S&P 500 Reaches September's Downside Target -- What Next?

Let's get one thing straight: The stock market is not anyone's friend.  The stock market is a vicious and brutal killing machine which chops the unwary into tiny bits.  Then, after it takes their last dime, it proceeds to head the direction they were hoping it would before they got chopped up.  The stock market hates you -- especially when you make money from it.  When you win, it wants that money back, and it will try to goad you into taking higher risks afterwards.  Even as it pays you your winnings, it will laugh the way John Malkovich did in Rounders and say:  "Fine.  It's a joke anyway.  After all, I am paying you with your money." 

One of the great cultural illusions still left over from the Great Bull Run is that the stock market is a friendly place, where ordinary folks can get rich.  This illusion has been reinvigorated recently by the recovery of equities markets to fresh all-time-highs.  But the market is not a friendly place: Equities are a process of price discovery, a whirlpool of liquidity, a zephyr of global uncertainty, and a casino-full of seemingly-friendly dealers who are happy to take your money and leave you with nothing.

Every trade has two sides, and the person or institution on the other side of the trade you just took isn't buying or selling so that you personally can make money.  Quite the opposite: Their goal is to make money too; so while it's not anything as insidious as "trying to make money at someone else's expense," the reality is that every single trade has a losing side.  Which makes the stock market a financial battleground.   

Recently, we discussed that the charts were suggesting a pattern of buying that was premature, also known as a bearish nest of first and second waves.  These 1-2 wave patterns are not only vicious to bulls because of their ultimate resolution lower; they're also vicious to unwary bears.  The pattern tends to get shorts covering right when they should be holding.  That's the psychology of the beast. Shorts have held through each of the wave two rallies and experienced lots of draw-down along the way, so they become increasingly anxious and skittish, and they become conditioned to expect another rally right when the third wave down hits.  It's a war; the market wants everyone's money.

Yesterday, the White House announced that Obama will nominate Janet "Stop with The" Yellen as next head of the Federal Reserve.  Futures put in the obligatory "oh, hurrah" bounce on this news, which strikes me as a non-event.  I doubt this announcement came as a big surprise to anyone who has cable television, though futures remain green as of this writing.

The first chart we'll look at is the S&P 500 (SPX) which has now captured September's downside target.  A small reaction rally, perhaps to revisit the key trend line which broke yesterday, would not be out of the ordinary.  If the most bearish 1-2 count is unfolding, bounces should remain fairly muted for a time.  The next downside target is 1640-45, which would be the target for the alternate bullish ABC count, and it will now require sustained trade above 1675 to call that into question.

On October 2, I noted that the wave count appeared to be even more bearish than I'd anticipated up to that point, and added a lower target for the preferred count of 1600-1610.  I've updated this chart to reflect that target, though part of me wants to add an asterix behind it, since it may need to be adjusted in real-time as the wave unfolds.

 The next chart provides a closer look at trend lines and channels:

Finally, the Philadelphia Bank Index (BKX) is, interestingly, still a bit shy of reaching August's preferred downside target.  The red annotation was added for today's update.

In conclusion, sellers accomplished exactly what they needed to yesterday, and broke through a key intermediate support line.  Most of the charts I've looked at suggest further downside awaits -- and if this is indeed a nested third wave, we still have a ways to go.  Trade safe.

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Why the Buy-the-Dip Mentality Could Lead to Trouble

Last week, I remarked to a few other traders that the "buy the dip" crowd seems to have been out in force lately, and that if and when support broke down, those buyers should provide heavy resistance to any rallies.  When observing the price charts, it appears every dip has been bought quickly.  This is leading to a halting decline that doesn't seem to want to get rolling.  From this behavior, we can extrapolate that most everyone is anticipating a positive resolution to not only the government shutdown, but also to the approaching debt ceiling deadline (October 17). 

This psychology of positive expectation is consistent with the latter stages of a bull run.  Contrast the current psychology with the last debt ceiling crisis, at the end of 2012.  The markets were fearful and panicky then, and lots of folks were convinced we were about to crash.  Of course, the ultimately-positive resolution then kicked off a massive rally which has continued largely unabated through the present.  That psychology of fear was consistent with the early stages of a bull run.

