Saturday, August 2, 2014

MTU Weekend Ed. - Monthly Outlook Update (8/1/14)

stocks, bonds, USD, gold

This past week’s strong sell-off in stocks offers the possibility of a larger pullback or a trend reversal. However, the asynchronous tops among benchmark indexes present a challenge to the bearish interpretation at the moment. While these asynchronous tops can precede a sizable decline, they can also track an ongoing correction, ex ante. (See discussions below.) A drop below the low of a yet to be completed five wave decline confirms, while a failure to confirm suggests a short term buying opportunity.

Technical damage
After making a moderate new high of 1991.39 in July (1.18% above the June high of 1968.17), SP500 fell decisively this past week, down 1.51% for the month of July and down 3.76% from its all time high to Friday’s low. SP500 closed below its 50-day moving average (for the 3rd time this year) and the Dow is now down 0.5% for the year. A bearish engulfing pattern is present with the June and July candles on the monthly chart, as well as a successful head-and-shoulders top in lower time frames.

In Monthly Outlook Update (6/27/14) for July, we outlined three topping scenarios for stocks. Two of these scenarios have tracked price actions well over the past month. See Chart 1 (INDU and SPX) and Chart 2 (RUT and SPX).

Based on the scenario in Chart 1, stocks topped in July and are likely to experience either a sizable pullback or a trend change into a bear market.

Based on the scenario in Chart 2, stocks have been in a lengthy consolidation since the beginning of the year and the recent sell-off marked the final decline which is likely to be sizable.

 If a major top is in, we argued in Seeing the Forest for the Trees (7/25/14) that it is likely best to track the sell-off from an orthodox high. Based on that analysis, we count the sell-off to Friday’s low as a 3-wave decline to Friday’s low (Chart 3).

Since a 5-wave decline is necessary for a larger decline, a fifth wave sell-off next week to retest Friday’s low is required. A full retrace of the subsequent rebound to below the fifth wave low offers confirmation of a larger decline.

A failure to confirm suggests
a short term buying opportunity
It is interesting to note that different benchmark stock indexes have registered their nominal highs at substantially different times. Chart 4 shows that the nominal highs are hours, days and even weeks apart across the Dow, SP500, Nasdaq indexes, and the Russell2000.

While these asynchronous tops can precede a sizable decline, they can also track an ongoing correction, ex ante.  This possibility poses a challenge to the bearish interpretation of the current sell-off.

Consider the price actions of the Russell2000 and SP500 (Chart 5). RUT topped at the beginning of July while SP500 peaked three weeks later. As Chart 5 illustrates, it is possible that RUT has traced out a double zigzag correction while SP500 has moved along an expanded flat-like corrective structure. Chart 6 shows the current pullback as a part of the advance since the February low.

Long term U.S. Treasury yields are spending time between their long term resistance and the upper EDT support as shown in Chart 7.  A break in either direction is likely some time away. Please see discussions in our Monthly Outlook Update for June and July for details.

Price actions in July suggests two near term possibilities (Chart 8).

[green] An ABC rally in bonds ended at the May low in yields.  Note that the blue base channel appears to offer strong support.

[red] The 2014 rally in bonds is a part of an expanded flat consolidation dating back to mid-2013. Expect one more drop in yield to complete wave (c) of the expanded flat, perhaps to fill the gap around the 2.35% area.

The USD index rose an impressive 2.17% in July.  As expected, it bounced off its trend line support (Chart 9) and support from a prior EDT (Chart 10) discussed last month.  The USD index is now at potential resistance highlighted by the gray line in Chart 10, where its strength determines the near term direction of the dollar index.  Odds appear to favor a weaker dollar.

There's no change to the two key longer term tracking scenarios on Gold (Chart 11). Please see the previous Monthly Outlook Update for details.

Chart 12 presents near term tracking counts.  The wedging price action on the July sell-off may suggest a run at 1350 next.