The Averages Discount Everything (except "Acts of God")
Technical Analysis of Stock Trends (Robert D. Edwards and John Magee)
Another Magic Act
Last Wednesday, the Fed confirmed the end of the stimulative QE program, citing vastly improved economic conditions. In reaction, the market marched us down to a different drumbeat, and echoes of Black Tuesday reverberated throughout the financial Twittersphere. But as I've always said, the market is a magician, a master in the art of misdirection.
Amidst the background of a snare drum roll, I gazed at the chart of the S&P 500 (SPX) and thereupon published chart 1 below. The preponderance of the evidence still portended a bullish outcome. Amazingly, the index managed to regain its footing on Thursday, as did all the major indices. In particular, the Nasdaq 100 (NDX) left behind a bullish trail (the Cup and Handle pattern in chart 2) that foreshadowed Friday's skyrocketing action.
Chart 1. Amidst Wednesday's ominous drum roll, the preponderance of the evidence still portended a bullish outcome. Last Friday, the SPX managed
to fully recoup its recent losses and should be well on its way to 2095. Along the way, a brief respite is to be expected upon reaching an interim target
Chart 2. The NDX left behind a bullish trail on Thursday in the form of a Cup and Handle that foreshadowed Friday's stampede through the
short-covering exit door. A brief respite is to be expected upon reaching an interim target of ~4210.
Exactly NOT Like 2011
In my opinion, the Philly Semiconductor Index (SOX) has been one of the most reliable forward-looking indicators of all. It has consistently shined a bright light on the U.S. stock market since the latter emanated from the summer 2011 rubble. Chart 1 below depicts the SOX/SPX relative-strength ratio index and the multi-month bullish base (i.e., the blue Head and Shoulders bottom) it traced out from mid 2012 through early 2013. The subsequent breakout unsurprisingly foreshadowed 2013's exceptionally strong performance, the consequences of which continue to permeate the pores of the 2014 stock market.
Chart 3. The SOX/SPX relative-strength ratio index formed a bullish base from mid 2012 through early 2013, ushering in an exceptionally strong bull
leg in the U.S. stock market. (This chart was published on October 29th).
Next, chart 4 below is an embodiment of the spirit of technical analysis and its inherent precursory powers. In February 2011, amidst the Japanese catastrophe, the SOX reversed course upon running into a brick wall in the form of the 2004-2007 triangle's b-d line. As the SOX declined, the stock market surprisingly kept rallying through June and much of July before the string finally snapped. It's precisely this multi-month bearish disparity, between the SOX on one hand and the major stock indices on the other, that precipitated the summer 2011 swoon!
Enter 2014. The year got off to a chaotic start with the SOX hardly budging. Having cleared the entire price zone occupied by the 2004-2007 triangle, the SOX briefly 'exhaled' to the tune of 7 percent in April on the heels of a whopping 12 percent gain during the first three months of 2014. The SOX would then bottom on April 15th while still up 4.2 percent for the year. In contrast, this tepid two-week pullback, which tested a prior resistance zone (i.e., top of triangle), was dwarfed by 8.7 percent and 10 percent pullbacks in the Nasdaq 100 and the Russell 2000, respectively. The Nasdaq 100 would then bottom on April 15th at a 5 percent deficit for the year. As for the Russell 2000, its bottom came a month later on May 15th at a 7 percent deficit for the year.
In short, the corrective action in the indices during the first few months of 2014 was largely unconfirmed by the SOX, almost inevitably setting the stage for the spring/summer rally. As well, the March-July 2011 rally leading up to the summer swoon was largely unconfirmed by the SOX. One could say the two periods are diametric opposites of each other, having the SOX as a common guiding light.
Chart 4. The SOX embarked on a breathtaking rally in early June 2012. The recent pullback is by far the most pronounced since the 2011 and 2012
corrections. (This chart was published on October 29th).
Based on the wave structure at hand, the SPX is expected to reach 2095 (chart 5), and possibly as high as 2138-2145 (chart 6). to complete wave 3. As for the Nasdaq Composite (COMPQ), its wave structure (chart 7) is implying a bullish assault at the all-time high set back almost 15 years ago. The chart also depicts two potential harmonic targets for wave 3, namely, ~4160 and ~5200. Both wave analyses were carried out using the Harmonic Elliott Wave (HEW) model, as opposed to the widespread classic model.
Upon the completion of their respective third waves (i.e., wave 3 in the SPX and wave 3 in the COMPQ), the indices appear to be suggesting imminent corrective action to ensue. We shall see.
Chart 5. The SPX is on its way to completing wave 3 of the 5-wave rally that began in early June 2012. This wave analysis suggests an upside target of
2095 to 2116. (This chart was published on October 19th).
Chart 6. The SPX's recent correction back-tested the harmonic Butterfly PRZ (1923-1849) that was reached in late 2013. An extreme resistance cluster
lies in the 2138-2145 price zone.
Chart 7. The COMPQ is implying an imminent move targeting the 15-year old all time-high to complete wave 3 of a 5-wave rally that began back in
The monthly charts of the COMPQ and the RUT both sport recognizable patterns with calculable upside objectives. Starting with the COMPQ, chart 8 depicts a harmonic Crab pattern foreshadowing an upside target of 7000-7600 (the potential end of the 5-wave run that began back in October 2002). As far as the RUT, chart 9 depicts a classic Right-Angled and Ascending Broadening formation whose upside objective is roughly 1400. That said, please note that none of this is ever an exact science.
Chart 8. COMPQ - A decisive move above 4673 would leave the harmonic Crab as the only viable option.
Chart 9. RUT - The Right-Angled and Ascending Broadening Formation foreshadows an upside target of 1370 to 1418.
Risk Appetite / Rally Confirmation
To sum it all up, chart 10 below depicts the QQQ/SPY relative-strength ratio index. Clearly, the QQQ has outperformed the SPY in recent weeks and has also managed to register yet another new high. In short, investors' appetite for risk is alive and well.
Finally, The Nasdaq Banking Index (BANK) has burst through the supply line that just a few weeks ago seemed insurmountable. Although the index is still well off its highs, it seems to be confirming, at least for the time being, the currently-unfolding bull leg in the stock market.
As they say, "don't fight BANK".
Chart 10. The QQQ/SPY relative-strength ratio continues to rise and make new highs. Investors' appetite for risk is evidenced by the QQQ's
outperformance relative to SPY.
Chart 11. BANK recently burst through the supply line that seemed insurmountable just a few weeks ago. "Don't fight Bank", they say. At least for the
time being, it's confirming the ongoing stock market rally.
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