I've talked about this many times, but in order to grow legs, bull runs need sellers just before the move starts.  Those sellers then become buyers on the way up, and actually fuel the move.  Conversely, bear runs need buyers positioning themselves wrong ahead of time, so those buyers can become sellers on the way down.  The majority simply has to be on the wrong side of the trade for any extended move to occur -- and that's where the psychology comes in.  Expectations have to be the inverse of the ultimate reality, in order for traders to position themselves incorrectly in the first place.

So sentiment has to be bullish for a bear move to start, and it has to be bearish for a bull move to start.  Just as we watched sellers position for the negative outcome back in December, we may now be witnessing buyers getting positioned for a positive outcome that never materializes.

Obviously, I can't tell the future -- but what I can tell is that if things go south, they're going to go south quickly, because the charts are showing us this.  Frequent readers have heard me use the term "nest of first and second waves."  That's Elliott Wave terminology -- in simple terms, (in a decline) a nested series of waves shows us buyers jumping in at each new low, which prevents the move from gaining steam early on.  This has a coiling effect on the market, and the price charts show us how the majority of traders are positioning themselves.  Since they're on the wrong side, when the move finally breaks and kicks off the third wave, it runs hard and fast as those early buyers suddenly exit en masse. 

On Friday, I noted that it's difficult to find a pattern that doesn't require new lows, and mentioned that we may see a big gap down come Monday.  Right now, futures are suggesting a double-digit gap lower for the S&P 500 (SPX) -- and Friday's action has allowed me to narrow down the potentials further, and also to provide some qualifiers to help sort one from the next.  The chart below outlines the details (on #2, "idea" should be "ideal."  A lack of typos would be "idea," but I can't seem to live up to that ideal.)

It's worth noting that the NYSE Composite (NYA) has dipped below the first key pivot, and if Monday's gap down sticks, will have been firmly rejected on the back-test.

The first blue-box target zone on the legacy SPX chart has come within a few points of capture, and presently looks likely to be captured in the upcoming sessions.  If the nest of first and second waves is unfolding, the market will ultimately blow through that target.

In conclusion, I still feel it's unlikely the market will escape new lows.  To the contrary, the pattern continues to appear to be a bearish coiling pattern, and trade below 1665 is likely to lead to an extended sell-off.  Presently, the most bullish pattern I can find (of good probability) is simply an ending diagonal c-wave that grinds a bit higher to start off the week.  Trade safe.

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How Many Fed Chairmen Does It Take to Replace a Light Bulb?

Q: How many Fed Chairmen does it take to replace a burnt-out light bulb?

A:  None.  The Federal Reserve is not currently forecasting any darkness, and feels the fundamentals support continued illumination.

Last update expected lower prices, and the market has since delivered.  Looking at the charts now, I still find it difficult to locate a pattern which suggests a meaningful bottom has occurred.  There's one potential pattern that's intermediate bullish, but the short-term charts suggest even that pattern would still require a new low.

We'll start off with the S&P 500 (SPX).  Most of the details are in the chart annotations, but to quickly summarize:

1.  The decline from 1696 is clearly three waves right now.  That leaves open the potential of an expanded flat (shown in blue).  The market will need to break out over the black and red trend lines to give that pattern legs, and the possible targets in that event are noted.

2.  The mega-bear potential is that the market is winding up for a big, sustained decline (a bearish nest of first and second waves).  That option is shown in black.

3.  There's really only one bullish potential I can find, which also results from the three-wave decline: an ending diagonal c-wave which tests the blue trend line.  Bears don't want to see another three-wave decline here, or that pattern gains traction.  Below 1657, and we can probably forget the bullish alternate for the time being.


Given the complexity of the options, I've tried to simplify this chart as much as possible -- and the main simple point to convey is: I find it hard to locate a pattern that doesn't still require new lows. 

 

 
The Philadelphia Bank Index (BKX) also still appears to want new lows.  This chart is virtually unchanged since early July.

The Dow Jones Industrial Average (INDU) has been a real dog lately, and the decline off the all-time-high has been relentless.  We've previously discussed the massive potential broadening top/megaphone pattern.  While INDU managed to clear August's engulfing candlestick last month, it's interesting to note that INDU has formed another bearish-looking monthly candlestick for September.  The long wick shows INDU's advance to the all-time-high was met with strong selling pressure... again.

In conclusion, I don't see much that suggests the market can escape another new low.  If bulls can form another three-wave decline here and stick save SPX at the major trend line, they could finally put a stop to the decline.  If they can't, then what we've seen so far has only been the warm-up, and the market is going to run into some serious selling pressure very soon.  Trade safe.

