While I do believe that the actual number on Friday is totally coincidental, the action over the last few days has provided some interesting technical clues to what might be developing in the market. Let me caveat here that I generally view the market as a chaotic environment and that any analysis tool has to be taken with a grain of salt. I'll also caveat that I'll be writing about some technical market detail without a lot of explanation, so forgive me now. From what I've learned, Technical Analysis (or any other analysis) is not an effective tool for predicting the future, however it can provide some insight for understanding what has happened in the past and what might be happening currently. Predicting the future can be fun, but is pretty dangerous for trying to make money. So let's dust of the Elliot Wave Theory and see what might be going on and have some fun in the process.
In my last post, I took a macro view of the economic and market cycles over the last 60 years and concluded that the SPX could see 600 without too much effort. Around that time (when the SPX closed at 821) I drew the following lines on the weekly chart to see how an Elliott Wave pattern might be forming up. Technicals hadn't been working for me in a while and I'm still reeling from the market's thrashing on sentimental reactions, but I felt it was a time to take a step back and look with a fresh perspective. Elliott Wave Theory is an analysis tool that posits that markets move in a series of patterned trends (impulse waves) and counter trends (corrective waves). A lot of the theory relies of Fibonacci numbers, which oddly enough do seem to play out in the market action and I drew out Fibonaccis on the charts in this post. There are some great resources out on the net and in popular Technical analysis literature on Elliott Wave Theory, so I'll leave it to the true experts for a full explanation of the theory. For Ellioticians, it looked like we had potentially put in a Wave 4 pivot the first week of the year based on weekly charts, although I was skeptical at the time before the big red bars started to show up. For the Wave 5 pattern, I simply used the Wave 1 line and tacked it on to the last pivot point, which coincidentally landed right on 600 as a price target and thus caught my interest since I had (dangerously) pinned that number into my memory after my last post.
So what does this mean for the shorter term picture, particularly after a huge up day like today? Today's action was quite impressive and it looks like we're in for a bit of a bear market rally for the next leg. If the pattern holds, we should quickly run up to 800 to 875 in the next few sessions. The CNBC Wonks have been talking bottoms pretty convincingly for a few days and I suspect that within a few days, optimism will start sweating out of the reporters. A couple days of this and everyone will be talking about the deal of a lifetime in the next bull market. I'm sure that someone will even posit that Warren Buffet's comment that the economy has "fallen off a cliff" is the seminal turning point of the bear market. Hell, even the President is recommending folks to buy stocks. This is the sucker bet I mentioned in the title of the post and one should exercise extreme caution at this point. Let's take a look at a daily chart:
One of the key characteristics of Elliott Wave analysis is that it is a Fractal system. When the market is in a larger Elliot wave pattern, the patterns within the legs of that pattern should mimic the patterns of the larger trend. For example, a major impulse wave should contain 3 smaller impulse waves and 2 corrective waves within it. Presuming we are in a true 5 wave bear market, the blue lines on the daily chart represent the shorter term patterns (including projections) within the last leg down in the weekly chart above. The long blue line that goes off the right of the chart is the same price projection drawn on the weekly, however recent price action has been even more aggressive than anticipated back in January.
So back to the 666 support level… Corrective waves like the one we just entered and seem committed to as of today are characterized by rapid moves against the trend (I still find it odd to talk about an up-move as a correction). Take a look at the ABC pattern (Purple) in between wave 1 and 2 on the daily chart. This is the type of pattern I would expect to see develop over the next couple weeks – high volatility and fast moves to the upside, although the next development should be more pronounced than the January & February action. Once we put this in, and get into the 800s, I think we'll see the final leg down in the bear market (to 600 or so) and we can get back to some reasonable bullishness. I'm pretty sure there will be some catalyst that we'll look back in history and ascribe significance to this final down move – could be a terrorist event, a natural disaster, commercial real estate foreclosures, a currency default or simply the market doing what it needed to do, but there will be something.
So that's it with predicting the future for today. I do think that the market is charged for a bit of a rally at this point, although I'm skeptical of anything sticking. I'm also totally skeptical of my own analysis, including the beauty of Elliott Wave, but for now, avoiding jumping in with the herd seems like the best position and being ready for either direction is prudence. That's the beauty of options.
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