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Capsule Short-term indicators have turned negative and a decline looks eminent. This decline should be part of a medium-term bottoming process. This may or may not involve a modest new low but once complete a solid medium-term bear market rally should unfold. The bonds remain on a sell signal for both the short and medium-term The XAU remains in a short-term consolidation/correction. Once the correction is complete, and it may be close, the bullish medium and long-term pattern should reassert itself, and a move above the mid December peak is the minimum expectation. Elliott Wave and FibonacciIn the January 8 report I talked about the idea that the rally from December 21 could be viewed as a “d” wave of a diagonal triangle from the September 1 peak. The subsequent rally the past two weeks has moved the S&P slightly above the January 5 peak. This is very close to a 50% retracement of the decline from November 6 to December 21 and about as far as a “d” or fourth wave should travel in relation to a third wave. Thus much further strength would likely invalidate this count. This would still leave us with a couple of possibilities regarding the post September 1 decline. The first and most obvious is that the decline is only the “a” wave of a larger a-b-c and the post December 21 advance part of a large “b” wave. It is also possible that the rally from December 21 is a “b” wave but only related to the Post November 6 decline. A move much above the peak seen on Friday would leave one of the above two counts in the forefront and would also indicate higher prices at least on a near-term basis. So, where does that leave the post September 1 decline in relation to the March peak?. In mid December I talked about the possibility that the orthodox peak of the post 1998 wave 5 advance was in fact seen at the September 1 peak and not on March 24. Under that count the March 24 peak was a “b” wave of a larger “d” wave triangle from January that culminated at the May low. At this point I am still operating with the idea that March 24 was in fact the orthodox peak of wave 5 from 1987. However, if that is the case then the decline from September 1 has to either be a second three or a “c” wave. If it is a “c” wave then it is a diagonal triangle and as discussed above it is very difficult to count the pattern from September 1 as a completed diagonal triangle. It is not impossible though as we can count the December 11 to December 21 decline as wave “e” complete with a throw over of the lower trend line. The problem with this count is the fact that this decline can be very easily counted as a five on the daily chart and that fits in netter with the idea that it was a “c” wave from November 6 and not an “e” wave. This is obviously not a lot of help as there are still a number of possible counts. However, the most important point to keep in mind at least on a longer-term basis is that the rally from December 21 is not impulsive so in any case it need be viewed as a corrective advance no matter how far it does carry. The bottom line is that it is possible to count the post September 1 decline as a completed diagonal triangle. As such the rally from December 21 could be in the early stages of correcting the entire post March decline. However, it is much more likely that the rally is directly related to either the November 6 or September 1 decline. At the January 2000 peak the DJIA can be counted as having completed a five-wave advance from the October 1998 low and as such completing the entire pattern from October (December) 1987. The decline into the October 18 low from the September peak is a five. That five is either the first wave of a much larger five-wave pattern or a “c” wave from last January. The rally from October 18 to November 6 can be counted as a five. While coming close the DJIA has still not moved into the area of the .618 retracement of the October 18-November 6 advance. On January 4 the DJIA did move slightly above the November 6 peak. This leaves us with one of two possible counts following the November 6 peak. The first is that the rally to November 6 was an “a” wave, the pattern up into the January 3 low a “b” wave triangle and the move up into January 4 a “c” wave completing a correction of the decline from September 1 to October 18. The latter is that the rally into November 6 was the first wave of a larger pattern. The decline into November 30 wave “a”, the rally into January 4 a “b” wave of an irregular and the decline currently part of a larger “c” wave. The former is a very bearish count while the latter has bullish implications and following a break below the November 30 low a sharp rally back above the November 6 peak should unfold. Whether this rally is we get it can make it to new highs is not clear as it may still be counted as a “c” wave of a more complex “b” wave from October 18. Meanwhile, the DJIA has spent most of the time following the November 6 peak in a fairly tight range giving very few clues as to its intentions. For the time being we need to focus on support and resistance points but sooner or later the DJIA will tip its hand. The NASDAQ 100 is in a very similar position as the S&P. However in early January it did move below the December 21 low unlike the S&P and that did satisfy what I had been looking for to complete the pattern from September 1. As is the case with the S&P, the rally from early January is best approached as corrective and not the start of a new impulse wave to the upside. As is also the case with