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Reaction Rally or Meaningful Bottom?

If W.C. Fields were still alive, he might change his famous punchline to: "I went to Washington D.C., but it was closed."  On Tuesday, the market acted as if Washington's shutdown was the best thing it had heard in weeks -- a clear case of "sell the rumor, buy the news."  However, I think the rally was a second wave fake-out, and continue to believe we're headed for lower prices.  I don't believe we're headed lower because of the situation in D.C., per se -- I follow charts first and news second, and I felt the charts were pointed lower before all this started.  However, the situation in D.C. could be the catalyst the psychological shift the charts were suggesting was due to occur. 

How long will the shutdown last?  Well, in one sense, politicians have already crossed the Rubicon and are past the hardest part of actually letting the government shut down.  Now that the deadline has passed and the worst has happened, one would think the immediate psychological pressure to reach an agreement is at least somewhat lessened.  In other words, if politicians couldn't reach an agreement when they were under the gun, it seems unlikely that they'll suddenly reach one tomorrow.  I obviously have no idea how long it will continue, but by this reasoning, it could drag on for a while -- and this type of event tends to increase market volatility.  Markets are generally uncomfortable with gross uncertainty, and the government shutdown is creating lots of future uncertainty.    

There are some other effects from the shutdown which will impact the market in both subtle and obvious ways:

1.  Economists estimate a loss of 0.3% of GDP for each month Washington remains shut down, so there is a direct and negative economic impact.

2.   The Labor Department won't be reporting September's nonfarm payrolls (NFP), which impacts us as soon as Friday.  This is probably fine, since they'd only need to revise the number later anyway.

3.  The Commodity Futures Trading Commission (CFTC), which is the agency that regulates the trading of options and futures, has only 28 of its usual 680-member staff monitoring for market manipulators and unusual activity.  Since they're no longer watching, I wanted to personally verify there was nothing suspicious going on in the futures market -- so last night I put in a couple small orders, both to be filled at market. I'm happy to report that the market was functioning smoothly, and my ES (E-mini S&P) market buy order was filled instantly and seamlessly, at ES 25,392.50.  I likewise had no trouble selling those same contracts later with a market sell order, and was quickly filled at ES 105.75.  Maybe I'll stick to limit orders until the CFTC returns...

On top of the shutdown, we have the debt ceiling crisis still approaching.  On October 17, the government has to stop borrowing money if an agreement isn't reached.  This is of course a problem for a government that borrows .40 of every dollar it spends.

The charts continue to suggest to me that further downside awaits, and the first chart I'd like to share is the 5-minute S&P 500 (SPX) chart.  The action on Tuesday caused me to revisit the short-term wave count, and there are presently two main options which could fit the structure.  My preferred count is that the decline represents five waves, while the last rally was an ABC correction to that decline.  The first alternate is just a variation on the theme, and an option that's simply unforeseeable:  the market can string together a series of three corrective sequences to form a larger ABC, thus creating a more complex corrective rally.  I can't predict that in advance; I can only anticipate it as it unfolds in real-time.  There are already enough waves in place for the reaction rally to be complete, so I'll stick with that interpretation until proven otherwise.

The more truly-alternate count is shown in green, which considers the possibility that the market has declined in a somewhat oddly-structured ABC fourth wave.  That option will start to gain more traction if the market reclaims 1697, especially on a closing basis, but I'd have to see the form it takes to determine whether a break over 1697 is simply the black alternate playing out (which would be my first inclination).  The only thing that looks even marginally iffy for bears here is the breakout and thus far successful back-test of the black channel; bears need to push the market back through the upper black trend line and keep it there.

That's a lot to digest -- so under the "keep it simple" philosophy: it appears most likely that the rally is over, and we're headed for new lows.

   
Next up is the Philadelphia Bank Index (BKX), which still looks like it needs further downside before we can start considering the potential of a complete fractal.  Even if this is the intermediately-bullish ABC, one generally expects to see a much better Fibonacci relationship between waves A and C than there is currently.

There are a few things worth observing on the SPX hourly chart.  First, notice the breakdown and apparent back-test of the red uptrend line (bearish); second, RSI confirmed the low at 1674, which usually indicates that prices will break that low heading forward (bearish); third, note that black wave (1) hasn't been overlapped yet, which still allows the potential for a final thrust toward "alt: (5)" (this is not bearish or bullish, it's simply a fact).  The black uptrend line appears to be absolutely critical for the bulls over the intermediate term, and of course we're not there yet.  If my near-term preferred count is right, we should at least test that price zone in the upcoming sessions.

