Special alert: Have equities topped?

They don’t ring a bell at the top. Market tops aren’t advertised, they just happen. We have a tale of two markets on our hands. On the one hand, we have the belief that the market bottomed in March 2009 at 666 and we are riding off into the sunset on a New Bull Market – and then we have those who believe it is just a rally in a bear market. My expectation was clearly predicted in my Sequence of Events in the Cycle report in February 2009. The original chart is the top chart below, and the current chart is the next chart. The charts confirm that I expected a sharp rally even when the market was collapsing early this year. What has occurred since is more than I could have hoped for. The key message is to look carefully where we are now.

The following chart tells an incredible story. The red channel tops line goes from the all-time high in October 2007 through the recent September 23 top. Its bottom line is paralleled off the November 2008 low. During the decline, the market went from a couple of contacts with the upper channel to a couple of contacts with the lower channel … and now back up to touch the upper channel. That alone is basically all that needs to be said. We can talk about the market being overbought and overextended; we can mention a bullish sentiment reading of 92% at recent levels vs. a bullish reading of just 2% at the March low; we can mention the record low cash levels for stock funds, etc. We can even point out the S&P 500 had a divergent sell signal. It doesn’t matter. The market went from one end of the channel to the other and it should have a correction.

Is it a given that the market has topped? No, but it’s a pretty good bet. Running from the bottom of a large channel to the top is an extreme move and is almost always an ideal spot to take a position in the opposite direction. In reviewing comments from my August 28th Alert, I said “My next turn date is mid-September as I mentioned in my prior Alert. I had assumed that we would top in late August and have an initial decline and then rally back into mid-September and then fall apart. I don’t have any reason to change that outlook.” That turned out to be a decent call – the market made its ‘orthodox’ top on 9/17 and then made a divergent top on 9/23.
We have had a huge amount of momentum built up in this rally along with an overwhelming bullish sentiment. We have just completed the third quarter and after such strong market action, one would have expected “window dressing” i.e. where money managers buy stocks to show they were invested during such a strong quarter. That didn’t happen – the market’s high close was Sept. 22, not yesterday. We were also expecting beginning of the new quarter inflows – that certainly didn’t happen today. Those were two very good excuses for the market to advance and it rejected them with a serious setback.
There is still a chance that the market can go back and make a higher high, but the probability is now significantly slimmer. Looking at the daily S&P chart on the next page, we see that the black trend line was broken today. We also broke down from a near term triangle pattern. The red arrows in the chart are where my system (below) gave a divergent sell signal at the top on September 22. That is probably the “C” wave top and where the next decline begins. It will be interesting to see if the market can rebound tomorrow.

My roadmap is on page 2 and I have no reason to change my thinking. My big picture viewpoint is based on the Long Wave cycle. I have stated that there are two more phases of the cycle that have yet to occur. They are the Liquidation phase and the Capitulation phase (see page 2). A number of people have asked why I don’t view the March low as the Capitulation phase low. Capitulation lows end with people absolutely hating stocks. Price to earnings ratios should be at about 6 or 7; dividend yields should be at 6% or higher; and the market should be selling at or below book value, and that’s just to match the capitulation lows of 1974 and 1982. This is a bigger cycle and, if anything, the numbers should be worse. Further, we have only had one leg down in this bear market. A bear market of this degree should have at least one more major leg down, and it should be BELOW the March low.

What about the Plunge Protection Team? Well, this would be an absolutely excellent time for them to re-emerge. Without their intervention I would expect the market could have a very bleak October. The notorious PPT was nowhere to be seen about this time last year when the market began its horrendous decline. They certainly did little to prevent an almost 60% decline in the market. Presuming you will be saved by the PPT is a very risky bet.

Let’s take a look at the weekly S&P chart at the top of page 5 to get an idea of what the ‘big picture’ looks like. The large black channel defines the price action of the S&P from the October 2007 top. Note that each of the trend lines acted as resistance for the market as it approached each line from below. The red trend lines define the rising wedge pattern – a pattern that has been broken with today’s price action. Both indicators below are bearish. Volume declined as the market made its high on Sept. 23 and rose the past two days as the market fell – both bearish. The S&P was down over 2.5% and the DJIA and NY Composite were both down over 2%. The Semiconductor Index was down almost 5% and the Financials down just under 4.5%. The market has been experiencing distribution for the past couple of weeks at least. Today a very high percentage of the NYSE stocks were down. A good friend of mine has a numerical program that gave its first monthly sell signal yesterday since the market top in 2000. His weekly system is set up to do the same depending on tomorrow’s close. The same is a possibility on his daily numbers. He hasn’t seen all three give a signal together in 25 years of working his program – it hasn’t happened yet, but it is worth watching.

Well, with all this bearishness does it mean the rally is definitely over? No, it still could make another high, but the odds of that have fallen dramatically. Is there anything positive in the short term? Not much, but if you look at the chart below an argument can be made for a rally. From the peak, there is an A-B-C decline into a lower channel line intersection at today’s low. It is also the first level of support for the market. The $SOX or semiconductor index has also dropped to a level of potential support. Any rally should be short lived.

Finally, let’s look at the U.S. Dollar. From its 2005 high (1) it dropped to its 2008 low (2) and then rallied to its 2008 peak (3). That rally retraced 88.6% of the decline. The current decline has retraced close to 88.6% of the 2008 advance. This makes it likely that the dollar will now rally. This should also translate to a selloff in the stock market. It will be interesting to see how gold will react. The obvious assumption is that gold would go down, but there is ever increasing demand for gold – so it should be interesting to see which direction wins out.

All the best,
Garrett Jones


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