At the start of the third quarter, markets are at a critical inflection point. Many Elliotticians and other market analysts have abandoned hopes for a second half recovery and now look for a crash or another significant decline from current levels as the economic strain of a cratered financial system and the weak U.S. dollar are compounded by record-high energy prices. But with all three of these headwinds now at technical levels that can produce key reversals, stock indexes may be closer to the conclusion of a move than the beginning.
In spring it was apparent that support at the 1256 area in the S&P 500 was critical. At the time, there were serious flaws with the bearish counts attempting to see an impulsive move down from the October 2007 high. The deciding line for whether stocks would enter a bear market in the S&Ps was 1440, which is where they topped in May and have been on the defensive ever since.
Now that stocks have returned to the 1256 area on the S&P, sentiment is predictably bearish. Clearly, if stocks make the previous low at S&P 1256 into serious resistance, the bears will have the upper hand and the potential for further declines becomes distinct. But, as the chart shows, there has already been a major crash, relatively contained to financial stocks like Citigroup. As you can see in the chart, while financial stocks are now completing five waves down, the decline from the October 2007 high in the major indexes into the start of the third quarter can be viewed as a complex correction.
After poking below the previous lows, a quick recovery would preserve a bullish technical outlook. And a recovery in the bank stocks simultaneous with a rally in the dollar and sell-off in oil would provide significant lift to stock indexes that could put a lasting bottom in place. The trend reversals may even be somewhat gradual, but the current look of stock indexes appears to be a recipe for a bottom, not a top.
Dominick Mazza is a technical analyst and full-time trader. He hosts a trading forum at www.tradingthecharts.com.