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August 23, 2008

Monotonous Creep

Friday's action felt like one of those water torture sessions circa 2006 where everyone knows the market should be declining, but instead the audience is treated to a monotonous creep higher. The problem, I believe, is that everyone and his brother shorted the break of the bear flag in the S&P 500, so there was no one left to sell. The lethargic march higher can be attributed to the shorts slowly timing out their positions. It certainly was not the bulls who were pushing this market higher. If it were, the move would have been much more exuberant, especially considering oil coughed up Thursday's $6 gain and then some.

From a technical standpoint, the bulk of Friday's action took the form of a consolidation of the rally off Thursday's low. Price also escaped a 2-week long consolidation channel, so one would have to continue to hold a modest upside bias for the coming hours.

stock chart

I am nevertheless on high alert for signs of the start the next down leg because I believe it will be a doosie, and I want to be heavily positioned in front of it. For Elliott Wave enthusiasts, here is my interpretation of the labelling from the start of the bear:

stock chart

As you can see, the impulse waves all take 5-wave forms and all upward corrections are 3-wave, as would be expected. We are currently in a wave 2 correction of primary Wave 3 down. So why do I expect wave 3 of 3 to be so nasty? Apart from the dismal macro environment in which we find ourselves, wave 3 of 3 typically sees the largest moves. It is the heart of the cycle, after all. However, take a look at the last minor wave 5: the one that ended wave 1 of primary Wave 3 (the drop into the July low). It stretched much further than the first four waves of the move, and I think this disproportion is telling us that something is very wrong. Combine this interpretation with all the red flags about Lowry's selling pressure and left-translated 4-year cycles that Gary has posted for us, and I think there is ample cause for a bearish outlook.


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