Rising Wedge Spells Trouble

The rising wedge pattern has become fairly obvious. It points to a weakening uptrend that is in danger of imminent reversal. This is not the time to hang around for a sell signal. By the time the sell signal comes, gains will become losses. This is not the time to be buying breakouts. They will likely fail. Better to be safe than sorry. Better to buy back in at higher prices than to take a big loss.

However, we need to know what would invalidate the wedge pattern. If the SP500 exceeds 1147.91, then we know that the ending diagonal is extending with one more down up sequence since the length of wave (v) of [c] would be too long. With the 61.8% retracement level at 1140, it is not likely to occur, but the ending diagonal could extend to as high as 1177 without invalidating the pattern. That final number can only be determined after the next swing high and swing low are generated. Unless volume and breadth begin to support the uptrend, I am hesitant to wait that long.

Closer By The Day

We are now probably at most one to three weeks away from a top in the stock markets. As we approach the coming reversal, dramatic moves in a few stocks may make the rally appear more durable than it really is. For every stock like PCLN there are many stocks that are lanquishing. The Bullish Percent Index for the Nasdaq Composite stands at 50.99 today. The Nasdaq 100 to SP500 ratio is well below its June high with lagging momentum, as is the Russell 2000 to SP500 ratio. These are not indications of a strong market.

So far, everything about this rally smacks of a B wave. Some say it's a 2nd wave, but that view is premature. Although I think the rally has more to go in time, I don't think it has to much more to go in price. Any new high next week would be sufficient to complete the wave count as a zigzag with an ending diagonal, though it probably won't be that easy. The market will probably tread sideways a bit longer, but the point is that the risk of a sharp downside reversal is rising.

I will be looking for the SP500 to make it to 1140, the Qs to 47.68, IBM to attempt a breakout and GOOG to make it to 520 to 540, among other clues, to tell me that it is time to bail on this rally. If I'm wrong, I am really not worried. I'd rather be wrong than get caught on the wrong side of wave C down. Just because you are a trend follower doesn't mean you have to wait around for the obvious.

Today I sold NFLX for a gain of 14% after buying it near the 38.2% retracement of its 2010 rally. I will be looking to sell, not buy, over the next two weeks as stocks and indexes approach expected targets.

Is The Rally Over?

While today's selling is a cause for concern I do not believe the rally is over. The main reason is that we have 5 waves up from the 7/1 low. The SP500 did not exceed its 6/21 high, so it is unlikely that the 5 wave up move is wave c of an ending diagonal triangle in an upward flat correction. Thus, we should expect another new rally high. As long as the current downmove holds above 1088 or so, all of the sideways movement since 7/27 could be considered as part of a small degree x wave in the still unfolding double zigzag upward correction. This would lead to a higher target for the rally. Either way, whether there is one or two more upward pushes to complete the rally, it is premature to call the rally over at this point. Even so, I would prefer to see the SP500 hold above 1100 until it can move higher.

Update On GOOG

The top chart of GOOG is from July 2 where I showed that it had bottomed in 5 waves. The bottom chart is the current picture and shows GOOG beginning wave C up. Based on a measured move in time and price, I expect wave C to terminate around 550 by next Friday or thereabouts.

GOOG has been one of the weaker Nasdaq 100 stocks. It didn't even make a new high in April with most other stocks. So, it wouldn't be surprising that it might rollover ahead of the rest of the market.

But when we see high profile stocks like GOOG and IBM hit their targets, it will be time to think about exiting other long positions as the top is probably not far away. I suspect AAPL will only be able to retest its June high as well. Until we some significant change in the character of the market, we have to believe the story these stocks are telling.

As a side note, the QLD trade that I entered on 7/16 at 54.50 on the first pullback off of the 7/1 low is now up 11.5%. I have an order to sell in at 65.50, but I am beginning to think it may not make it given the weak uptrend. I may be looking to sell into the next surge in the indexes or when the SP500 hits 1140 should either occur. Next week will be key in this regard.

What's Going On With Oil?