In conclusion, I can see there's outlier potential present for a bottom, but I don't feel it's likely the market has put in a meaningful bottom yet, so I remain in "sell the bounce" mode for the time being.  If the preferred count is correct, the market is on the precipice of continuing the decline, and should pick up momentum heading forward.  Since nothing is ever a sure thing, stay alert to the alternate counts if the decline starts to look like it's three waves instead of five, and bears can't crack 1675.  Trade safe.

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Is Social Mood Turning?

In Friday's updated, I noted that the charts suggested further downside was imminent.  Friday's market indeed closed in the red, and as of Sunday evening anyway, futures are implying a 10+ point gap down for the S&P 500 (SPX) cash open on Monday.

The big news item right now is the looming threat of government shutdown.  I'm not going to comment on the sides in this debate, but I do find the reaction of the public extremely interesting:  A recent NY Times poll shows that 8 in 10 Americans disapprove of the threat of government shutdown, from either Congress or the President.  I have no intention of debating who's right or wrong here, however, I do have some thoughts I'd like to share about a larger trend in American philosophy.

A different, yet conceptually related, Gallup poll ostensibly shows that 53% of Americans think that compromise in Washington is more important than sticking to principle.  In my mind, that poll result is at least partially suspect, though, since the way the question was phrased almost certainly impacted the result.  The question is reprinted below: notice how "compromise" was linked to "in order to get things done," whereas "stick to beliefs" was linked to "even if little gets done."  The poll would probably have turned out at least slightly differently if they had linked "stick to beliefs" with "in order to get things done" and vice-versa.  But being the crazy radical that I am, I'm going to challenge the entire question. 

I believe two presupposition behind the above question are fallacy.

First: when did compromise for its own sake become any kind of meaningful ideal?  Pardon my French, but what a bunch of balderdash.  Compromise isn't an ideal -- by definition, it's what happens when you bend your ideals.  Of course, compromise can be a good thing, as it often is in a marriage -- but it can also be a very bad and harmful thing, depending on what you're compromising, and with whom you're compromising.  If my neighbor suggests that he wants to burn my house down in order to improve his view of the ocean, I'm not going to compromise simply to live up to the ideal of compromise.  And I'm not going to compromise for the sake of "getting things done."  I'm going to stand on principle and try to subvert his intentions, even if he accuses me of being "an argumentative obstacle to progress."

Which brings us to the second fallacy: Even if compromise were an ideal, compromise simply for the sake of "getting things done" is not necessarily positive, because "getting things done" is not unilaterally synonymous with progress.  I can drive my car off a cliff, or smash all my toes with a ball-peen hammer, and I'm "getting things done." 

Further, my idea of progress may not agree with yours.  Progress, whether in Washington or elsewhere, is really nothing more than someone's opinion.  And since opinions will always differ, we simply cannot "all just get along" via the vague ideal of compromise as the solution.  Nor should we want to.  Do any of us really want to live in a country where nobody stands on principle, and nobody truly fights for or against anything?  I don't think the majority really want that; I think they simply haven't thought it through.

In my opinion, ideals which have real value are those which are always the right course of action regardless of circumstance: ideals such as honesty, integrity, kindness, etc.  Those are things we can and should strive toward at all times.  But compromise simply cannot be an ideal that stands unto itself, because it's not always the right thing to do. 

The fact is, the seemingly-painless solutions we sometimes reach with "win-win compromises" are often only painless over the short run.  Over the long run, bad ideas eventually have lasting consequences if put into action.

We face a possible government shutdown, and most Americans feel a shutdown would hurt them -- so compromise seems to offer some vague solution as a way to subvert that pain.  We may not really know what compromise looks like in this situation, but we know (at least over the short run) that it probably won't be as painful as a shutdown.  And thus we get 80% disapproval.  I don't personally know whether a compromise here would be good or bad in the long run -- I don't pretend to have a solution, and that's not really my point.  My point is simply that I don't believe we should automatically assume that compromise in general is necessarily always better than the alternative.  

Sorry, rant over.

