Friday, January 14, 2011

MTU Weekend Ed. - Hope Rally Ends Here (Jan 2011 attempt) (1/14/11 Close)

You are here (SP500)
Hope Rally Update (12/3/2010) observes that the U.S. stock market has experienced three policy-induced hope rallies since late 2008/early 2009. Hope Rally Ends Here (Dec 2010 attempt) (12/15/2010) alerts a potential top according to one of the tracking counts, which turns out to be premature. In hindsight, that particular top in broad market indexes is only minute wave [i] of minor wave 5 since the July 2010 low. In other words, minor wave 5 has since extended. As the market goes into 2011, Hope Rally Update 2 (12/31/2010) outlines four major scenarios regarding the potential trajectory of the hope rally going forward (Chart 1).

Currently, the market is approaching another logical point for a potential top as the proposed minor wave 5 has nearly exhausted its subdivisions (Chart 2) - baring a less likely extension of minor wave 3. Thus, a retrace of the advance since the July 2010 low is likely. Moreover, two of the major scenarios in Chart 1 suggest a meaningful top with downside potential exceeding 20%. The gray count calls for the end of a large zigzag while the blue count calls for the end of a motive five-wave advance since the March 2009 low. And the pink count sees only a partial retrace of the recent advance, but a correction nevertheless. The "15" handle on the VIX is certainly not encouraging (Chart 3 to the right). The personality of the anticipated pullback will inform us which of the four counts is tracking the best.

Dow Jones World Stock Index ($DJW)
The wave structure of the DJ World Stock Index ($DJW) is also informative since (1) it has arrived at a very similar point and (2) its broad global coverage of approximately 95% of the market capitalization of 50 countries adds credibility. See Chart 4.

The subdivisions of minor wave 5 since its July low is still open for debate and is subject to the risk of being meaningfully incomplete. However, minor wave 3 is 1.61 times minor wave 1 and the index is at a level where minor wave 5 reaches equality with minor wave 1. These textbook style characteristics deserve attention.

Nasdaq 100 Index ($NDX)
NDX is tracing out a different wave structure at a larger degree since its Y2K peak (Chart 5). However, as Chart 6 shows, NDX is either at wave 3 or 5 of (C) based on the red count or is very close to that point based on the green count.

Here are a couple of scenarios how bonds could rally on a pullback in stocks, at least initially (Chart 7 and Chart 8, 30Y UST prices) .

The relatively moderate rally in bonds based on the blue count as wave [iv]-up probably corresponds to a moderate correction in stocks (e.g. the pink count in Chart 1).

The relatively aggressive rally in bonds based on the green count as wave 2-up probably corresponds to a deep correction in stocks (e.g. the blue or gray counts in Chart 1).