Most likely, the stock market is now correcting the entire hope rally as evidence by this past week's outsized decline.
This sell-off has the potential to mark the end of the entire hope rally and push stocks to below 2008/2009 lows over time (Chart 1).
The ambiguities in wave structures around the top, perhaps with the exception of the Nasdaq 100 index (Chart 2), also leave room for the sell-off to be a sizable but temporary correction dating back to the February high (Chart 3) - before an advance to fresh recovery highs.
Unfortunately, confirmation in either case is likely weeks and even months away, offering limited benefits.
So manage risks accordingly. Without taking a directional view, at current levels of SP500, the risk to net short exposure is 14.274% (1370.58/1199.28, 171.3 index points) and the risk to net long exposure is undetermined until the initial impulse wave decline from early July (once the current 3-down is over, likely missing 4-up and 5-down) or late July highs (likely approaching its end) runs its course (Chart 4).
Elliott wave analysis help identify top tracking scenarios (counts), bullish and bearish.
Bearish Scenario - Hope Rally is over
Chart 1 above shows that the hope rally since the 2008/2009 low, in the form of a simple zigzag, is likely over. Under this interpretation, the current top marks the end of a counter-trend rally (wave b-up) that retraces the 2000-2009 decline (wave a-down, an expanded flat). The bear market has resumed (wave c-down) with targets most likely below the 2008/2009 low.
One cannot help noticing the technical ambiguities around the top though.
First, the final advance to the nominal high of 1370.58 in May counts much better as a three. One way to get around this is to introduce an odd shaped wave (4) as indicated, perhaps zigzag with a large flat wave B or a running flat. Another wavy to get around this is to count the Hope Rally as a series of disproportionate threes instead of a zigzag.
Second, one needs to assume truncation in nearly all major benchmark indexes if an orthodox top occurred in early July or in late July (Chart 3, red). One way to get around this is to note that both July highs are higher than the February high in U.S. stocks. One can interpret the Feb-June correction as a flat. However, there would be severe truncation in DJ World Stock Index (Chart 5) and Global Dow Index (Chart 6), where the July highs are meaningfully below May highs. At any rate, it is a failure in a nominal sense nonetheless, in many indexes.
These ambiguities in wave structures around the top introduce the possibility that the current sell-off is only a sizable but temporary correction dating back to the February high (Chart 3) in the form of a zigzag with a triangle B wave (Chart 3, green) or a large flat-like double three (Chart 3, blue).
Bullish Scenario - double zigzag, etc
Chart 7 and Chart 8 highlight the possibility of a large double zigzag or a small triple zigzag Hope Rally in SPX. Under this interpretation, a connecting wave [X] is in progress. Although the small triple zigzag count is stretching to its limit and now takes on a less desirable expanding form, 1162 is where [X2] equals [X1] (and Friday's low was 1168.09.) See Chart 3 green or blue for tracking.
Other bullish counts include large-sized lending or ending diagonals given the three-wave advance since the 2009 low. But these more bullish scenarios have the same practical implication for the foreseeable future.
In the case of NDX and RUT, an extended wave (3)-up in NDX (Chart 2 green) and expanding EDT in RUT (Chart 9) accommodate a bullish scenario.
Stepping away from wave analysis, one notices some interesting structures on the non-log scale weekly chart of SPX as of last week. Friday's low of 1168.09 comes at or close to
(a) the lower channel line off the 2010 low, when the upper channel line connects the April 2010 high to the May 2010 high (blue lines)
(b) the trend line connecting the June 2009 low and June 2010 low (red line)
(c) the 2009 high (green horizontal line)
(d) the lower iso-angle line off the 2009 low, when the upper iso-angle line connects the 2009 low and the 2011 high and the middle line connects the 2009 low and 2010 low (green lines)
(e) the 200-week simple moving average (black)