Saturday, February 19, 2011

A Reluctant Bull Reality Check

In psychology the term reality testing is used to describe objective measures by which we distinguish what is occurring in our mind versus what is happening in the external world.  I think a reality check is in order here. I have put forth the view that his rally would last longer than expected and probably retest the old SP500 highs.  I have also been expecting some sort of correction prior to continuation of that advance based on elliott wave theories, cycles and sentiment.  However, we have passed the point at which any of the evidence supports the view that an intermediate term correction would reasonably be expected to occur.  While it is disappointing to have missed a substantial advance from the July 2010 low, that is in the past and is of no value going forward.  The question at this point is what happens from here and what do we do about it?

We can see from the above chart that nasdaq relative strength has been waning since mid-January.  While this divergence in strength usually precedes or coincides with market corrections, there were several such occurrences in 2010 that only led to minor pullbacks or consolidations.  So, I don't put much weight on this at the moment.

The PPO of the equity put/call ratio has worked off the extreme bullish sentiment that was seen in mid-December and is now neutral.  The fact that the market continued higher while this occurred is actually quite bullish.  Although investment advisors have become extremely bullish as has been widely reported, the investing public has not.  The percent of retail investors expecting another flash crash in the next six months has risen from 60% to 75% in recent weeks - maintaining an opposing sentiment to investment advisors.  So, overall the sentiment picture has moved to neutral.

Leading stocks like Aruba Networks are breaking out.  The action in ARUN yesterday does not appear to be an exhaustion gap or climax move.  It appears to be a third wave breakout.

CME is showing a very bullish (1), (2), 1, 2 elliott wave count that is not at all ambiguous.  This stock has been a leading/coincident indicator for the market.

The SP500 has pretty much moved through all strong resistance zones except the 1370 area.  If that level is surpassed there is nothing really to hold it back.  I show trendline breakout projections from 1574 to as high as 1867.  I suspect that instead of wave (5) of [C], the SP500 is in wave 3 of (3) of [C].  Since third waves are not constrained other than not being the shortest wave, there is no theoretical limit to how far it can go.  However, a typical 1.618 relationship to wave 1 gives 1476.  If wave [C] is 1.618 times wave [A] the target is 1906, and 1.618 times the decline from 2007 to 2009 gives a target of 2138.  So, we have a potential range of targets from 1370 to 2138.

The potential for a bullish advance in the Dollar that would coincide with a market correction appears to have been invalidated yesterday as well.  It seems that the bearish case is falling apart at the seams.  Most of the damage to the bearish case has happened in this past week.  As for me, I had been looking to take advantage of an expected correction for shorting opportunities.  These have not come to pass.  Also, I said that once the expected correction was over, I would not be shorting this market again until the cyclical bull market is over.  I believe the time for shorting is over, and traders should not waste any more time and money on that exercise, but concentrate on looking for long opportunities.

At this point traders who are not long the Qs or other indexes should wait for a pullback or small correction to find an entry point, but many stocks are setting up with bases and should be considered as primary candidates.  CME above is an example, but there are many others.


Ender2012 said...

Excellent synopsis and compelling go-forward plan. It's been so frustrating watching every tool and indicator fail under the pressure of QE1 and QE2. It seems like the only investors who benefited from the rally were those who never sold the collapse, don't know what an indicator is or simply put on the blinders and drank the POMO punch early. Maybe it's time to pinch my nose and go long, too.

Anonymous said...

Thanks for your comment. Whether it's POMO or bilateral time symmetry as Terry Laundry suggests I don't know, but Terry Laundry has been right on target lately. You might want to look at his recent charts for ideas to find entry points into a possible May intermediate top.