Market Analysis - May 15, 2012

The markets have been in a persistent downtrend since early April 2012 peak. It was mentioned on this blog on April 5, 2012 that the markets might have already topped. So far this analysis, seems to be true. There can be myriad of reasons given about the recent decline, such as Euro zone elections, political uncertainty and others. However, no one talked about these potential reasons a month ago. At that time, the only thing everyone talked about was the bullish prospects of the stock market and the associated rationale. For example, easy monetary policy by the Federal Reserves, picking up of US Housing sector and fixing of Euro zone problems.

These observations highlight the importance of objective stock market analysis. Please note that I have mentioned this several times before that accurate analysis is a gift of God.

Now coming to today's market, it was mentioned in the comments section one week ago that the market was supposed to put in a short term bottom with in the turn window. Although the market did bottom in the turn window, the bounce turned out to be very subdued i.e. it only retraced around 38% of the previous decline. This behavior tells us that the market is trading heavy and can decline further. 


In fact, several markets have completed the 8/4 test to the downside which means that the markets are in a downtrend. As long as the market remains below 1376 and ultimately below 1416, market remains in a down trend. Although the IPM turn model has not been run, the market's next turn date is estimated to be near the end of the month. Therefore, market can continue to decline in May.


Update May 15, 2012 - 1:50 PM

The market pattern shown above clearly suggests that the market is entering the 3 of 3 wave down. Some might regard this pattern as an ABC decline, which would be followed by a rally. However, the market turn date is far away, which means that markets should not turn soon. Therefore, the highest probability count at the current moment is a 1-2, 1-2 count, which means that the market decline will accelerate soon. 3 of 3 waves are the strongest part of the wave structure, and are accompanied by strongest momentum. 

In order for this structure to materialize, market should start declining sharply beginning today/tomorrow. If the market rises above 1366 level then we would have to re-evaluate the situation. Therefore, a good stop location is above 1366. As mentioned above, the market is in a primary downtrend. Hence, rallies are prone to failure until unless market completes the 8/4 test to the upside (which will take another 2-3 months).

Note: Yesterday market generated a VIX based buy signal. If the market does not start to rally soon based on this signal then the market's decline will accelerate to the down side. This observation is in harmony with the earlier analysis.

IPM Turn Window Update!!

Over the past week or so, markets have managed to stay above critical levels, thus, preventing an immediate decline. However, over the last week the market structure has been choppy at best, with several up/down gyrations. This kind of behavior is a hallmark of market correction, rather than a new rally phase.

Yesterday, I was surprised by the Put/Call ratio activity. Although market's rise was neither sharp nor significant, the Put/Call ratio collapsed. This kind of activity does not bode well for the market's immediate future. Lower Put/Call ratio means complacency and complacency leads to market declines. After witnessing this curious market action, I decided to re-run the IPM Turn Model to gather some insight about the market direction.

After re-running the Inflection Point Model, following outcome was achieved.

According to this analysis the next IPM turn date is scheduled for May 3, 2012 (+/- 4 days, Higher Probability: -2/+4 days). 

Over the past few weeks, I have tried to optimize the IPM turn model to define whether the market will Top or Bottom at the next turn date. Per analysis, next IPM turn date should be a market bottom. Please note that this bottom could result in a brief rally, followed by a new low in May 2012. 

This market potential is possible when market pattern is taken into account. If this pattern is confirmed, we will see further selling. Confirmation of this pattern will coincide with confirmation of the 8/4 test in the major indices. A break below 1360 and 12800 will confirm this pattern in SP500 and DJIA, respectively. 

Please note that since, we only have 6-7 days left in the IPM turn date, markets should start declining very soon i.e. Today/Tomorrow!!

Euro Completes 8/4 Test - Get Ready!!!

It looks like Euro will complete its 8/4 test to the down side tonight. This could open floodgates to the downside. This could have severe consequences for the broader market. Firstly, it would confirm the down-trend prediction of the global equity index. Secondly, it could push US dollar higher, thus, bringing back the risk-off trade. Thirdly, risk-off trade could fuel another bond rally.

