Saturday, January 19, 2013

MTU Weekend Ed. - Downside Risks Increasing (1/18/13)

The proposed small-degree pullback (1/11/13) in stocks, while still on the table (Chart 1, blue-alt, green), most likely went sideways (Chart 1, blue, red). Instead, stocks have been subdividing and crawling higher over the past week pushing SP500 up 0.95%.  In light of waning momentum, VIX approaching its pre-crisis lows (Chart 2) and price-structures completing, risks of a near term pullback, but more importantly/interestingly, a larger-degree pullback or a trend reversal have increased significantly. We discuss these down-side risks below.

a near-term pullback
As Chart 3 illustrates, it is possible to count the rise in SP500 since the “cliff-low” as an odd-shaped five-wave advance. We should count it as wave C, wave [i] of 3 or wave 3 off the November low (Chart 1, green). Under this interpretation, a pullback as wave [ii] of 3 or wave 4 is imminent.

An initial target is around the 1460 area for wave 4 and the 1440 area for wave [ii] of 3.

Also note that despite the advance in recent months and a new recovery high, price still sits within the base channel.

a larger-degree pullback
As discussed above, the advance since the November low is so far three waves contained within the base channel and accompanied by waning momentum. This raised the possibility of a lengthy flat correction dating back to the September high (Chart 4).

Under this scenario, the September high is point 5 of our Hope Rally model. The coming sell-off serves as wave C-down of the proposed flat to reach the red point 6. The subsequent advance to red point 7 will conclude Hope Rally.

An initial target is around the 1350 area for the proposed sell-off.

While this scenario is likely to frustrate both bulls and bears, it is nevertheless reasonable, interesting.  The proposed sell-off  may also have a precedent, as the circled areas in Chart 5 illustrate.

The proposed larger-degree pullback , but not the end of the Hope Rally, can also be wave D of a larger wedge/EDT since the 2011 low (Chart 4, purple).

trend reversal
On the other hand, if the November low is indeed black point 6 of our Hope Rally model, stocks are fast approaching the terminal black point 7.

In terms of wave counts, candidates for the pending high under this interpretation are (1) the green and red wave C in Chart 1, (2) the purple wave E of a large wedge/EDT in Chart 4, (3) the green wave 5 (following a wave 4 decline) in Chart 1.

Option (1) and (2) above imply an imminent decline, while option (3) allows for more time, likely measured in weeks.

bullish contingency
Our analysis would not be complete without a mention of the bullish scenario. The primary bullish scenario is the green count in Chart 1 where the pending high is wave [i]-up of 3-up. Wave 3 extends to complete its five wave advance. Wave 4-down and Wave 5-up follow to conclude the hope rally. Under this scenario, the end of the Hope Rally is likely months away.