Monday, April 14, 2014

Penguins can't fly, but they still try.

"May you live in interesting times".  - proverbial Chinese curse (although, actually may have been penned by a Brit.)  ref: http://en.wikipedia.org/wiki/May_you_live_in_interesting_times

Well, things just got much more interesting in the markets.  One could look at this as a curse or as an opportunity depending on your perspective.  I choose opportunity.

But let's not dwell on what happened in the past, let's talk about possibilities for the future.  The following is my logic behind what I believe to be the most likely scenario out of many possible scenarios for the $SPX.

First, the big picture.  Here's a 5-year, monthly chart of the $SPX (see below).  The Elder bar chart goes from the lower left to the upper right, making a series of higher highs and higher lows.  During bull trends, we sometimes get corrections which will swing to the other side of the 10m EMA and test the monthly pivot or monthly S1 support.  It feels awful, but this is completely normal.  During bear trends, we will get a series of red monthly Elder bars (3 or more) and blow away S1 support after making a lower high.  To sum up, this looks like a market in correction.  Elder bars are still blue (neutral).  We haven't had a red monthly Elder bar in years!  (That part is not normal and it wouldn't be a surprise to see one in the next few months).  The correction still may have much more work and time to go (and still be a correction in a bull market).

The 1-year weekly Elder bar chart also shows a market in correction (see below).  Note that the bars go from the lower left of the chart to the upper right (uptrending).  Zooming in , the weekly Elder bars are red, the 10w EMA is broken and turning lower, and price is back in the lower range after a failed B/O.  The red bars suggest that the lower edge of the box will get tested (1770.45).  If that level should fail on a weekly close, the simple range break projection projects to ~1692 (when Columbus sailed the ocean blue!).  I'm getting ahead of myself, though.  We haven't even touched the 30w SMA on the bottom of the box yet.  On the bullish side, the 10w EMA is still above the 30w SMA and like I said price is > 30 SMA.  Therefore, like the monthly, this also looks like a normal correction in a bull market.

Switching to the daily, we see a market where the 10d EMA is still above the 50d SMA, but price did close below both the 10d EMA and 50d SMA levels.  The 10d EMA has rolled over and rapidly approaching the 50d SMA.  Volume on the down days is higher than the up days.  Price is making a series of lower lows and lower highs (down trending).  Unlike the weekly and monthly charts, price on the daily is not moving from the lower left to upper right.  Rather it is moving across the chart like a tennis ball bouncing down the road (sideways).  This makes sense as the weekly tells us we're back in the lower range (box).  It may be too small to see next to the volume bars, but the daily RSI(2) level is @ 13.44 (which is short-term oversold).

The $COMPQ and $NDX have been leading the $SPX down and you can see that reflected in the $VXN which is already at the magic 21 level.  I'm not sure why that level has been important over the last year - all I know is that it's a level where we've reversed 3 times.  I tend to bet with the trend until it changes, so I wouldn't expect this time to be different.  What I do expect is that the $VXN is leading the $VIX just as the $COMPQ and $NDX have led on the downside.  This means that the $VIX could also get to 21-22 and that will put more pressure on the $SPX.

The % of stocks >50d SMA in the $SPX has dropped from a recent high of 84% to 39% on Friday.  Like the $VIX >21, this has been an excellent indicator of buying opportunities in the past year (and beyond).  It doesn't like to stay above 83% or below 33% for very long.  So, typically, you wouldn't want to be buying index longs above 83%.  Likewise, you wouldn't want to be starting new index shorts below 33%.  The only caveat with this excellent indicator is that during bear trends (as judged by weekly and monthly price charts) it can go to zero.  That's what happens (0% readings) in entrenched bear trends and the weekly and monthly charts are NOT suggesting that's our current status.

Another indicator which is still somewhat new to me but nonetheless useful is the Participation Index.  (It's good to learn new stuff.)  When the PI has several climatic readings below -70 that seems to indicate a flush-out of nervous longs and overzealous shorts.  So far, we've had 1 reading below -70 in this current decline.  Typically, we get more than 1.

OK, so what does it all mean?  The weekly and monthly charts point to a market in a correction within the broader context of a bull market.  The daily chart is weak.  $VIX, $SPXA50R, and $SPX_PI are all suggesting at least 1 more flush down.

Putting all the pieces together, the most likely scenario on the daily time frame is a weak bounce to alleviate the oversold condition [RSI(2) = 13.44].  (Picture a penguin trying to fly.)  Then, 1 more flush down which will align the indicators:  $VIX>21, $SPXA50R <33%, $SPX_PI < -70.  Usually, when all 3 line up, we get a trade-able rally which could take us to the end of April.  After that we'll see how things shape up, but my bias is to expect a summer slowdown (not a crash) - possibly testing the monthly pivot (S1) and reaching the box projection of 1692 on the weekly chart.  This would also jive with negative seasonality and mid-year presidential cycle work.

Now that I have a likely blueprint in hand, I'll be on the lookout to see where I'm wrong.  Where could I be wrong?  Basically, anything that suggests a sharp rally or a sharp correction/crash.  A violent rally next week of >2% on heavy volume would poke a hole in the "penguin flying theory".  A sustained rally well past the end of April would make me question the summer correction.  Alternatively, if we got no bounce at all and instead see the $VIX start spiking well past 21, say >30, and the $SPXA50R and $SPX_PI seeing multiple hard thrusts below 33% and -70 that would suggest a bear phase ahead (not just a correction).