Friday, August 27, 2010

MTU Weekend Ed. - Looming Point of Recognition (8/27/10 Close)

Bottom Line
Stock market actions over the past three trading sessions offer new clues to the wave structure which suggest that additional upside for the current rebound is likely very limited. A significant sell-off is likely around the corner.

10-year Treasury note yield has entered the target zone (see The Bond Mania (8/20/10)). A trend reversal in the 10-year note (and possibly in long term UST in general) has likely started.

If this interpretation is correct, the outstanding question is how to reconcile the anticipated sell-off in both stocks and bonds at this “early” stage of P3-down. A potential explanation is “the point of recognition of a cycle degree decline.” While the orthodox point of recognition under the P3-down scenario is wave 3 of (3)-down, wave 3 of (1)-down could be forceful enough to accelerate the recognition process.

Here’s one way markets might develop. One of my tracking scenarios marks last Wednesday’s low as wave [i]-down of 3 of (1)-down (gray labeled count in Chart 1). Wave [ii]-up may take SPX to the 1080-1100 area and allow time for bonds to complete a decent-sized first impulse wave within the new trend.

(Note that additional rebound in stocks is not required as the rebound can be considered complete short of a squiggle high and one of the other tracking scenarios marks last Wednesday’s low as wave (i) of [iii]-down of 3 of (1)-down (red labeled count in Chart 1).

As stocks sell off again (as wave [iii] of 3 of (1)-down), bonds rally but will not be able to recover all the lost ground. Recognition soon comes as the sell-off in stocks accelerates and “the bond bubble bursts.” It could be wishful thinking at the moment as alternative scenarios do exist (Chart 1, Chart 2 and Chart 3), but it’s definitely prudent to respect the risk.

“Evidence” in stocks – due diligence on readers’ part required
The wave structure over the past three trading sessions is most likely corrective (Chart 4). If this is the case, the likelihood of the blue-labeled count in Chart 1, which allows SPX to rise above the August high, is greatly reduced. Friday’s lower lows in many cash indices also reduce the likelihood of a larger triangle highlighted in Chart 2. This leaves the top counts squarely in the more bearish camp (gray and red labeled counts in Chart 1).

The rebound could even be considered complete (short of a squiggle high). A continued rebound (in the form of a likely double three) is unlikely to push SPX beyond the 1080-1100 area.

A potential reversal in 10-year Treasuries
Chart 5 and Chart 6 update those highlighted in The Bond Mania (8/20/10). Note that Friday’s reversal comes within a day of a potential turn-date as highlighted in Chart 6. Please see The Bond Mania (8/20/10) for a detailed discussion of the long term trend in U.S. interest rates.