From a chartist perspective, it's interesting that we had the threat of the fiscal cliff near the second wave bottom, and now we have the threat of government shutdown near the (assumed) fifth wave peak.  One of the concepts behind Elliott Wave Theory is that social mood goes through predictable cycles (human nature doesn't change) -- and those cycles leave patterns on the charts indicating the psychology of the masses is reversing from positive to negative (or vice-versa) at major peaks and troughs.

No change in the charts and projections from the last few updates:

Near-term, it appears the market is about to enter a smaller-degree nested third wave.  This suggests selling pressure should continue for the foreseeable near-term future, as the market will need to unravel several low-degree fourth and fifth waves before finding a meaningful bottom.

In conclusion, the projections from last week are tracking well so far, and there's presently no sign that any type of bottom is imminent.  As noted previously, I continue to suspect we've seen a turn in the higher degree wave structure, and that the market is in for an intermediate decline.  Trade safe.

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Charts Suggest Further Downside Awaits

It's unusual that I feel this confident about the market's future.  Doesn't mean I can't be wrong (long time readers know I'm quite capable of being wrong sometimes; and according to my wife, I'm wrong exactly 100% of the time, so she'd probably fade me) -- but I'd say I'm roughly 75% certain that the market has another leg down in its not-too-distant future.
 
I'm going to start off with the Philadelphia Bank Index (BKX), which I watch closely since it has performed as a leading indicator of the broad market for the past several years.  On September 23, I wrote:

The Philadelphia Bank Index (BKX) continues to look weak, and may be the canary in the coal mine here.  Long-time readers know I believe that trouble for BKX equates to trouble for the broad market, and BKX still looks like it wants new lows.  

BXK has since made new lows -- and the decline there doesn't look finished.  Based on the mid-term historical evidence, I simply don't believe any rally in the S&P 500 (SPX) can grow legs if the banks aren't participating.

Further adding to my confidence is the fact that the decline from the all-time-high in the S&P 500 (SPX) appears to have been an impulse.  This suggests at least one more leg down of equal or greater length.

This has been a market that's difficult to get too far in front of, but I continue to feel that a larger intermediate decline is pending.  The chart below shows my first target zone only, but I suspect we're headed into the 1500's at the minimum before it's all said and done.  I'll reassess that thesis if and when the blue box target is reached.

In conclusion, I feel fairly confident that the decline from the all-time-high was impulsive, and I thus expect the market has at least one more leg down still to come.  Further, I suspect this is actually the early stages of a larger decline.  Nevertheless, once another leg down forms to allow the potential of a complete ABC (assuming I'm not dead wrong, of course), I'll reassess that intermediate outlook.  Trade safe.

Market Continues to Look Toppy

In the last update, I ended with the thought:

I continue to feel that downside risk outweighs upside risk at this moment.  Bulls could do a few things to change that -- for example, a breakout in BKX would go a long way toward causing me to rethink my position.  Barring that, I remain unconvinced that the present rally has staying power; and the market hasn't shown me anything recently to change that view.

The market action since has been encouraging to my thesis, and if I had to sum up the present market with one thought, it would be: "The top appears a lot closer than the bottom."

I want to lead off the charts with the NYSE Composite (NYA), because it represents the broad market much better than the S&P 500 (SPX) does.  The pattern here also appears somewhat cleaner.  We can see there's a pretty clear five-wave structure now in place, complete with a classic third wave overthrow of the upper channel boundary (red iii).  The chart annotations contain most of my thoughts.

 
The preferred count suggests the top is in, but the structure allows for a marginal new high without creating any material changes in the intermediate picture.  Near-term, I suspect we're going to see the market begin a snap-back rally soon.

The SPX preferred count remains unchanged from the past few updates, but I have deleted the mega-bull alternate count for the moment -- right now that alternate count looks like a low-odds long shot.  Obviously if that changes heading forward, we'll take another look at it as needed.  I still feel the apparent bearish rising wedge (between the converging black trend lines) has merit, and the minimum expectations of that pattern are for prices to return to the point at which it began. 

In conclusion, the charts continue to suggest the market is forming a meaningful top, but as the old saying goes, "They don't ring a bell at the top."  Important turns actually require the majority of players to be caught wrong-footed -- which means the market will do everything in its power to confuse and misdirect before a turn.  That tendency makes nailing important turns particularly challenging -- and tops in particular tend to be very whippy and frustrating affairs, which virtually always drag on longer than you think they will.  The market of the past few months has certainly lived up to that billing.  Trade safe.