Forth Week in Roof Phase

The S&P 500 index is still in the “Roof” phase (Bull Trap) of the intermediate-term “Three Peaks and a Domed House” pattern. The broad market should be topping and a correction would come next. The Leading-Wave Index forecast indicates a short-term bearish time-window until 4/10/2013 followed by a neutral period.

Table of Contents

• Broad Market in a Short-Term Bearish Time-Window
• Intermediate-Term Picture of the S&P 500 Index
• Long-Term Picture of the S&P 500 Index
• Short-Term Picture of the S&P 500 Index
• Market Ratio and Competitive Strength
• Gold (Weekly) in 19-Month Descending Triangle Pattern
• Gold (Daily) in 6-Month Descending Broadening Wedge
• Silver in 5-Month Falling Wedge
• Gold/Silver Stocks in 6-Month Downtrend Channel
• Crude Oil in 10-Month Ascending Triangle
• US Dollar in 7-Month Broadening Ascending Triangle
• US Treasury Bond Returned into 3-Year Uptrend Channel
• Asset Class Performance Ranking with Equity Leading
• Sector Performance Ranking with Biotech Sector Leading
• BRIC Stock Market Performance Ranking with the Russian Market Lagging

Broad Market in a Short-Term Bearish Time-Window

The Broad Market Instability Index (BIX), measured from over 8000 U.S. stocks, closed at 87 on Friday (up from 11 the previous week) which is above the panic threshold level of 44 and indicates a bearish market. The Leading-Wave Index (LWX) is in a short-term bearish time-window. Based on the forecast of the LWX, the broad market would be in a short-term bearish time-window until 4/10/2013 (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:

Intermediate-Term Picture: S&P 500 Index in “Three Peaks and a Domed House” Formation

We have been tracking the current speculated “Three Peaks and a Domed House” pattern of the S&P 500 index for 23 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 SPX is still in the “Roof” phase. The market is in a mixed sentiment and becomes very sensitive to any good or bad news. The “Roof” phase is typically a “Bull Trap” for blind trend-followers. One major characteristics in this phase is a negative divergence between the price and technical indicators. Before the “Plunge” phase, there are still two steps: 1) completion of the “Roof” phase, and 2) a phase transition from “Roof” to “Plunge”.

This intermediate-term “Three Peaks and a Domed House” formation also can be checked with the standard weekly MACD Histogram indicator mathematically mapped on the following SPX daily chart, marked with each stage of the market cycle. The current market is in the distribution stage in which prices usually are very choppy.

Scenario 1: 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 had a massive washout and reset the market in early March 2009 as “ground zero” for the beginning of wave count.

There are four degrees of waves: Primary, Intermediate, Minor, and Minute waves in this weekly chart. The SPX currently is in primary wave [3], intermediate wave (3), minor wave 3, and minute wave [a]. Superposition of the third waves in multiple degrees typically carries the best part of a bull market.

How high can this third primary wave go? A long-term price target for primary wave [3] is projected at 1770 by using 0.618 extension of wave [1]. However, there would be a couple of corrective waves, i.e., minor wave 4 and intermediate wave (4), before the price target of 1770.

Scenario 2: There is another way to count Elliott waves. If we consider the large cycle degree, since 2000, the SPX has been in “Flat” waves with:

Cycle wave A from the high in 2000 to the low in 2002,
Cycle wave B from the low in 2002 to the high in 2007,
Cycle wave C (W) from the high in 2007 to the low in 2009,
Cycle wave (X) from the low in 2009 to the current high in 2013.

The following weekly chart of the SPX shows a detail wave structure for cycle wave (X) from the low in 2009 to the present high in 2013. It contains impulsive wave [A], corrective wave [B], and impulsive wave [C] in the primary degree.

Wave [C] is in a Diagonal Triangle (rising wadge) formation having intermediate wave (4) overlapped with intermediate wave (1). The diagonal triangle appeared in either wave 5 or wave c is typically characterized as an Ending Diagonal, which corresponds to a bearish rising wedge pattern in our case. If prices break to the downside of the diagonal, another corrective wave A in the cycle degree should be the next.

Scenario 1 and scenario 2 give tow different perspectives, bullish in the former one and bearish in the latter one. But both of them suggest that at this point the current market faces a correction, just a matter of how deep. It can be cross-checked with the potential “Plunge” phase of the current “Three-Peaks and a Domed House” pattern of the SPX.

The following daily chart of the S&P 500 index shows a wave structure in the minute degree with waves [i], [ii], [iii], [iv], and [v] in a well-defined bullish uptrend channel from mid-November to the present.

Wave [v] should have ended, and Wave [a] just starts. Prices are going to test the lower boundary of the 4-month-long uptrend channel. Breaking-down the lower boundary of the channel should be a sign for a trend change.

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 will talk about one pair of markets in the table above. Last week, I discussed the U.S. stock market vs. the international stock market. This week let’s check small-cap stocks vs. large-cap stocks again.

Small-Caps vs. Large-Caps: The chart below is a daily chart in 8-month time span for the ratio of the Russell 2000 index of smaller companies divided by the Russell 1000 index of largest companies. Rising in the ratio indicates outperforming of small-cap stocks. The ratio formed a 3-month Ascending Broadening Wedge pattern. This pattern is a typical topping formation. In March the ratio formed a Partial Rising pattern which the ratio could not reach the upper boundary of the wedge. This partial rising is typical bearish sign for a downside breakout from the wedge. Last week the ratio actually broke through the lower boundary of the wedge. The sharp decline in the ratio indicates much weakening in small-cap stocks.

The weekly chart shows that the gold index has formed a 19-month Descending Triangle pattern in the intermediate-term. Prices are testing the lower boundary of the triangle. Defending the price level of 1575 is critical for gold to prevent a free fall.

The gold index has formed a 6-month Descending Broadening Wedge. It also has a 6-week trading range inside the wedge. Prices could be in sideways before a breakout from the wedge.

The silver index showed more weakness than gold. It has formed a 5-month Falling Wedge. It would be bearish until prices break out from the upper boundary of the wedge.

Gold/silver mining stocks are in a 6-month downtrend channel, very bearish.

Crude oil has been in a 10-month ascending triangle pattern. It could be in sideways before it break out from the triangle.

The U.S. dollar is forming a 7-month Broadening Ascending Triangle pattern. Although this pattern has a bearish bias, but it has poor performance of direction suggestion. The U.S. dollar should continue its consolidation.

The 30-year U.S. treasury returned to a 3-year uptrend channel after it rebounded in March, and regained strength. Considering the current deflationary environment indicated by the inflation rate below 3%, bonds have an inverse relationship with stocks. Strengthening in bonds means weakening in stocks.

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, and gold 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 3.40% above the EMA89. Outperforming sectors are Biotech (12.64%), Healthcare (7.55%), and Pharmaceuticals (6.85%). Underperforming sectors are Precious Metals (-11.80), Materials (-2.30%), and Technology (-1.50%). The DJ Industrial Average 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 Russian market is lagging.