Friday, February 18, 2011

MTU Weekend Ed. - Bull market, B-wave and Beyond (2/18/11 Close)

Bull market, B-wave and Beyond
Based on the analysis and discussion in the following posts - The Big Picture (2/21/10),
A Potential x Wave (2/4/11) and Logical Ending Points (2/11/11) - the current assessment is that the broad U.S. stock market is tracing out a b-wave (for a better pun, technically a likely x-wave) of cycle or super-cycle degree (Chart 1, blue labels).

The challenge of this particular b-wave/x-wave, which began after the 2000-2009 expanded flat, is that it can end at the completion of one or a combination of three-wave corrective structures, either below or above the 2007 high as discussed in Logical Ending Points (2/11/11).

Note that the advance since the 2009 low in broad indexes (such as $WLSH, $SPX and $INDU) is visually a three-wave structure (Chart 1, blue labels). Moreover, the first Fibonacci time turning point at a larger scale is also approaching. The hope rally has lasted about 24 months to date. 0.236 times the 2000-2009 decline is 25 months (+/- 1). The next turning point, at 0.382 times, is around late 2011 to early 2012.

Thus, one should be cognizant of the risk of a logical ending point ahead.

At the same time, one keeps an eye on the two less likely but respectably probable scenarios - the much discussed bearish P[2] count (Chart 1, red labels) and bullish P[3] count (Chart 1, green labels).

In either case, the market has entered a critical phase where the bearish P[2] count calls for a reversal in the not too distant future, whereas the bullish P[3] count calls for an accelerated advance before long.

The key challenge to the P[2] count is a deep retracement and several indexes having already exceeded their 2007 high (see Chart 2). The key challenge to the P[3] count is that current bullish sentiment does not favor an accelerated advance.

These challenges add to the merit of a b-wave / x-wave interpretation.

Counting the QE2 Rally

Taking into account of the wave structures in a basket of indexes such as those in Chart 2, one finds 5 waves since the late August 2010 low (Chart 3, blue labels) and 7 waves since the July 2010 low (Chart 3, green labels), using Wilshire 5000 as a proxy.

Regarding wave labeling, it's sensible to treat the late August 2010 low as the orthodox end to the correction from the April 2010 high (Chart 3, blue labels). After all, the sell-off into late August 2010 was likely truncated by the great QE2 front-running (Chart 4).

The Russell 2000 index may be the one domestic index with the clearest wave structure to support this particular wave count (Chart 5). The same count tracks the German DAX well so far (Chart 6).

The implications of this particular count are two-fold.

First, this particular count accommodates the b-wave, P[2] and P[3] count alike. It allows the b-wave count to terminate or a meaningful correction to serve as a connecting wave if this b-wave develops into a combination. It allows the P[2] count to terminate below the 2007 high in broad market indexes. It also allows the P[3] count to have its wave (2) pullback to alleviate the prevalent bullish sentiment.

All three scenarios, under this wave labeling, call for a meaningful pullback to correct the advance the late August 2010 low.

Second, the late January low is a critical pivot. In theory, the top is in when an impulse wave (likely 5 waves) ends from the January low. Fortunately, since wave 3 is shorter than wave 1 under this interpretation. Therefore, there exists a cap to any upside potential. This cap also serves to invalidate this count when exceeded. In SP500, this cap is 1397.52 (and 1404.13 max). Note that wave 5 reaches 0.618 times wave 3 at 1350.76 (or 1354.85).

Alternatively, if the nominal low in July 2010 is indeed the end of the correction since the April 2010 high, wave #7 is currently in progress. Once wave #7 completes, wave #8-down and wave #9-up will follow. The wave #8 pullback is likely moderate. This count tracks the UK FTSE, which historically has a high correlation with the SP500 index (Chart 7).

Near term outlook - the advance in stocks since the January low
As discussed above, the January low is a critical pivot under the proposed wave count on the QE2 rally. The real challenge, therefore, is to correctly track the impulse wave advance since the January low and identify its top.

The near term wave structures in major indexes, however, have become more dissimilar lately. To some extent, this divergence is a logical reflection of a relatively weak fifth wave if the proposed count is correct. The task at hand is therefore to analyze each index individually. I will highlight the primary count for each index below and omit the alternative counts for now, but one needs to keep an open mind. Here we go.

SPX and WLSH (Chart 8) are tracing out an extended wave [iii], while INDU is tracing out an extended wave [v] (Chart 9).

Small caps appear to have more upside potential than do large caps. Both NDX and RUT are tracing out an extended wave [iii] which is yet to finish (Chart 10 and Chart 11).

Whither the dollar
The primary count on the dollar is bearish for the intermediate term. In other words, the USD index is still completing its lengthy primary wave [2] down - see the blue count in Chart 10. The red and green counts in Chart 12, as well as a potential multi-year triangle represent alternative possibilities.

Chart 13 offers a near term count based on the primary count. If this count is correct, one should leave room for an extended wave [v] down to complete wave C of (Y) of [2].