This chain reaction of events could morph into something substantial, especially if DJIA and Russell 2000 break below recent lows because these two indices will then join the Euro in completing the 8/4 test to the downside. As we know, 8/4 test has been a tremendous asset for our trading.

Detailed Euro analysis will be presented later tomorrow. 

Market Analysis - Friday the 13th

Market is down on the heels of market beating results by JP Morgan, Google, and Wells Fargo. Please keep in mind that the IPM turn window expired yesterday. So it will be interesting to see if the market's two day sharp rally ended during the IPM turn window and now we are headed down for the next 2-3 weeks, as the next IPM window is far way.

Furthermore, we had a Weekly IPM turn window which indicates that there is a very high-probability that a market top has been put in place.

As mentioned before, 8/4 test will be our guideline for any trend change. So far, Russell 2000 and DJIA have completed the setup and re-test phase of the 8/4 test. If they can break below Tuesday's lows then the 8/4 test will be completed and the trend will be confirmed to the downside.

The following was written as part of the comments in the last post

Global Equity Index - Weekly

In the short-term it would be interesting to see how the next few days turn out. In order for the market to continue its decline, we should first rally in the short-term. Since we are in the IPM turn window and earnings season has started, it would be appropriate to see the market rallying up till Thursday followed by another decline. This would be the most appropriate scenario because currently we are not seeing any real panic in this selling, as evident from put-call ratios. This suggests that there is more decline to come.

On the other hand, if the market bottoms within the next few days and rallies sharply, it might be starting the next rally leg. But this scenario would require the global equity index to rally also, which looks a lot lower probability.

Global Equity Index - Weekly

We started analyzing the Global Equity Proxy Index last November, in order to better gauge the market direction. At that time, it was mentioned that this index was in the bear market territory, and was one of the reasons why we stayed on the sidelines for so long. In other words, while the US stock market was rallying, global equity markets were not. This suggested that there was something financially wrong on the global scale.

This argument makes more sense if you take into account the fact that the debt problem is a global issue. And when you couple the debt problem with European and Chinese economic slow down, it paints a very dangerous picture for the stability of the global economy. Under such circumstances, it is hard for US to keep marching forward: Either US will catch-up with the global markets to the down side or global markets will start rallying sharply. Although there is also a third option of Fed printing more money, but that is not happening today.

Therefore, right now the first scenario is playing out i.e. the global markets have started pulling down the US stocks.

Technical Developments
On the weekly timescale, the global equity index has found resistance at the long-term moving average (shown below). This moving average has been the differentiating factor between a global bull and global bear market, for at least last 10 years. For example, market stayed above this MA from 2003 to 2007, and then stayed below this average from 2008-2009. At the same times, the indicators are tiring. Therefore, this tells us that we are in a territory where caution is required.

Elliott Wave Analysis
As is evident from the chart, the global index decline sported a clear 5-wave structure from the top in May 2012 to bottom in October 2011. Since then it has risen in 3-waves. 3-wave rise is a classic correction pattern. Furthermore, Wave a = Wave c. In other words, 5-waves decline when followed  by a 3-wave rise, suggests that the trend has reversed.

To summarize, there is a high potential that we have already seen the market top. In case, global equities can rally and sharply break above this important M.A., situation would change. However, until then one should be very careful.

Interesting Developments!!!

Based on the stock market structural developments, it seems like we have already topped.

We will try to compile a special report dealing with the following topics to comprehensively analyze the market structure. We will be looking at the wave structure and potential support/resistance levels.

1- SP500: Weekly chart analysis
2- SP500: Daily Chart
3- SP500: Hourly chart
4- SP500: 15 min
5- Global equity proxy: Weekly analysis
6- Global equity proxy: Daily analysis

Finally, since recent IPM Turn dates were: March 27 (+4, -2 days), April 5 (-2, +4 days); we could have already topped.

