Market Weekly Update

The Leading-Wave index raises a red flag for a short-term overbought market with a projected bearish time-window until 2/7/2013. The “Three Peaks and a Domed House” formation on the S&P 500 index suggests that the “Roof” phase could be around 1570 with a price range between 1550 and 1590, as an intermediate-term price target. The Elliott Wave analysis projects 1770 as a long-term price target for the SPX.

• Leading-Wave Index Raised a Red Flag
• Intermediate-Term Picture of the S&P 500 Index
• Long-Term Picture of the S&P 500 Index
• Market Ratio and Competitive Strength
• Gold (Weekly) in a 18-Month Symmetrical Triangle Pattern
• Gold (Daily) in a 4-Month Downtrend Channel
• Silver in a 4-Month Downtrend Channel
• Crude Oil Bullish Breakout from 7-Month Symmetrical Triangle
• US Dollar in a 4-Month Descending Triangle
• US Treasury Bond Weakening
• Asset Class Performance Ranking with Oil Leading
• Sector Performance Ranking with Home Construction Sector Leading
• BRIC Stock Market Performance Ranking with the Chinese Market Leading

The Broad Market Instability Index (BIX), measured from over 8000 U.S. stocks, closed at 8 on Friday (down from 14 the previous week) which is below the panic threshold level of 44 and indicates a bullish market. Last week the Leading-Wave Index (LWX) continued raising a red flag with its first-week negative readings after two months (see the first table above). Based on the forecast of the LWX, the broad market should be in a short-term bearish time-window until 2/7/2013 (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 14 weeks since my Weekly Update of 10/31/2012. The “Three Peaks and a Domed House” pattern is a complex chart formation, 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 and 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 hit 4-month low near 1350 which was in the “Basement” phase. This phase is typically a “bear trap” near the bottom of a down cycle with a bearish market sentiment combining all bearish views from both headline news and 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 typically a phase transition from the “Basement” phase to the “First Floor” phase while the broad market continues the accumulation stage although the general sentiment is skeptical, or even still bearish.

First Floor phase: In January, the SPX spent about weeks in the “First Floor” phase between 1450 and 1470. This phase is typically a consolidation in price movement. The accumulation stage of the market cycle usually ends in this phase with a change of the general market sentiment from bearish to neutral.

Continuation Advance: Currently the SPX is drifting up for a continuation advance above the “First Floor” phase. This advance is a phase transition from the “First Floor” to the “Roof”, and it usually has two segment up-moves with wave 21 and wave 23 as described in George Lindsay’s original model, as the general market sentiment becomes bullish. Negative divergences between market prices and technical indicators start building up.

Roof Phase: The SPX is approaching the “Roof” phase but it is not there yet. The price target for the “Roof” phase is projected at 1570 with a range between 1550 and 1590. Please be aware of that the “Roof” phase is also typically a “Bull Trap” for blind trend-followers.

This ongoing intermediate-term “Three Peaks and a Domed House” formation is supported by the standard weekly MACD Histogram indicator mathematically mapped on the following SPX daily chart, marked with each stage of the market cycle. The market currently is in the mark-up stage with rising MACD above the zero line.

There are several ways to count Elliott Wave on the S&P 500 index. If you have seen another count somewhere else, please just treat my count as a second opinion. The following chart is a weekly chart of the S&P 500 index, with my Elliott Wave count, in a four-year time span. The stock market crash of 2008 resets the market in early March 2009 as “ground zero” for the beginning of wave count.

Primary Wave: From the 2009 low, the primary wave of the SPX carried impulsive wave [1] up to a high in May of 2011, and corrective wave [2] down in August of 2011. Since then, the SPX has been in impulsive primary wave [3].

Intermediate Wave: Inside the current primary wave [3], the intermediate wave started from August low in 2011, with wave (1) up to April high in 2012 and wave (2) down to June low in 2012. Then the SPX has been in intermediate wave (3).

Minor Wave: Inside the current intermediate wave (3), the minor wave started from June low in 2011, with wave 1 up to last September high and wave 2 down to last November low. Then, the SPX has been in minor wave 3.

