Market Weekly Update

Happy New Year!

The broad stock market is on the way to build a “Domed House” and to challenge multi-year highs or even all-time highs. Outperforming of small-cap stocks indicates that the January Effect remains intact. Home construction, banks, and internet sectors are leading the market higher.

• Leading-Wave Index Continues Its Bullish Readings
• The S&P 500 Index in the “First Floor” Phase
• January Effect
• Chinese Stock Market Reached the Price Target 2270
• Gold is in the “Run” Phase of a Bump-and-Run Reversal Top Pattern
• Gold in a 3-Month Downtrend Channel
• Silver in a 3-Month Downtrend Channel
• Gold/Silver Mining Stocks Still in a 6-Month Uptrend Channel
• Crude Oil in a 7-Month Symmetrical Triangle
• US Dollar in a 4-Month Descending Triangle
• US Treasury Bond Weakening
• Asset Class Performance Ranking with Equity Leading
• Sector Performance Ranking with Home Construction Sector Leading
• BRIC Stock Market Performance Ranking with the Chinese Market Leading

Since 11/19/2012, the Leading-Wave Index (LWX) has been continuously bullish for seven weeks. Last week the broad market moved up sharply higher in line with the steady bullish readings of the LWX. The Broad Market Instability Index (BIX), measured from over 8000 U.S. stocks, closed at 2 on Friday (down from 4 the previous week) which is below the panic threshold level of 44 and indicates a very bullish market. Based on the forecast of the LWX, the broad market should be in a short-term bullish time-window until 1/17/2013 (see the second table above). The daily chart of the Wilshire 5000 index below has the price bars color coded with the LWX indicator. The current market status is summarized as follows:

We have been tracking the current speculated “Three Peaks and a Domed House” pattern of the S&P 500 index for 10 weeks since my Weekly Update on 10/31/2012. The “Three Peaks and a Domed House” pattern is one of complex chart patterns, and it presents higher difficulties or challenges for a single technical indicator or system to handle the market throughout the entire pattern. It enhances risks also opportunities for both the bulls and bears.

In speaking of “the Three Peaks and a Domed House” pattern, my version modified from George Lindsay’s basic model uses a macro or “phase-counting” approach which is different from Lindsay’s original micro approach (which uses “wave-counting” from 1 to 28) in that it divides the “Three Peaks and the Domed House” pattern into five major phases as follows: 1) Three Peaks, 2) Basement, 3) First Floor, 4) Roof, and 5) Plunge.

The progressional development of the current speculated “Three Peaks and a Domed House” pattern is as follows:

Three Peaks phase: From mid-September to mid-October, the SPX formed three peaks in a trading range between 1430 and 1460 while the broad market was in the distribution stage of the market cycle. That was the earliest warning sign for a beginning of “Three Peaks and a Domed House” formation.

Separating Decline: From late October to mid-November, the SPX declined about 110 points from 1460 to 1350. Typically, this decline is a phase transition from the “Three Peaks” phase to the “Basement” phase, and corresponds to the mark-down stage of the market cycle. It usually moves much faster than general technical indicators can respond.

Basement phase: Around mid-November the SPX was in the “Basement” phase that is typically a “bear trap” with a bearish market sentiment combining all bearish views from both headline news and majority of popular technical indicators. The accumulation stage of the market cycle usually starts from here and it progresses stealthily.

Swift Advance: From mid-November to early January, the SPX sharply advanced about 110 points from 1350 to 1460. This advance is a phase transition from the “Basement” phase to the “First Floor” phase while the broad market was still in the accumulation stage of the market cycle with a bearish market sentiment.

First Floor phase: The target price range for this phase has been projected between 1440 and 1460 which is near the previous high of last September. The powerful advance during last week made a milestone by finally reaching the level of 1460 in the targeted “First Floor” phase. As the “First Floor” phase matures, the accumulation stage of the market cycle should gradually come to an end, and the mark-up stage could start immediately with another advance towards the “Roof” phase of the domed house.

The current speculated “Three Peaks and a Domed House” pattern is also supported by the typical weekly MACD Histogram indicator mathematically mapped on the following SPX daily chart, marked with each stage of the market cycle. There is a good article titled “Market Cycles: The Key To Maximum Returns” on Investopedia.com which talks about the market behaviors at different stages of the market cycle.

It is the time to check the “January Effect” that small-cap stocks tend to outperform big caps in January. The following chart is a typical way to gauge the “January Effect” by using the ratio of the Russell 2000 index of smaller companies divided by the Russell 1000 index of largest companies. When the ratio is rising, smaller companies are outperforming big blue chips.

Since mid-November, the ratio has launched a strong uptrend. That indicates the “January Effect” has already started. It shows no evidence of sell-off in December. Also the latest readings of the ratio have been significantly higher than the September high. The strength in small-cap stocks could boost the broad stock market to advance beyond the “First Floor” phase of the speculated “Three-Peaks and a Domed House” pattern.

The recent impressively rebounded Chinese stock market broke to the upside of a 4-month Descending Broadening Triangle pattern. The projected upside price target at 2270 was reached last week. It may have a consolidation ahead.

The gold index has been in an intermediate-term Bump-and-Run Reversal Top pattern since I identified this pattern on gold in my article “How Low Can Gold Go on a Correction?” in August of 2011. Currently the gold price is below the “Lead-in Trendline” and it is in the “Run” phase. It is a bearish sign for gold with a breakdown from the support of the first target line at 1700. The next support could be at 1550 near the 2nd target line.

The gold index has formed a 3-month downtrend channel. Prices have recently tested the lower boundary of the channel twice. An upswing towards the upper boundary of the channel should be expected.

Same as gold, the silver index has formed a 3-month downtrend channel. Prices have recently tested the lower boundary of the channel twice. An upswing towards the upper boundary of the channel should be expected.

Gold/silver mining stocks are testing the lower boundary of the 6-month uptrend channel. Prices may bounce off the lower boundary of the channel from here.

Crude oil has formed a 7-month Symmetrical Triangle pattern. Prices may move in a converging range bounded between 86 and 94. Currently prices have reached the upper boundary at 94, and a pullback could be expected.

The US dollar index is in a 4-month Descending Triangle pattern, and the direction of a breakout from this triangle could be important to the next move of the dollar. Currently the dollar is testing the upper boundary of the triangle.

Although the 30-Year US Treasury Bond could be in a possible “Bump-and-Run” formation, the recent price movement has violated the steep-upward-sloping trendline (the pike line). Therefore, the price target of 172 is negated. Considering the current deflationary environment indicated by the inflation rate below 3%, bonds have an inverse relationship with stocks. Strengthening in stocks means weakening in bonds. The next check point is to see if the treasury bond breaks down the warning line or the upper line of the uptrend channel.

The following table is the percentage change of each asset class (in ETFs) against the 89-day exponential moving average (EMA89). Currently equity is outperforming. The U.S. treasury bond is underperforming.

The following table is the percentage change of sectors and major market indexes against the 89-day exponential moving average (EMA89). The Dow Jones Wilshire 5000 index, as an average or a benchmark of the total market, is 4.21% above the EMA89. Outperforming sectors are Home Construction (9.92%), Banks (9.63%), and Internet (7.53%). Underperforming sectors are Precious Metals (-4.69%), Technology (0.58%), and Utilities (1.00%). The Russell 2000 small-cap is outperforming and the NASDAQ 100 is underperforming.

The table below is the percentage change of the BRIC stock market indexes against the 89-day exponential moving average (EMA89), also in comparison to the US market. Currently the Chinese market is leading, and all BRIC markets are outperforming the US market.