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When the market swooned in mid-May, a couple of important characteristics seemed to have changed. The consistency of the drop which extended over 11 days was one important break with the recent past. Whereas previous pullbacks were generally slower and indecisive, the May swoon was sharp and impulsive. The market then began to rally 2 weeks ago off of an oversold condition – seemingly the perfect opportunity for the Bulls to go long for their typical bull rally. The market then tried to rally for 7 trading days, recovering almost 50 percent of the previous drop (in the S&P 500), and it appeared that, once again, it was time to don the rally hats for another market rescue followed by a rise to new multi-year highs.
Last weekend, the public and fund managers had two days to digest the in-progress rally and contemplate whether to go long (or longer). Anxious shorts late to the swoon also had some time to decide whether they wanted to continue with the spanking they were (once again) getting. But come Monday (June 5th), after a strong open, the market closed down. On Tuesday (June 6th), following a strong opening, the market closed down. On Wednesday (June 7th), following a strong opening, the market closed down. Do you see a pattern developing? Strong opens with weak closes tends to suggest a weakening market. This contrasts what traders have become used to the last 2 years - “flagpole rallies” - where the market opens strong, bases or corrects in the late morning and early afternoon, and finally rallies at about 2pm Wall Street time into the close. Below is a two month chart where each bar represents an hour of trading in the S&P 500 exchange traded fund (SPY). If the Mid-May swoon can be considered a Wave 1 down, the following 7 day rally can be considered a Wave 2 correction against the suspected down trend. This would be confirmed with a close below the 124.5 marker, where it is indicated that “Hope ends here.” I believe that this will be the point at which traders’ distant memories will kick in and remind them that the stock market can be both risky and financially devastating.
What Else Changed This Time? What has changed is the technical breakdown of formerly leading stock market sectors. Over the last 2 years, such technical breakdowns have been rare, but recently, the homebuilder sector has broken down completely. Three weeks ago with the homebuilder sector hovering near the neckline of a 2 year head and shoulder reversal, based on recent stock market experience, a sharp tradable rally would have been expected. Yet what actually occurred was a technical breakdown instead. As it turned out, contrary to recent history, instead of buying the pullback, the profitable trade would have been to sell into the weakness. I think that this turn of events in the homebuilders is likely to portend similar happenings in other sectors, stocks, and stock market indices. Something appears to have changed this May in the stock market.
More (Potential) Signs of Confirmation that Something Has Changed Many indices and stock groups sit near support levels where a break may result in the correct trade of selling into weakness. For example, consider the capital consumer product stocks featured last week. All of last week’s featured charts have well-defined support levels. If these are broken, it will add another strong piece of evidence that the character of the stock market has changed and the correct trade will be to sell into weakness. Similarly, as of Wednesday evening, the transportation index (and ETF) sits near a critical support level, which is easily highlighted by the point-and-figure chart. A “sell” signal would be generated if the transport ETF trades at 81 or less.
EW Failed Pattern Revisited In early January, a case was presented for a dramatic reversal of the mid and small cap stock market indices that was based on a terminal diagonal pattern in Elliott Wave terms. (See long term weekly chart, below). At that time (as was pointed out) the pattern had not yet been validated, and therefore could not be used as a basis for trading. Since January, the proposed pattern failed to completely materialize. It became invalid when the 5th wave extended, thereby making proposed Wave 3 the shortest of the impulsive waves. (It invalidated the pattern because according to Elliott Wave, Wave 3 can never be the shortest wave.). Although the formerly proposed diagonal triangle failed, the two trendlines that defined the pattern are still technically important. The green line defining the higher highs has been broken to the upside earlier this spring, and then it failed as support. Recently on Monday the green line has acted as resistance. The blue trendline of lower highs is still of technical importance. The trendline, which began almost 2 years ago, has been touched 3 times. A breach of the blue trendline will be technically important and is likely to signal the dramatic reversal of the Russell 200 index back to the low 500’s.
Today’s Market Today’s market opened neutral, headed down and at about mid day, proceeded to head higher. Bearish minded folks selling into apparent weakness got burned, at least on a daily basis. Below is an update of last night’s chart of the S&P 500 ETF with my annotations. Each bar equals one hour of trading action.
It would have been more accurate to note that “hope ends with a close below here” (below 124.5). Following an apparent break of support to the downside, the major indices scored a decisive one-half day rally thereby resulting in a market that was little changed for the day. The daily candlestick chart, which illustrates a strong hammer today, seems to suggest a bullish reversal of the previous three-day downtrend. Note that the hammer is confirmed with volume of well over 3 billion shares traded. I don’t have time to check my facts, but today may have been the highest volume of shares traded on the NYSE ever – 3.53 billion shares in one day! All of the major indices have put out a similar hammer pattern to what’s illustrated below.
My feeling is still that this is a compelling market to watch; but not one for large commitments. And the market, with its extreme high volume has become even more compelling. Here’s why. With the textbook hammer setup, which occurred right at short term support in the S&P 500, we are at a time and place where buying stocks has traditionally produced a sharp and profitable rally. In short, based on 4 years of market experience, it is time for Pavlov’s Bull Dogs to come and buy the market. With a 4 year history book at their side, this is a short term “no brainer.” However, if we do not get our rally off of the hammer over the next few days, and the market turns down there will no longer be a reason to buy. Such a happening would mark the second time in less than a month that the swing trading crowd went to the trough for short term profits and came up with only a loss for their efforts. Then it could be said (with certainty) that something has changed in the market thereby flipping the correct trade from buying into weakness to selling into weakness. Check for yourself, but I suspect that today’s action will qualify for an Investors Business Daily initial rally day. (It’s important to check for yourself!). If this is so, then only a “follow through” day will be needed for their green light to buy. The market is likely to be on an important turning point. The high volume referenced above was driven by HUGE trading volume in ETFs. The S&P, Nasdaq 100, and Dow Jones Industrial ETFs traded more 3 times the average daily volume! At the minimum, this will provide fodder for stock market conspiracy theorists perhaps suggesting that to prop the market, manipulators were on the buy side of the equations today. Then who was on the sell side? There is a tendency for technicians to attempt to make grandiose calls to try to set themselves apart from the crowd. The following remarks are therefore prefaced as not a grandiose prediction. But with today’s action resulting in a strong technical signal to buy the market, a decisive high volume reversal tomorrow to the downside would eliminate a lot of hope from the market, and add some serious fear. The selling could gain momentum on its side to a point where the market’s historically high valuations will matter. It’s only one day, but given the high volume today and the closeness of key short term technical levels, tomorrow is an important day. Similar action was exhibited by both stocks, commodity stocks, precious metals stocks, and oil stocks. All four are running on the same playing field in the same direction and this is reason to be skeptical of any of these. The dollar put in a bullish day, as did bonds. Feel free to let me know what you are seeing if you wish. Have a great evening. Martin Goldberg
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