the S&P it is too early to tell whether the rally is correcting the entire decline from September, or from either the October 20 peak or the decline from just December 11. Since the rally exceeded the .618 retracement of the December 11 decline by a decent enough margin we have to assume that, at a minimum it is correcting the decline from October 20. this also suggests that the January low may well have completed the post September decline and that the current rally is likely the “a” wave of a larger pattern. The rally from January 8 on the S&P remains corrective on the daily and hourly chart. Fridays early rally may have completed the “c’ wave diagonal triangle discussed in Friday’s letter or it may have only completed wave “c” of that pattern. The S&P did hold right at initial support levels given Friday. A break of that low would confirm that the post January 8 rally and possibly the rally from December 21 was complete. Until that occurs we cannot rule out a shot above Friday’s high. There is not much to add on a short-term basis regarding the DJIA but we should be close to a resolution of the pattern and that could add to a resolution of the medium-term pattern as well. The NDX still shows a seven-wave or corrective pattern on the daily chart from January 8. I am still of the view that this rally is completing the rally from early January and is either a “c” wave or a second three. If the former it cannot be counted as complete so a move back above the high of last Friday would be needed. If the latter then it may be counted as complete now. Watch Friday’s low which like the S&P was quite close to important short-term support. Support S&P; 1335-1336, 1323-1325, 1305-1308, DJIA; 10,500-10,510, 10,180-10,200, NDX; 2620-2625, 2585-2593. Resistance; S&P 1347-1348, 1357-1359, 1368-1370, DJIA; 10,6770-10,678, 10,810-10,822, NDX; 2700-2708, 2785-2795. Trend changes for the next two-week are as follows: January 22, January 26*, January 28*, February 2. *denotes important. Bonds If indeed the January 3 rally completed all of the post January 2000 rally then wave “c” or 3 from the 1998 peak is in progress. If that is the case then we have to see the bonds decline in a five-wave pattern. So far the decline in bonds from the January 3 peak in bonds is a clear three-wave pattern on the daily chart. If it is the beginning of wave “c” or 3 we will know soon enough as the most likely scenario would be that the bonds are about to enter a third of a third and an acceleration to the downside will be directly ahead. A failure to do so would most likely imply that the second or “b” wave correction from January 2000 is not complete, which would allow for a modest new high above the January 3 peak. The daily range oscillators are neutral but weak while the daily trend oscillators are negative. Short-term momentum is negative. The weekly range oscillators are headed lower from weak overbought levels and are slightly negative. The weekly trend oscillators have moved to neutral and are close to going negative. Medium-term momentum is weak and near a confirming sell signal. Sentiment measures remain negative with the latest reading from Market Vane at 72% bulls and Consensus Inc. at 54%. Support: 102 17/32 +/- 13/32, 101 17/32 +/- 16/32. Resistance; 104 21/32, 105 07/32 +/- 8/32. Please note that the above support resistance calculations are based on a constant bond chart and currently this is running about 4/32 below the nearby futures (March). Short-term momentum remains negative and sentiment, in spite of the sharp drop in price from January 3 is still way too high. Medium-term momentum is close to turning negative and that could add pressure to the downside. I remain bearish both short and medium-term. XAU The rally from late October to mid December on the XAU can be counted as a five-wave pattern on both the daily and weekly chart. The decline from December 13 is corrective and I continue to view this decline as a second or “b” wave from October. Short-term momentum has corrected the gross overbought readings seen at the December peak while medium-term momentum is still very positive. Sentiment meanwhile remains positive with Market Vane reporting only 14% bulls on gold futures and Consensus Inc. at 40%. The correction from December may have further to go but looks to be close to complete. However, until the indicators turn positive, and they are not far from doing, I have to remain neutral. Medium and long-term I remain bullish. Support: 47.40, 46.00. Resistance: 49.87, 51.15-51.40. Indicator Review
The DJIA over the past two weeks has actually lost ground while the broad based NYSE Composite is barely positive. Over the same period the S&P is up over 3 percent. After several months of relative weakness this should not come as much of a surprise. I had been anticipating this for quite sometime and while it is still too early to tell whether this is more than a short-term development it does seem to be the beginning of a shift on a medium-term basis. Last week we also began to see other signs that support the idea that a shift back to technology stocks is underway. Breadth through most of the fourth quarter had been doing exceptionally well. This was also the case in other periods where “tech” was weak such as the rally in the DJIA in April of 1999. When “tech” had been strong breadth and the broader based averages such as the NYSE Composite tended to lag and in some periods actually declined. Breadth is still doing OK but last week there was a noticeable deterioration in the daily totals, especially