Minute Wave: Inside the current minor wave 3, the minute wave started from last November low near 1350, with wave [i] up to 1448 in mid-December, and wave [ii] down to 1400 in the end of December. So far the SPX has been up about 110 points in minute wave [iii]. Wave [iii] is projected to end at 1512 (based on 0.618 extension of wave [i]), and corrective wave [iv] probably is due to come. Wave [iv] may go sideways because wave [ii] in December was relatively sharp.

It is very significant for a potential strong bull market in superposition of the third waves in multiple wave degrees at the same time.

Long-Term Target Projection: This wave count suggests that the SPX may have strong potential to move much higher beyond its 2007 high, in the current presidential cycle. By using the height of primary wave [1] described above, the price target for primary wave [3] is estimated as:

(1350-670)x0.618 + 1350 = 1770.

The magnitude from the 2009 low to this price target, could be comparable to the total 1100-point advance of the SPX in the big bull market between 1995 and 2000. Actually, the SPX has been already up about 843 points since the 2009 low. Only about 257 points left in the upside, i.e., the SPX reaching 1770 from the present level of 1513, to exactly match the total-point move of the SPX in the period of 1995-2000.

The market ratio is very helpful to compare strengths between two markets. The table below tracks weekly performances for several pairs of markets, i.e., the euro vs. the US dollar, the Greek market vs. the Chinese market, the long-term rate vs. the short-term rate, the S&P 500 index vs. gold, small caps vs. large caps, the US market vs. the world market, and Apple vs. BlackBerry.

For each pair of markets listed in the table, the market ratio is calculated by dividing one market by another. Then the competitive strength is further evaluated from a percentage change of the ratio against its 89-day exponential moving average. The results divide the markets into two groups: outperforming markets and underperforming markets, for this week as follows:

This year each week I am going to talk about one pair of markets in the table above. Last week I discussed the market ratio of Apple to BlackBerry. This week I focus on the pair of the Russell 2000 (small-caps) and the Russell 1000 (large caps).

Small-Caps vs. Large-Caps: At the beginning of January, we checked the “January Effect”. Now it is the time to check it again as January ended. The “January Effect” means 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. Last Wednesday, the ratio sharply broke the 10-week uptrendline to the downside, that could be a sign for ending the “January Effect”. Also there is a megaphone pattern formed on the ratio for last four weeks. This pattern is a typical topping formation. It suggests that small-cap stocks should start to weaken and large-cap stocks should become outperforming small-cap stocks.

The weekly chart shows that the gold index has formed a 18-month Symmetrical Triangle pattern in the intermediate-term. Prices have wound around 1700. Gold could continue the sideways near this level before it breaks out from the triangle. Gold has coupled with the Japanese yen very well for last five years. The recent sharp decline of the Japanese yen may raise a question: will gold follow the yen to decline or will it decouple from the yen?

The gold index has formed a 4-month downtrend channel. Also it is forming a 6-week horizontal channel inside the downtrend channel. It indicates that gold currently is in sideways. We may pay attention to the competitive strength between the SPX and gold updated every week in the table of the Market Ratio and Competitive Strength section above.

Same as gold, the silver index has formed a 4-month downtrend channel. It also is forming a 2-month symmetrical triangle.

Crude oil formed a 7-month Symmetrical Triangle pattern. It has broken the upper boundary of the triangle. An upside price target is projected at 106.

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. Now it is testing the lower boundary of the triangle.

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 30-year U.S. treasury bond has recently broken a 2-year rising wedge pattern to the downside. A price target could be projected at 134.

The following table is the percentage change of each asset class (in ETFs) against the 89-day exponential moving average (EMA89). Currently crude oil is outperforming, and 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 5.66% above the EMA89. Outperforming sectors are Home Construction (11.22%), Internet (10.03%), and Biotech (7.99%). Underperforming sectors are Precious Metals (-6.12%), Technology (1.03%), and Telecommunication (2.88%). The S&P 400 Mid-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 the Brazilian market is lagging.