ELLIOTT WAVE COUNT FOR THE S&P 500 - RELATIVE STRENGTH IN DEFENSIVE SECTORS - MEDIUM-TERM UPTRENDS REMAIN IN FORCE - LONG-TERM WEAKNESS IN FINANCE - COMMODITIES LIKELY TO FOLLOW STOCKS - XLE HITS LONG-TERM RESISTANCE ZONE

ELLIOTT WAVE COUNT FOR THE S&P 500 ... Link for todays video. At the risk of opening Pandoras box, I am going to offer some long-term Elliott Wave analysis for the S&P 500. Like much of technical analysis, Elliott Wave is subjective and open to interpretation. Chart 1 shows the S&P 500 as a 5-day exponential moving average over the last three years. Price action encompasses the October 2007 peak around 1550, the March 2009 low around 670 and the 2009 advance above 1150. I last showed such a chart in Arts Charts on September 18th. Believe it or not, the basic analysis remains unchanged. If we assume that bear markets consist of five waves (3 down and 2 up), it looks like the 2009 advance was Wave 4 of a five wave decline. Wave 3 is typically the longest and deepest of the three down waves. The decline from May 2008 to March 2009 was certainly extreme. Given the severity of this decline, a monster corrective Wave was certainly possible. This would be Wave 4, which extends from the March low to the January high. Also notice that Wave 4 retraced around 62% of Wave 3 and formed an ABC pattern. Wave A extends from the March low to the June high, Wave B represents the June-July correction and Wave C extends from the July low to the January high. The Fibonacci retracement, overall wave count and ABC correction fit nicely with Elliott wave theory. No wonder Bob Prechter is so bearish! This is as good a spot as any for a top to form.

Chart 1

In mid September, I suggested that Wave 4 could conceivably reach 1145, which it has. The key was, and still is, the uptrend in Wave 4. The bulls have a clear edge as long as the trend remains up for Wave 4. A trend reversal or end of Wave 4 would signal the start of Wave 5. Even though the Wave 4 uptrend remains in place, lets look at some Wave 5 projections. Wave 5 could exceed the low of Wave 3 or it could be a truncated Wave 5. Needless to say, a move below the Wave 3 low would entail some pretty dire economic or financial consequences. As a truncated Wave 5, the decline could retrace a portion of Wave 4. This might entail a 50-62% retracement and a move towards the support zone around 900. Projecting the start and extent of Wave 5 is tricky business - just like predicting the stock market.

DEFENSIVE SECTORS PERKING UP... A lot of potentially bearish indications surfaced last week. First, the S&P 500 experienced its sharpest three day decline since March. Second, the volatility indices surged as fear and uncertainty gripped the market. Third, some defensive sectors have been outperforming the past month. Chart 2 shows the S&P Sector Perfchart comparing the performance of the nine sectors against the S&P 500. This is relative performance (relative gain/loss), not absolute performance (actual gain/loss). The Technology and consumer discretionary sectors show relative weakness over the past month. In contrast, consumer staples and healthcare show relative strength. Technology represents the markets appetite for risk and consumer discretionary is the most economically sensitive sector. Relative weakness in these two sectors is negative. Healthcare and consumer staples are defensive sectors that usually outperform during risk-averse market periods.

Chart 2

OVERALL TREND REMAINS UP FOR MAJOR INDEX ETFS... Despite recent negatives, the overall trends remain up for the major index ETFs. DIA, IWM, QQQQ and SPY all recorded new 52-week highs within the last two weeks. In addition, all remain above support zones established by the prior consolidations (late November to early December). Chart 3 shows the Dow Diamonds (DIA) with support at 101-102. Chart 4 shows the Russell 2000 ETF (IWM) with support around 61-62. Chart 5 shows the Nasdaq 100 ETF (QQQQ) with support at 43. A downtrend requires a lower low and/or support break of some sort. Last weeks decline was the shot across the bow. Further weakness with important support breaks would reverse the uptrend and signal the start of a downtrend that could last several months. Before getting too bearish, I would also like to point out that tops can be more complicated and drawn out than bottoms. This is why distribution patterns form (head-and-shoulders, double top, triple top, diamond).

Chart 3

Chart 4

Chart 5

LONG-TERM WEAKNESS IN FINANCE... The Financials SPDR (XLF) has been relatively weak for months. Chart 6 shows XLF over the last three years, which encompasses the big decline from September 2008 to March 2009. This decline started with the Lehman bankruptcy on September 15, 2008. XLF bounced back with a sharp rally from March to August 2009, but this advance only retraced 50% of the prior decline. The ETF hit 15 in August and traded flat the next 4-5 months. While XLF was meandering around 15, SPY added another 15% with an advance from 100 to 115. The inability of XLF to rally with the market over the last 4-5 months shows relative weakness, which is now turning into absolute weakness. XLF formed a lower high in January and was one of the weakest sectors last week. Chart 7 shows XLF with a triangle forming over the last few months. A move below 14 would break triangle support and weigh on the rest of the market. Finance is still the second biggest sector in the S&P 500.

Chart 6

Chart 7

COMMODITIES FOLLOWING STOCKS... The combination of a strong Dollar and weak stock market would likely be bearish for commodities. Chart 8 shows the US Oil Fund ETF (USO) over the last two years. The S&P 500 peaked in October 2007 and USO peaked in June 2008, nine months later. Even though USO held up longer than the stock market, the 2008 plunge in the stock market took oil along for the ride. This plunge was aided by strength in the Dollar. With the Euro under pressure and the stock market getting hit, we should keep an eye on oil and commodities. After an incredibly sharp decline below 20 at the end of 2008, USO worked its way back to 25 at the end of 2009. While the overall trend since March is up, the rally over the last 10 months pales in comparison to the prior decline. In addition, this advance formed a rising wedge, which is typical for corrective rallies. A break below the wedge trendline would be quite negative. On the daily chart, USO established support with higher lows in October and December. A move below 35 would break the October low, forge a lower low and reverse the uptrend. Chart 10 shows the DB Commodity Index Tracking ETF (DBC), which is heavily weighted with oil related commodities.

Chart 8

Chart 9

Chart 10

XLE HITS LONG-TERM RESISTANCE ZONE... Any significant move in oil would likely weigh on the energy sector. Chart 11 shows the Energy SPDR (XLE) hitting a resistance zone around 60 for the second time in four months. After a sharp decline below 40 in the second half of 2008, XLF bounced back to 60 in the second half of 2009. This advance retraced a little less than 50% of the prior decline. This retracement is shallower than other sector retracements over this same timeframe. XLE also has resistance around 60 coming from broken support levels. Chart 12 shows the daily bar chart focusing on the current advance. XLE hit resistance twice around 60 and established support at 54. It looks like a double top that would be confirmed with a support break at 54.

Chart 11

Chart 12