on days that the NASDAQ was strong. Price/volume relationships have been OK but nothing exceptional and I would have to rate it as neutral. I am seeing similar behavior from the high/low statistics. The daily new highs peaked in late December and in spite of higher prices in the averages last week, the number of new highs fell way below the late December and even the early January totals. The new lows remain quite low and are not much of a problem. The weekly new highs are painting the same picture as the daily new highs with last weeks total nearly half as much as what we saw in late December and early January. Granted last week was shortened by the holiday on Monday but we also saw a sharp drop in the new highs the prior week as well. The high/low indicators are mixed with one turning negative and the other still OK but the latter has reached overbought levels and is not far from a short-term sell signal. The Russell 2000 has had a fairly solid two weeks and in fact has done better than the S&P over that time span. However, towards the end of last week it too had begun to take a back seat to the NASDAQ averages and to a smaller degree the S&P. I am neutral short-term but see the potential for a bit more upside. The Medium-term is neutral but improving. The Value-line also had a nice run and in fact moved to new all time highs before slipping towards weeks end. I had been pointing out from time to time that the Value-line looked to need at least one more modest new high to complete its post 1998 pattern and with last weeks rally the minimum requirements are in place. I am neutral for both the short and medium-term but like the Russell, the medium-term is improving. However, my expectations are that on a relative strength basis these averages will begin to weaken and that could become quite dramatic. The NASDAQ Composite and the NDX have come to the forefront the past two weeks and have far and away been the place to be. I suspect that we are in the early stages of a medium-term shift in relative strength and expect that this area will come to the forefront. I am neutral on the short-term with the idea that a decline is close at hand. Medium-term I am neutral but with the idea that these averages are close to completing a bottom. The DJTA was hit fairly hard the past two weeks as another sector that had been strong throughout the last quarter has weakened in the face of strength in technology stocks. The short-term is neutral but looks lower. I am moving from bullish to neutral on the medium-term. The DJUA and UTY fell over 20% from their peaks in late December into their lows last week. They are very oversold short-term and could rally further. I remain neutral on the short-term. Medium-term the picture remains very negative and I see no indication that the decline is over. On the contrary, I fully expect to see the current lows broken once the short-term bounce concludes and the likelihood of a complete retracement of the 2000 rally is quite high. I am bearish both on a medium and long-term basis. The breadth oscillator has been moving lower since reaching very overbought readings in late December. In fact we have a confirmed negative divergence in place and a short-term sell signal. This indicator did, however, reach levels that are consistent with an initiation or thrust signal and this has to be viewed as a modestly positive indication for the medium-term. The volume oscillator has also turned down from overbought levels and it too has locked in negative divergences. Unlike the breadth oscillator it did not come close to a thrust signal and that does detract a bit from the positive signal from the breadth oscillator. The 3-day oscillator is weak and on a sell signal short-term. The McClellan oscillator is in the same position as the breadth oscillator and on a short-term sell signal. The 10-day and open 10-day Arms have finally moved down from their extreme oversold readings. The open 10-day Arms is slightly oversold while the 10-day is neutral. The five-day Arms is slightly overbought and the 21-day Arms is oversold and bullish. The daily range oscillators are neutral. The daily trend oscillators are negative on the DJIA and slightly positive on the S&P. The weekly breadth oscillators are slightly overbought. The weekly range oscillators are negative but very close to turning positive. The technical barometer has improved slightly on the inside position but remains on a sell signal for the outside position. The sentiment composite has improved but only slightly so and is low neutral The sentiment polls are mixed. Market Vane and Consensus Inc. remain very positive. Investors Intelligence has been over 50% bulls for 10 straight weeks with last weeks reading the highest since June of 1999. The percentage of bears is not as bad as it was a few weeks ago but is still very low and this indicator remains negative. The American Association of Individual Investors (AAII) has improved but has a long way to go before becoming even neutral let alone positive. NYSE members continue to be strong net buyers and this is the biggest positive for the market from a sentiment perspective on a medium-term basis. The insider sell/buy ratio has weakened but is still only neutral. The CBOE put to call ratio has moved down substantially with the 10-day moving average very close to where it was just prior to the November 6 peak. The OEX ratio is also very low and very negative. The Rydex ratio is close to where it was at the December 11 peak but has a little further to go before reaching the