SPX Update: Bears Have Left the Building -- Look Out Below

I think being long this market right now is exceptionally risky.

Yesterday, I suggested that the sentiment survey due out today from the American Association of Individual Investors would indicate that sentiment levels were reaching bullish extremes.  The survey actually exceeded my expectations: not from the bulls so much, but from the lack of bears.  The percentage of bearish investors is approaching the lowest levels of the past decade, and this type of sentiment is generally bad for bulls. If most of the buyers have already bought, and most of the short-sellers have already covered, the market is going to have a hard time putting together a meaningful rally.

This is when it's most challenging to be a bear -- when virtually no one else is (the same applies to being bullish, like I was at the beginning of October)... but this is also when it's most profitable. 

Sentiment data is not to be construed as a guarantee of an immediate top (or bottom) -- in fact, the last time the bearish percentage was this low was December 2010, and the SPX went on to rally another 100 points before putting in the 2011 top and crashing over the summer.  Prior to that, one has to go all the way back to July of 2005 to find bearish investors this non-existent (the market fell through the rest of July); one can also find readings this low near the 2002 top (in February/March of '02 -- market lost over 30% afterwards), and near some of the major tops of the 2001 bear market.  But one can't trade on sentiment alone, because extreme readings can last a long time; however, this is a strong confirming indicator to the wave structure of the Minor (2) top.

It also suggests an ongoing state of suspended disbelief in the fundamental problems facing the world governments and economies.  Just as a few examples of the differences between now and the last time we saw readings this extreme:  back in December 2010, the TED spread was less than half its current level of 0.57, Italy's bonds were yielding around 4.5%, and QE2 was alive and well and feeding the stock market with liquidity. 

The market action yesterday finally took some of the short-term options off the table, and the call I made yesterday now appears to be the correct read:  either the top is in already, or there's one last spike high coming (ideally, just above the October highs, but not required).  

The Minor (3) decline should be just around the corner.  To reiterate a bit, I expect the first leg of Minor (3) to take out the October low of 1074.  My ideal target for the S&P 500 (SPX) is 1000-1050, however, wave extensions are always possible, and the 800's would not be out of the question.  It's been a frustrating market for swing-trader bears since the October top, with the bullish alternate counts seeming to win at every turn (although, a lot of points should have been picked up by the more nimble traders who took profits in the target zones).  The days of bear frustration should finally be drawing to a close.

Below is the intermediate term chart, which is unchanged of late:

The second chart I'd like to share is a very short-term chart, and presents a slightly altered take on yesterday's ending diagonal.  I'm genuinely not sure yet which diagonal could prove correct (assuming the top isn't in already), but the overall feel of an ending diagonal is certainly present, and the three-wave rallies seem to confirm that.  For those not well-versed in Elliott Wave, an ending diagonal consists of five 3-wave moves, and generally indicates buying exhaustion, as a balance is being reached between buyers and sellers.

My solid expectation now is that the top is either in, or will be after one more spike high.  I would take a very cautious stance with long positions at these levels (i.e.- I wouldn't hold longs here, personally, at least not for more than a short trade).  The temptation is always to go long after the meat of the rally is over, and your linear-projecting brain thinks it's "safe."  That's essentially what fifth waves are: the stragglers who missed the turn trying to jump on a bandwagon they already missed.  Another term for these traders would be "the bag holders" because they're the ones buying at the top (or selling at the bottom).  Successful trading often involves doing the exact opposite of what your emotions want you to do.

The last chart is the ending diagonal speculative count shown yesterday.  As I said, I'm genuinely not sure exactly how the end will shake out here -- the chart above and the one below are both completely viable, as is the view that the top is in.  We're really picking nits when we're talking about a couple percentage points of upside verses 20% or more downside.  The larger point I'm trying to drive home is that I don't believe this is a zone where swing-traders want to establish long positions -- exactly the opposite; I think swing traders should continue establishing shorts.  Nimble day traders are another matter, of course. 

What I like about the chart below is the "shake-out" factor it presents, both to weak longs (who dump when this heads lower) and to weak shorts (who dump when it heads higher).  It would simply be the path of greatest confusion.  An interesting factor to keep in mind is that Friday is a non-farm payroll day.  I've mentioned this before, but it bears repeating: on non-farm payroll days, the market often reverses from the direction of the open.  So if the open is down, it often reverses up and vice-versa.  Again, like everything else, this is just another odds-on favored historical fact; it doesn't guarantee a reversal.

On the other side of the coin, what I like about the count which suggests that the top is in already is that I don't think anyone's expecting that at all.  Major tops and bottoms should always leave the majority expecting the trend to continue, even if it's "just a little farther."

In conclusion (if you haven't already figured this out from the body of the article), my expectation is unchanged from yesterday: either the top is in already, or it will be after one more lunge higher.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com