SETTING A SHORT-TERM BEAR TRAP - REGIONAL BANK ETF RECOVERS BIG TIME - XLF LEADS SECTORS HIGHER - THE PANIC PHASE OF A BEAR MARKET - SPY NEARS 62% RETRACEMENT MARK - MAJOR INDEX ETFS REMAIN IN MEDIUM-TERM UPTRENDS

SPRINGING THE BEAR TRAP... Video Link (click here) Fighting the bigger trend is a dangerous game. With a sharp sell-off in the final hour on Wednesday, the S&P 500 ETF (SPY) broke below its prior low to reverse the short-term uptrend. This support break did not last long. Instead of continuing lower or consolidating below the support break today, chart 1 shows SPY firming and then surging back above broken support to spring a potential bear trap. The ability to recover quickly and strongly is a warning to bears. As long as the medium-term uptrend remains, a bullish resolution to short-term pullbacks is more likely than a bearish resolution. Having said that, I will note that SPY has yet to exceed its prior highs around 110. Chart 1 shows SPY forging a lower low on Wednesday, we have yet to see a higher high and CCI has yet to surge above +100. Technically, the short-term downtrend is still alive - barely. And, just to keep things interesting, Amazon, American Express and Broadcom report after the close today.

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REGIONAL BANKS REBOUND... Yesterday I reported on relative weakness in the Regional Bank SPDR (KRE) after a sharp decline on high volume. Most of this decline occurred in the final hour of trading. In particular, banks were hit after a banking analyst downgraded Wells Fargo (WFC) to sell from neutral. Despite Wall Streets reaction on Wednesday afternoon, the Regional Bank SPDR firmed Thursday morning and surged above Wednesdays high today. Welcome to earnings season. A bad report sparks a sell-off one day while a good report ignites buying pressure the next.

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Chart 3 shows KRE with a bounce off triangle support today. There is a support zone around 20-20.5 extending back to the August lows. Even though KRE still shows relative weakness over the last few months, support is holding and the bulls have reclaimed the edge for two reasons. First, the ETF surged in July-August and then formed a big triangle. This surge is bullish and the triangle is neutral. Overall, this triangle has a bullish bias because of the July-August surge. Second, the ETF recovered immediately after yesterdays debacle and upside volume was strong today. A break below the October lows would turn this chart bearish again.

FINANCE SECTOR ALSO REBOUNDS... After leading the sectors lower on Wednesday, the Financials SPDR (XLF) led the sectors higher on Thursday. Chart 4 shows XLF opening strong and moving above yesterdays close. The ETF has yet to fill last weeks gap or exceed yesterdays high, but this rebound show resilience nonetheless. I am marking a short-term resistance level based on this weeks high. Look for follow through above these levels. Keep in mind that the medium-term uptrend provides a powerful headwind for short-term downtrends. After all, the medium-term trend is bigger and stronger than the short-term trend. Even though last weeks island reversal and this weeks decline showed short-term weakness within a medium-term uptrend, the medium-term uptrend has all the trump cards.

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BEAR MARKETS AND DOW THEORY... It never hurts to review the classics. This past week I was reviewing Dow Theory from Technical Analysis of Stock Trends (Edwards & Magee 1948). It is a classic that every aspiring technical analyst should read and it can be found in the Stockcharts.com bookstore. No, I dont have the original 1948 version, but the chapter on Dow Theory is virtually unchanged. When reviewing the phases of a bear market, I was struck by the following paragraph:

The second phase is the Panic Phase. Buyers begin to thin out and sellers become more urgent; the downward trend of prices suddenly accelerates into an almost vertical drop, while volume mounts to climatic proportions. After the panic phase (which usually runs too far relative to then-existing business conditions), there may be a fairly long Secondary Recovery or a sideways movement, and then the third phase begins.

This version of the panic phase sure sounds like the May 2008 to March 2009. Chart 5 shows the S&P 500 ETF (SPY) over the last three years. The first phase of the bear market clearly started with the peak in October 2007. After a secondary bounce in early 2008, the second or panic phase started with the peak in May 2008. This decline included a panic in September, a lower low in November and a final low in March 2009. Does the November-December bounce count as the secondary recovery (orange highlight)? If so, then this would make the January-March decline the third, and final, phase of the bear market. By extension, this would make this years rally the start of a new bull market.

Chart 5

Given the depth of the May-November decline, I think the November-December bounce was too shallow and short to be considered a secondary recovery. According to Dow Theory, there may be a fairly long secondary recovery. This fits with the current recovery from March to October. If we are indeed in such a recovery now, then resistance may be at hand soon. The Fibonacci Retracements Tool shows SPY within 5% of the 62% retracement mark at 1209. This is the maximum one would expect from a secondary recovery.

FOCUSING ON THIS YEARS UPTREND... Even if the March-October advance is one big secondary rally and the Fibonacci retracement is near, this is NOT reason enough to turn bearish now. Why? Because the March-October uptrend has yet to actually reverse. SPY is clearly overextended after a 20% advance in the last 2-3 months and near a long-term retracement, but the uptrend since March has yet to actually reverse. Turning bearish now would be picking a top, not identifying a reversal. This is what separates top pickers from trend followers.

Chart 6 shows SPY from March to October. SPY remains in an uptrend with a rising wedge taking shape. These are potentially bearish patterns, but wedges require confirmation with a trendline break, at the very least. Technically, the trend is up as long as the wedge rises. As far as I am concerned, it would take a break below the early October low to reverse this uptrend. In fact, I would also require the other three major index ETFs to break their early October lows. Think of it as confirmation of a trend change. This means a medium-term trend reversal would occur if the S&P 500 ETF (SPY), Russell 2000 ETF (IWM), Nasdaq 100 ETF (QQQQ) and Dow Diamonds (DIA) all break their October lows. These other charts are also shown for reference.

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