POSITIVE DIVERGENCES AND PROXIMITY TO 2002 LOW INCREASE ODDS FOR SHORT-TERM BOTTOM -- SO DOES THE DOUBLE TOP IN THE VIX INDEX -- GOLD BREAKOUT HINTS AT OVERSOLD BOUNCE IN OTHER COMMODITIES
SHORT-TERM TREND HAS IMPROVED ... I wrote on Monday that I thought the major market indexes could reach their early November peak and/or their 50-day moving averages on the current rebound. That's not such an ambitious forecast. Even so, a number of readers asked why I was even that optimistic. Actually, there are several reasons. Let's take just three here. Earlier in the month, I wrote about a triangle formation in the S&P 500 that lasted from mid-October to mid-November. I explained that a triangle formation carries good and bad news. The bad news is that, in a downtrend, the triangle is usually followed by another downleg. The good news is that, according to Elliott Wave Theory, a triangle is usually a fourth wave in a five-wave decline. I've marked off those five waves in Chart 1. Once that fifth wave is completed, the decline starting in mid-September has run its course and a rebound is due. How do we know when the fifth wave is complete? In this case, there are at least two clues. The first clue is that the S&P 500 bounced off major chart at its 2002 low at 768 last week (horizontal line). Since that's a potential major support level, that's a logical spot for a rebound to start. The other clue is the number of short-term positive divergences that have appeared on daily charts. On Monday, I showed a positive divergence on the 14-day RSI line. Today, I'm showing a similar pattern on the daily MACD lines (below chart).
Chart 1
MACD POSITIVE DIVERGENCE... The two lines below Chart 1 are the daily MACD lines which measure the market's short-term trend. They turned negative in early September as the market started its last big downturn. The lines turned positive in October during the triangle formation. While the S&P fell to a new low last week, however, notice that the MACD lines failed to do so. In fact, they appear to be turning positive again today. The fact there there are two "rising bottoms" in the MACD lines suggests that the last downleg was the final one (at least for now). [Oscillator divergences during a fifth wave are especially meaningful]. That raises the question as to how far a rebound could carry. Once a fifth wave is complete in a downtrend, a rally to the top of the fourth wave is normal. That would be the early November peak. That would also be a fifty percent retracement of the September/November decline, and would put the S&P close to its 50-day average as shown in Chart 3. The ability of the S&P to climb back above its late-October low near 850 is another positive sign.
Chart 2
DOUBLE TOP IN VIX IS ALSO ENCOURAGING... One of our readers asked if the "double top" in the CBOE Volatility (VIX) Index meant anything. I think so. First of all, the inability of the VIX to exceed its November high is another positive short-term divergence for the market. The VIX and the S&P trend in opposite directions. The uptrend in the VIX since early September has mirrored the decline in the S&P 500. Except for last week. Last week's peak in the VIX fell short of its late-October peak. That occurred while the S&P was hitting a new low. That's a positive divergence for the market. Notice also that the daily MACD lines are turning negative for the second time in a month. Even more meaningful is the fact that the VIX is threatening to break its 50-day average for the first time in nearly three months. A downturn in the VIX is good for stocks.
Chart 3
MORE ON GOLD BREAKOUT ... One of our readers asked what criteria I used to describe the recent upside "breakout" in gold. I explained exactly what criteria I used in last Friday's market message in the headline: "Gold Breaks Out to New High for the Month". I explained that gold had climbed above its recent consolidation pattern to turn its short-term trend higher. Chart 4 shows the upside breakout (see circle). The same reader asked why I didn't include crude oil since it had also rebounded. I didn't include oil because it didn't achieve any upside breakout. I did suggest, however, that the gold breakout hinted at a short-term top in the dollar which could boost other commodities. Chart 4 shows the United States Oil ETF (USO) still in a downtrend. Its 14-day RSI line and its daily MACD lines, however, are showing positive divergences. That suggests that crude and other commodities may also bounce along with the stock market. Other factor favoring an oil bounce is the relatively solid performance by energy stocks. Chart 6 shows the Energy SPDR (XLE) holding above its October lows and heading toward the top of its recent trading range. Its relative strength ratio (below chart) has been moving up all month. That also increases the odds that an oversold oil market is due for a bounce. Given the close correlation between stocks and commodities, a bounce in the former could lead to a similar bounce in the latter. That's especially true if the U.S. Dollar continues to weaken.
Chart 4
Chart 5
Chart 6
THANKSGIVING BOUNCE ... Not only does the market's short-term bounce finally give us something to be thankful about, Thanksgiving Day itself usually does also. At least most of the time. According to the Stock Traders Almanac, the days before and after Thanksgiving have seen market gains eighty percent of the time in the last fifty six years. That bodes well for the rest of the week and also increases the odds that November will end on an upnote. Although seasonal influences have been less pronounced over the past month, it's encouraging to know that December is traditionally the strongest month of the year. That's also according to the Stock Traders Almanac. It's probably asking too much to expect a strong market advance between now and year end. Most of would settle for a short-term bounce or a period of reasonable stability. That would certainly be something to be thankful for. Happy Thanksgiving.