Furthermore, Euro would complete the 8/4 test to the downside if it declines below 1.3. This would indicate that the market has topped.

Financial Contemplation

Market has been rising for the past few months, in spite of European issues and global economic slowdown. Some people have termed it as the US effect i.e. since the global economy is slowing down, people are bringing money into the US markets. Another widely shared understanding is that the US markets are levitating because of Federal Reserves monetary intervention. Although this might be true to a certain extent, market rise can be attributed to the lack of participation of individual investors.

As people are storing loads of money in money market funds and bonds, there is no significant participation of individual investors in the equity markets. For example, a lot of people on this blog are primarily out of the market. Although this is golden discipline, one thing that I have noticed over the past several years is that the market loves to induce maximum pain. Please note that the goal is to stay safe and buy with lowest risk. So if you are safe then you are doing well.

In today's market, max pain scenarios could be:

1- A complete collapse of the bond market. This would force people to seek refuge in the equities, raising the stock prices. This embracing of equities could give way to an equity market collapse.

However, based on the amount of free money being printed and the demand of US bonds in the global bond market (b/c of problems in Europe), this possibility remains low. There are so many international investors willing to support the US bond prices, along with the Federal Reserves. Therefore, it will be foolish to assume that the 30 year bond bull has come to an end. However, if the bond prices can decline below 2010 level then it would give an indication that the bond bull has ended. Absent this scenario, we should consider the 2nd alternative.

2- Equity markets rise into a speculative top, attracting many investors like they did in 1999 and 2006-2007. This leads to a market top in stocks. People leave the equities and jump onto the bond rally. This bond rally, would be sharp and could be the ultimate top of the 30 year bond bully. 

This second scenario would be another max pain alternative, as people pile up into equities at a time when they are about to top because of lack of bond yields, free money, and lack of other investment alternatives.  Once equity market tops, people jump ships to bonds only to witness another top.

If the 2nd scenario plays out, after 2-3 years (2015-2016) we will have the best time to buy property (at lowest possible mortgage rate) and the best time to buy stocks (after a market collapse). Please note that that will be a very tough time to buy anything because every one will be so pessimistic. You would have to be brave to do such an investment.

On the contrary, right now it is tough to stay away from the markets. US stock market has risen 20+% since October. Although almost no one can pick the exact bottom, the UST Algorithm's 8/4 test generated a buy signal in late November. But since it takes courage to buy at a point when the world is coming to an end, we were busy trying to pick short-term market gyrations that we missed the long-term change in trend. I surely have learnt my lesson, and have reduced listening to mainstream media.

In the mean time, it is wise to know that stock market is not the only source of income or for generating wealth. Wealth is generated when service is provided and God wills. Stock market creates wealth by providing liquidity to companies and ensuring that they perform to their maximum potential (fundamental analysis). As Mike mentioned in comments, there are so many other ways of making money and investing. For example:

1- Investing in start-ups
2- Diversifying: Buying Gold, Silver, Bonds
3- Buying property at a discounted price. Rent the property out. Hire a management service firm to manage the rental property. Use the rent to pay mortgage, tax, maintenance and other expenses. Deduct tax on the mortgage. All in all reap 5-10% dividends with a potential of price increase over a period of 5-10 years.
4- Personally optimize your budget e.g. cut waste and use the extra money to pay-off house/credit cards. For example, if one has $50000 in credit card debt and is paying 20% interest, investing $50000 in repayment of debt is equivalent of investing at 20% dividend, with no danger of stock price reduction.

In future, I will be talking about some of these ideas for educational purposes along with potential stock market investment opportunities.

For those who are long: Stop = 1387

Note: Sometimes we spend so much time making or trying to make money that we forget the great bounties we have been bestowed upon by God, like health, family and life. Enjoy these and be thankful. Wealth w/o health or family or life, is meaningless!!!