bigger tugs by both sides, where the deviation grows, not shrinks --- see growing oscillating signals at the bottom of this post Why e is the Coolest Number.

That type of action can be kept up for only a short time (maybe a few minutes), but certainly not for a few weeks except under the *rarest* of circumstances.

So given the choice between two counts with expanding ending diagonals, I absolutely find the one with the shorter and smaller expanding ending diagonal to be more believable.


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 ... wow. Where to begin?. Both XLF and BKX are necessary barometers when you are trying to gauge the heath of financials and banking. And guess what ... they ain't healthy.

XLF never reached 38% retrace (it did go past the required minimum of 23.6%). It is sporting some serious negative divergence on the RSI. It is in danger of breaking the support of its MACD wedge. But it has already broken down from it's large P2 price wedge! On top of the it is has now failed to recapture the support line on a retest. Support has now turned into resistance. Plus, I count P2 as being done for financials. I count a viable 5-wave run for the final C wave.

BKX is hitting its head on major resistance, with major RSI divergence. I can also count a complete move there too.

Goldman-Sucks, errr.. Sachs. This is **very** interesting. GS is undoubtedly the leader of financials. However that does not mean that XLF and BKX can't have completed P2 if GS has not. GS is one of the economic linchpins. And I believe the SPX and GS will end their P2s at the same time, but the weaker "cannon fodder" issues such as BAC and C and the weaker indices such as BKX and XLF will show weakness before the last financial behemoth.

GS has a P2 triple zigzag by my count. And I count a complete 1-2-3-4 with a 5 up yet to come for the final C wave. However, what is very interesting is that the final C wave is also taking the shape of a wedge. Much like SPX, 4 does not go into 1, so it is not technically an ED, but the fact that it is taking the shape of a wedge at the end of a very long wedge whose apex is in the middle of a huge resistance zone is not good for the bulls who are bullish on the biggest dealer of BS.

BAC "Death Wedge" is still in play. Apex right in the middle of huge long term resistance. But more importantly, BAC broke sideways out of the Wedge of Death support line and has *NOT* made a higher high. I believe that BAC is now undergoing the "WEDGIE OF DEATH" (copyright 2009 binve enterprises) ... (jk) :)

International Equities

As I was discussing a few weeks ago (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.

Hong Kong Hang Seng (HSI) was looking particularly strong up until last month. It broke sideways through its wedge support. It has since made higher highs, *but* the wedge support line has now become resistance. I count P2 as being complete for HSI. Keep in mind that the Hang Seng is heavily weighted in both Chinese issues AND financial issues. This is a very important barometer for speculative money.

South Korea Seoul Composite (KOSPI) has a very interesting chart. It broke through its first major resistance layer at 62% retrace. It is by far the strongest of the major Asian indices. However, it did overthrow its wedge near its apex (a very common finishing move) and it doing so closed the breakdown gap from July 2008. Since then it reversed sharply and through the bottom support line of the wedge. On top of that, even the strong end move sported negative divergence. It will be interesting to see where this one winds up in a month.

The Shanghai Composite (SSEC). Wow, what a train wreck. Read the notes on the chart, they tell the story

Here is a chart of the Tokyo NIKKEI. This is not the 2 year chart that I have been showing, but is a longer term chart that I was messing around with last month. It is worth showing here though. From Long Term Count of NIKKEI:

A friend and I were discussing the NIKKEI a few weeks ago, and he was theorizing that the NIKKEI had bottomed (or will soon) and might not drop as much as the rest of the world markets during the next few years. So I decided to take a look .... I am not so convinced.

Note: This count is not compliant with my EWP numbering scheme. I just assumed the 1990 peak as a top, and started counting the major and minor waves down from there (I am not trying to place the SuperCycle/Cycle/Primary Degree Waves for the NIKKEI in the proper place, just counting waves from the 1990 peak, assuming it is the end of a long impulse up). The wave structure looks *very* corrective, and per my counts does not look complete. It looks like a very large double-three in the making with only A-B-C-X-(1-2-3-4)of A done so far, with (5) of A-B-C to go.

This count was done to see if the NIKKEI might be a good place to hide during the next few years, and this count suggests that is not a good assumption. Take this for what it's worth.

The German DAX is also sporting a wedge within a wedge. Things are coming to a head here too. What is interesting though is that the structure of the rally for the DAX is *very* similar to that of the SPX. If we proceed on that assumption, then the DAX should also have 1 more wave up to complete Wave 2 (which would put it very close to 50% retracement)

The NDX is a proxy for the leadership of the US indices. This wedge is also quickly converging. I also count one more wave up for the NDX.

The Bombay Stock Exchange (BSE/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. Even more than that, the retest move itself is forming another wedge, which looks like it has run out. 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 (Thoughts on the US Dollar, Analysis of the USDX Long Term, Follow up on the Gold Blog):

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.

However, given all of that, there is likely to still be inverse correlation between the Dollar and Equities for the first part of Primary 3. When the next crisis occurs and the Fed and Treasury come up with some more "creative tactics" (such as Quantitative Easing) to deal with the problem, that is when we should look for a confidence crisis in the dollar alongside falling equity prices

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. The breakdown comes and goes, as can be seen in the chart below. But 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.

Oil is another interesting asset class. I am a very long term commodities bull. But on the short term, when I look at the oil chart, I see weakness. There have been a number of trendline support breaks with failed retests. The trader in me sees lower oil price soon. I think it will retest the 200 day MA in the not-too-distant future. Below that is a strong support level at $50 and *major* support at $35-$40. If it gets down that low, I am loading up (again) in my long term account.


All sentiment indicators are still reading highly bullish - CHECK! Read the notes on the charts, absolutely ridiculous.

VIX: This medium count is interesting in and of itself, including the down sloping trendline which was resistance for several months and is now acting like support.

But what is far more interesting is an examination of the VIX since 1994. A very important central line of action can be observed (VIX of 23). Look at the important peak reversals denoted by the blue arrows. Also look at the massive fight that takes place about this central line between 1997-2003 and again 2007-2008.

What is *very* interesting is that this correction has bottomed smack dab on that line. Coincidence? ... Not in my book.


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