I have talked in recent posts about the likely reasons why the market has defied what liquidity analysis suggested should be the onset of a bear market by now. The most important of those appears to be an increase in speculative leverage – margin, that is – which only increases risk over time.
Now it’s time to use the tools of technical analysis to look at two things – one, where the stock market is probably headed, and two, over how long a period. This is an exercise I undertake every week in the Wall Street Examiner Market Update Pro.
On this chart, the market has broken through one set of trend resistance lines and has immediately run into another set of those lines.
But it’s not a done deal that the SPX will make a breakout or even a run at a full test of the January high.
The chart also shows 2 different momentum indicators measuring the speed of the move over periods of 17 trading sessions and 29 sessions. Those time frames are important because they are half the length of the nominal 6-7 week cycle (short term trend) and the nominal 13 week cycle (call that short term or intermediate). These half span indicators are best at showing when cycles are topping or bottoming.
The shorter indicator has reached a level where it has repeatedly peaked, leading to at least a short-term market pullback in each case.
The 29 day rate of change is ambiguous, but it shows that the market is not as strong over that time frame as it was in the initial stage of this rally. It’s not definitive, but I’ll take it as a yellow flag in the context of a market hitting trend resistance around 2850-60.
We also see the VIX, aka the “Fear Index,” plotted on an inverted scale to mirror the direction of the market, showing sentiment ready for a short term rollover.
Based on this chart, a breakout to new highs is far from a done deal. In the short run at least, a pullback is due.
For a longer term view let’s look at a cycle wave chart with a couple of long term cycle and momentum indicators. The perspective there is of a bull market that is topping out, but that may have a bit more to run.
First let’s get the two year cycle out of the way. It hasn’t been a factor in recent years. A shorter cycle, nominally 10-12 months from low to low, has been the dominant cycle for trading trends of 3-6 months. The indicators at the bottom of the chart show clearly that it is turning up.
Here’s what’s scary for bears. The last high for this cycle was at the end of January. Therefore, ideally the next high isn’t due until the end of November, and possibly as late as next January. That’s plenty of time to blow the roof off. It doesn’t guarantee that that will happen, but it suggests that time won’t be a constraint.
On the other hand, if the technical indicators for that cycle start to signal a rollover earlier than that it would suggest that the 4 year cycle is out of gas and in the process of rolling over.
The 4 year cycle is where the bears have a foothold. Its projected price channel (teal color, dashed line) is still trending higher. But the cycle indicators, including momentum, suggest that the cycle is in the process of topping out. The bad news for bears and good news for those who have ignored my warnings to get out of the market, is that those periods take many months, during which prices often continue to rise.
There are 3 Possible Scenarios. One Could Put Bears in Charge
The market is now challenging several long term upside channel projection lines.
In this context, there are 3 scenarios to watch for…
First scenario: The market could top out here, putting the bears in charge. A sharp drop in price accompanied by a quick drop in the 10-12 month cycle momentum indicator would be needed for that to be the case.
Second scenario: The market makes a minor new high but runs out of gas finally in the 2900-3000 range when it again hits trend resistance. We would look for signs of a top to develop there, possibly in October-November.
Third scenario: Although it’s least likely, the market could see a strong breakout through the January high, supported by surging 10-12 month cycle momentum and a resurgence in 4 year cycle indicators. A 4 year cycle high would then ideally be due in May of next year, and could be even later. This is the case that long term bulls are banking on and I’m betting against.
However, if I’m wrong about that and price and momentum do break out, then the way to play it would to be to buy calls on the SPY or calls on a basket of stocks when the setup presents itself. We’re not there, and I don’t think that we’ll get there, but I would keep this thought in my back pocket for future reference.
Meanwhile, if you are looking for other trading ideas, long, short, or market neutral, check out my special collapse to profit/collapse to protection report, or check out why Shah Gilani is “DONE WITH STOCKS” and how he’s making money anyways.