Last weekend, I proposed a 5th wave decline for the SPX with first support at 1738 following a break of 1760 which we achieved on Monday. So far so good as the low for the decline was 1737.92 LOL. That was the easy part. Since then, we have witnessed a strong impulsive rally from support immediately into an important resistance area which was NOT confirmed by higher bond yields or stronger US$. I trade based on price evidence and at the moment we have conflicting signals from the various equity market indices as to the nature of the decline (impulsive or corrective). The SPX and DJIA look like clear impulsive declines, while the higher beta indices (NDX and Russell 2000) appear to be corrective zigzags in 3 waves. Hence, the near term dilemma for bulls and bears. It’s a crap-shoot right here and at these times it is often best to wait for more price information. If we turn down immediately from these levels impulsively, then the bears pick up the ball, otherwise, the bulls have a chance to push to new highs. My preferred count is that we are in wave (c) of an expanded flat for SPX and NDX while the DJIA and RUT appear to be ending double zigzag rallies off the recent lows with new lows to come. The bulls have not left the building…
SPX – With the 5 wave impulsive decline for wave 1 / A complete at 1738, we could then expect a 3 wave corrective counter-trend rally for wave 2 / B terminating at the 0.50 – 0.618 Fib retracement. The rally from the 1738 lows is impulsive and is either ALL of wave (c) of 2 expanded flat correction (black preferred count) or wave (a) of a potential zigzag correction (red count) with wave (b) and (c) of 2 to come. Alternatively, the bull market is back (green) and the 5 wave decline completed wave C of a flat correction and we head directly to new highs (lower probability but the potential cannot be ignored).
The rally has now entered my proposed sell zone in the 1798 – 1810 area with a cluster of measured resistance levels including: previous 4th wave extreme (1798), 0.618 Fib retracement (1808) and 50 day sma (1809). What matters now is the nature of any near term decline whether in 5 waves (impulsive) or 3 (corrective). The market’s reaction to this resistance zone will provide additional clues as to the bigger picture path forward. I prefer the expanded flat wave (c) option due to the overlapping and choppy nature of Wednesday’s marginal new low (not a clear 5 wave decline) and the expansiveness of the resulting impulsive rally. This count implies a decline in 5 waves immediately below 1738 for either wave C of (4) or 3 of (1). This strong rally is also consistent with bear market counter-trend moves.
The daily SPX chart below highlights the strength of the rally after catching trendline support at 1738. A strong close above the 50 sma will call into question the bearish count. That’s why we need to focus on the near term count and in particular, the structure of the initial decline from this resistance zone.
The DJIA also completed a 5 wave impulsive decline into Wednesday’s lows, but unlike the SPX, there appears to be no (b) wave low. The rally has been far more muted as it has only retraced 0.382 of its decline. The DJIA has been lagging for some time, and this has not changed, which tells me the nature of the market has not changed. I expect this counter-trend rally to be short lived as DJIA weakness continues. Once again, the nature and structure of the next near term decline will provide important clues going forward. I do not expect the DJIA to make new highs.
The higher beta indices such as the NDX and Russell 2000 do not look as impulsive on the recent decline but instead appear to have completed double zigzag declines. In particular, the NDX has outperformed all other indices while the Russell 2000 has lagged. In a strong advance towards new highs, I would expect the Russell 2000 to lead the advance and risk-on trade, not lag.
The NDX “looks” like a clear 5-3-5 zigzag corrective decline (green bullish count). However, it can also be counted as a bearish impulsive decline (black count) followed by an expanded flat correction. This rally “feels” like the C wave of an expanded flat so that remains my preferred option. This count is invalidated at new highs.
Nasdaq 100 15m
As mentioned previously, the Russell 2000 has declined in 2 impulsive waves completing either an A-B-C correction for wave (4) (green bullish count) OR a series of nested declines defined by [i],[ii], (i), (ii)… The rally from the lows has been weak and not particularly impulsive. Any reversal lower from these levels would be very bearish. The bearish (black) count is invalidated above 1145 and would “lock-in” a 3 wave decline suggesting new highs ahead. Trade back below 1082 will likely result in an accelerated selloff… we have clear points of ruin
Russell 2000 10m
To the FX markets…
The DXI is compressing for a very fast break out of the current range. With weekly BB’s tightening and ATR at 5 year lows, pressure is building for a resolution. 79.00 remains critical support for the US$ bulls and a break of this level targets 75 and below. Technically, the US$ has failed to make new swing highs (failed to confirm the Euro’s new lows), coupled with negative RSI divergence and potential MACD zero line reversal. The US$ is at a critical juncture with Yellen making her first public appearance as Fed Chairperson, 3 weeks of heavy US debt issuance/funding and another debt ceiling debate on deck. The timing is about right and the setup is there… this could be an exciting week.
The EUR/USD declined below 1.3507 as expected and the subsequent rally appears corrective. However, the EUR/USD is setup for a 3rd wave move in either direction. This coincides with the DXI at critical levels. I am looking to trade a break of either long above the 1.3737 prior swing high (red line) or short below 1.3477 (blue line) targeting a nested 3rd wave move.
The potential weak US$ theme would also translate into a 3rd wave decline in USD/JPY associated with the carry trade unwind. The near term count shows a complete leading diagonal decline for wave 1 and corrective counter-trend rally under way. While the potential exists for a deeper counter-trend rally, it is not required.
Consistent with the potential weak US$ theme are the precious metals which appear to be forming a strong base awaiting a breakout. Silver in particular has remained in a narrow trading range between $18.72 and $20.67. A close outside of this range will likely lead to a follow through acceleration in that direction.
In summary, the equity bulls have staged a strong comeback but that was not unexpected. On balance of probabilities however, I do not believe that this is the start of the next bull wave to new highs. The US$ risk here is too great to ignore and I expect the equity markets will follow accordingly. This is not a time for complacency as I expect greater volatility ahead for these markets.
I have attached the latest Liquidity Schedule for the remainder of February. This has changed dramatically. Treasury has announced an additional $50 bln in funding requirements this week culminating in a $112 bln liquidity drain for the remainder of February which will likely be negative for risk assets.
Updated February Liquidity Schedule
Trade safe 🙂