SPX, RUT, and VIX Updates: Market Placed on Crash Watch

A person is placed on suicide watch when he or she displays certain self-destructive patterns and behaviors.  Likewise, a market is placed on crash watch when it displays certain destructive patterns and behaviors.  As I've been warning about for the past couple weeks, this market has displayed certain "red flag" behaviors, and the pattern is now becoming quite dangerous if not reversed quickly. 

I should add that I use the term "crash" in the sense of "a strong, unrelenting decline that really messes up your portfolio."  Some people envision 1929 when they hear the word -- and while that's always possible, the charts below tell the story of my current expectations.

All hope is not lost yet for the bulls, as they have one major line of defense remaining, which we'll discuss in a moment -- but first, an explanation of why the market is being placed on crash watch.

In Elliott Wave Theory, one of the things we pay attention to is called the "base channel."  The majority of corrective moves remain (approximately) within this base channel, so when the market stays within the base channel, we can then expect the prior trend is more likely to resume.  However, when the market falls out of the base channel, it is strongly suggestive that the move is no longer a correction, but a new trend.

There's also a name for the channel which is expected to follow the base channel -- it's called the "acceleration channel."  Pretty self-explanatory.

The chart below shows the base channel in purple.  Yesterday, I thought the bulls might make a run at recovering that channel, but we can see in this chart that they were unable to do so. 

Unless the market finds support quickly and recovers the channel, the move has strong potential to accelerate lower.   

So, while the market remains outside this channel, it is officially on crash watch.  Long positions should be considered high risk as long as the market remains beneath the lower channel boundary, which now crosses roughly 1345.

As I talked about yesterday, the market has yet to see anything even approaching the level of strong selling that we'd expect to see at a meaningful low -- which means this strong-selling phase is most likely in the market's future.

Another indicator which agrees with the danger discussed above is the Volatility Index (VIX).  VIX effectively measures the amount of fear present in the market, so when VIX goes up, it means the market is going down.  A couple weeks ago, I talked about the fact that VIX had built a solid-looking base from which to launch a rally.  It has now broken out of that base and, so far, successfully back-tested that base.

The Russell 2000 (RUT) has also lost key support.  It is in a similar postion to SPX: unless it can rally back above the red trendline, it's in real danger.

The short-term picture has been extremely difficult to sort through, as the market has formed a number of somewhat unusual and unpredictable fractals filled with excessive overlap.  At this stage, a small bounce would fit nicely into the picture, but certainly isn't required.  The short-term pattern that's now formed is either:

1)  An ending pattern (ending diagonal) which will find a near-term bottom quickly (not necessarily an intermediate bottom)
2)  The prelude to a strong decline.

Unfortunately, the two patterns look almost identical at this phase in their development.  Paying attention to how the market behaves near the upper trendlines should help provide clues.  The blue "(2)?" annotation illustrates what could happen if this is an ending pattern.

The alternate count (in black) considers the potential of a decent bottom forming in the near future, possibly in the low 1300's (as discussed in a moment), which would allow the market to recover the base channel and thus be taken off crash watch. I currently consider this count to be the underdog.

Now let's discuss the bull defenses.  The last major line of defense for the bulls comes in near the 1290-1310 zone.  The two charts below illustrate this.

First is the S&P 500 monthly chart, which shows a series of support zones crossing just beneath the current price levels.

Next is an hourly chart, with a more detailed look at shorter-term support (and resistance).  This chart also echoes the importance of the 1290-1310 zone.  Bears should be alert to a bounce from this zone.

 
In conclusion, what happens in the next few sessions could be critical to the market's longer-term health.  Since May 4, I've been stating that the market is in a dangerous position -- but in the last couple sessions, the market's position has grown exponentially more troublesome.  If bulls want to have any hope of staving off a much deeper decline, they are going to need to stage a strong defense soon, and recover some key levels.  My expectation remains that the intermediate trend has indeed changed to down, but, as always, the market is the final authority.  Trade safe.

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