peak seen in early November. However, the levels of assets in both the Arktos and Ursa funds are at multi year low and this remains a huge negative. Summary and Conclusion The Elliott wave count shows both the DJIA and the S&P having finished large five-wave advances from the 1987 price low completing intermediate wave 3 of primary wave 3 from 1974. From purely a wave perspective it is indeed possible to count the structure from their respective peaks (January 2000 for the DJIA and March 2000 for the S&P) as complete. Does it seem likely that what we have seen so far is enough to quash the speculative excesses that have built up over the ensuing 13 plus years since the 1987 crash?. In a word, no. And in my view not even close yet. There are from a sentiment perspective some positive developments such as the continued low levels of bulls from both Consensus Inc and Market Vane. In addition, the rate of buying by NYSE members remains in my view the biggest positive development from a sentiment perspective that the market has going for it and clearly supports the idea that a rally of medium-term degree is close at hand. On the other hand the Investors Intelligence survey has for months shown a lot more bulls than bears and the recent readings are no exception. In December of 1994 for example the bearish percentage from Investors Intelligence was over 50% for nine straight weeks hitting a peak reading over 59%. And this was only after a sideways to flat market for about 10 months. Well from the peak last year the DJIA is down 7% and the S&P about 9 percent. That is a little bit weaker than what we saw in 1994 yet the best we saw from the bearish percentage was 37% while the average is much closer to 30%. That is a far cry from what we saw only 6 pears ago in spite of the fact that the decline in the averages was far worse. Funny how five years of almost straight up markets can do to investors expectations. This sure isn’t consistent with where this indicator has been at historically at important market lows. A similar picture can be gleaned from the American Association of Individual Investors (AAII) survey, which have consistently reported more bulls than bears. In spite of a near 50% drop in the NASDAQ averages and the worst year since 1981 for the S&P there is still a degree of complacency usually seen near market tops. The put to call ratio has dropped sharply as the often-wrong options traders have once again turned bullish far too quickly. The Rydex ratio is close to levels seen at the last important top in early November and is right near levels seen in mid December. In addition, the level of assets in the bear funds remains at multi year lows, indicating a lack of bearish views. On a short-term basis the technical backdrop has weakened substantially. There are a number of divergences that have now been confirmed coming from a variety of indicators. The short-term sentiment backdrop has weakened and the key indicators are close to where they were at the last short-term top. This along with the wave structure has combined to turn the short-term picture negative and the sell signal issued last Thursday night remains in place. Medium-term I believe that the market is in the process of completing a bottom that once finished will set the stage for a solid bear market rally. The short-term decline I see ahead should be part of that process. Whether it takes the S&P and the NASDAQ averages to new lows is hard to say. I think there is a good case that, on the S&P and the NASDAQ those lows are in, but a marginal new low would not surprise me either. In fact that may be what is needed to shake out the complacency that has built up. Long-term I remain bearish and view the coming rally as a bear market affair. If we can correct the sentiment backdrop this rally could be quite good. However, if the sentiment does not improve much this will likely inhibit the rally keeping it from its full potential price wise. We are holding a short position in the QQQ’s from an average of 65 5/8. They closed Friday and 66 5/16. Keep your stop at 70 ¼. ¼. Make sure to call the intra day hotline for any possible changes. Stock index futures traders are flat. Stand aside for the morning. Rydex switchers are holding a 20% Ursa and 40% Precious Metals position. Make sure to call the Noon Pacific hotline for any changes. The chart below shows the two
wave counts on the DJIA as discussed in the Elliott Wave section.
After
10 months of sideways to down coupled with a 50% loss in the NASDAQ the percent
of bears from Investors Intelligence is closer to levels seen at important
tops. Compare that to 1994 where we saw a huge number of bears, which reached
levels consistent with important bottoms. The
assets in both Ursa and Arktos are at levels consistent with tops not bottoms.
This is just another sign of how much complacency there still is. This needs to
improve dramatically before a sustainable rally can get underway.
The
10-day moving average of the CBOE put to call ratio has moved down and is close
to levels seen at the November peak. This is consistent with other measures of
short-term sentiment. The
McClellan oscillator did reach levels in late December that could be viewed as
an initiation signal. However, since that peak it has failed twice to confirm
new highs in the S&P and has also broken a trend line completing a
short-term sell signal. Note that in both late October and early December it
traced out a similar pattern turning down prior to a peak in price.
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