Friday, January 21, 2011

MTU Weekend Ed. - Were it not for financials ... (1/21/11 Close)

Stocks - topped or a fourth wave in progress

Stocks are potentially at a decision point between (1) an "immediate" end to the hope rally and (2) some meaningful delay of a "top" (say about 6 months) and possibly some meaningful upside potential.

Regarding the wave structure of the broad stock market, top choices are that
[1] The advance since the July low ended at the recent high earlier this week, meeting the expectation outlined in Hope Rally Ends Here (Jan 2011 attempt) (1/14/11).

If so, the wave structure of NDX suggests that the top is likely the end of the entire hope rally from the 2008/2009 lows. Completing the advance since the July low (Chart 1, red count) also completes a larger zigzag since the late 2008 low as well (Chart 2, red count). In addition, the long term count on NDX in Chart 2 shows that NDX has satisfied the minimum requirement of a top from a 10-year perspective by having achieved a recovery high.

The risk to this interpretation is threefold. First, wave [Y] of b has failed to reach equality with wave [W] of b (Chart 2). Second, the entire advance since the Jul'10 low could extend making the current top wave 1 of (C) of [Y]. Third, the current decline is a small degree 4th wave (see item [2] below).

Under this scenario, INDU has diverged from the rest of the pack. It potentially is in the final stretch of a rare expanding diagonal and should top soon (Chart 3 and Chart 4, blue count) .

[2] The pullback this week is a fourth wave - i.e. wave [iv] of 5 in SPX and INDU, but wave (iv) of [iii] of 3 in NDX (blue count in Chart 1, green counts in Chart 4 and Chart 5).

Here is a logical speculation under this scenario.

It is likely that minute wave [v] of minor wave 5 in SPX and INDU itself extends, offering room for NDX not only to finish [iii] of 3 but also [v] of 3 (Chart 1 and Chart 2, blue count).

In other words, some meaningful upside potential exists before minor wave 5 in SPX/INDU and minor wave 3 in NDX top together.

That top in SPX/INDU likely corresponds to wave A of the PINK count in Chart 2 of Hope Rally Ends Here (Jan 2011 attempt) (1/14/11). The subsequent pullback will likely be wave 4 in NDX and wave B in SPX/INDU, to be followed by a final advance as wave 5 in NDX and wave C in SPX/INDU.

Were it not for financials ...
Financials could play a key role in shaping the trajectory of the broader market. The numbers speak for themselves (Chart 6 and Chart 7). The risk of meaningfully validating the weakness implied by the sector's "severe" under-performance contrasts with the sector's potential to catch up with the rest of the market.

Standard & Poor's reports that financials, as the second largest sector, accounted for 16.24% of the SP500 index as of 1/21/2011.

Staples (10.43%), Tech (18.78%) and Discretionaries (10.50%) are either at all-time highs or practically there. These sectors represent 39.71% of the SP500 index.

Materials (3.57%), Energy (12.27%) , Industrials (11.07%), Health Care (10.91%) have retraced more than 2/3 of the 2007-2009 sell-off. These sectors represent 37.82% of the SP500 index.

The utilities sector (3.57%) has recovered half its loss.

Financials (16.24%) have lagged severely in both relative and absolute terms, regaining "only" about 40% of their prior loss. Were it not for financials, the SP500 index would be meaningfully higher and meaningfully closer to the prior peak.