Oil has moved up nicely since its late May low, but is this just a countertrend rally ahead of a more significant decline, the beginning of a move to much higher prices or neither? My strong suspicion is the latter of the three. Fundamental analysts put the upper end of oil's fair value range around $85. Many elliott wave technicians are calling for a strong wave c of B decline to below $50 before oil can move higher. The seasonal pattern for oil shows a top coming mid-September.

My take on the picture is that unless oil can punch through the median line and channel line resistance as well as the May high by late August well ahead of an expected top in September, oil is probably in the X wave of a combination flat correction. The low in May was probably wave W and wave Y, either a triangle or a zigzag is yet to come. At worst oil should most likely just retest the May low this fall as opposed to much lower levels.

Based on this view traders may want to consider taking profits at an approach to or retest of the May high and wait for a new long entry on a retest of the May low.

Light Volume Breakout

The rally extended today above the July high. This is an important outcome because it greatly increases the likelihood that the rally will continue throughout the month of August as previously proposed. It was disappointing that volume was light, but at the same time the McClellan Summation Indexes have moved solidly above the critical level that contained previous declines during the first leg up of the rally off of the March 2009 low.

Now there are clearly 5 waves up from the July 1 low, which means we have at least one more down up sequence to finish the rally. The last leg up for the Qs was 2.86 pts vs 4.04 pts for the first leg off of the 7/1 low. By similarity, we can project the target for the next 3 wave sequence at (2.86/4.04)*4.95+45.07 = 48.57. The 61.8% extension of the January range is 49.12 and the May 13 high was 48.79. I believe this range from 48.57 to 49.12 will be the most probable target for wave B up to terminate.

The low volume and the wave structure all point to a B wave for now. This would only change if we see a substantial range expansion on above average volume. I doubt we will. At the moment the B wave interpretation is the likely path with wave C down to come in September.

I will sit tight and ride the index positions for as much as I can during August with my fingers crossed that something doesn't derail the rally prematurely. The real action will be the fall selloff and the end of year rally. That is where the money will be made this year in my opinion.

Markets Vs Economy

There is much talk in the media and blogs of late about the current slowing in economic growth. There is little doubt that growth has slowed. The only question is by how much. Some are claiming that the government's numbers greatly overstate the economic activity and that we are already in another recession, while others only seem to think that another recession is imminent.

The problem with much of this talk is the implicit conclusion that the stock market must necessarily fall further, and possibly significantly, if we are in or headed into another recession. This is an erroneous conclusion, but it is being used to justify extreme predictions of stock market collapse in the year ahead. This is not to say that such a collapse can't or won't occur, but basing it on economic reports is not a valid approach to market forecasting.

In 1990, the SP500 fell around 20% and the decline ended in October 1990. The 1990-1991 recession officially ended in March of 1991, 5 months later. Presently, the SP500 has fallen 17.1% from its April peak, and if it bottoms this fall around 950 as I suspect, the total decline will be around 22%, which is about the same as that of 1990.

Please don't misunderstand what I am saying here. I am not trying to say that we are looking forward to a stock market advance like the 1990s. Certainly we are not. What I am saying is that the present slowing in economic activity has already been discounted by the stock market. Any additional stock market decline into the fall will probably mean that economic growth will continue to slow into early 2011 before a renewed resurgence in the latter half of 2011 and into 2012.

When technical market analysts of whatever school start using economic reports to support their analyses and forecasts, their work is suspect. If we have learned anything from the last 100 years from market analysis, it is that the market is a leading indicator. Therefore, any economic forecast that is not at least six months to a year ahead of market forecasts is of little value to market participants.

Furthermore, do not discount local anecdotal evidence in your understanding of the state of the economy. As bad as things are in many areas, there has been an increase in economic activity over the last year. In fact, a colleague of mine, a civil engineer who does land and development planning, presently has the most work he has had in over three years. He may have to hire more help to stay on top of all of the work. Land and development planning is the first step in both residential and commercial new construction work.

In conclusion, I am still expecting a fall selloff and we will probably see additional slowing of economic activity over the next six months, but it will most likely be followed by a resumption of the stock market uptrend and greater economic activity in 2011 and 2012. At that point, it will be time to be prepared for a more significant decline in both the stock market and the economy.