ALTERNATION SUGGESTS FLAT WAVE 4 FOR S&P 500 -- DEEPER CORRECTION TARGETS BROKEN RESISTANCE -- FINANCE HITS SUPPORT FROM RISING WEDGE TRENDLINE -- HOME-BUILDER AND HOME-CONSTRUCTION ETFS CONTINUE TO LAG -- MATERIALS SECTOR GOES THE WAY OF CHINESE STOCKS
ALTERNATION SUGGESTS FLAT WAVE 4 FOR S&P 500... Link for todays video. The S&P 500 has a five wave advance working since the July low. Wave 1 extends from the July low to the early August high. Wave 2 extends down to the late August low. Wave 3 extends up to the early November high. Wave 2 can be subdivided into a single zigzag correction with an ABC pattern. Single zigzags are the most basic of Elliott Wave corrections. In his book, Elliott Wave Principle, Prechter covers the rule of alternation within impulse waves. Basically, if Wave 2 is a simple zigzag, expect Wave 4 to be a sideways correction, such as a flat or triangle. Chart 1 shows a potential symmetrical triangle with an ABCDE pattern. With yearend approaching, it is possible that a shorter flat evolves with just an ABC pattern.
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Chart 1
According to Elliott Wave, fourth waves do not form as pullbacks or declines, but rather sideways trading ranges that build a base from which the fifth wave spring. As their name implies, flats are flat. They are three wave patterns that end with a break above Wave B. Triangles are five wave structures that form an ABCDE pattern, which is a more extended correction. For normal triangles, traders can expect support near the lows of Waves A and C. A break above the high of Wave D signals that wave 5 is underway. Abnormal triangles are also possible. In other words, we could see an expanding triangle with higher highs and lower lows over the next few weeks. Such a pattern would signal an increase in volatility as Wave D exceeds the high of Wave B and Wave E exceeds the high of Wave C.
BROKEN RESISTANCE AND RETRACEMENT ZONE TURN SUPPORT ... Despite the Elliott Wave expectation for a trading range correction now, traders should also be aware of alternatives, such as a deeper correction. Chart 2 shows the S&P 500 ETF (SPY) with an exhaustion gap and a channel break. Both are bearish developments that argue for a correction, which could be as a pullback or a flat trading range. Yes, there are two ways to correct. Should a pullback unfold, chartists should turned to the next important support zone. This means looking for more than one factor to confirm a support area. Two factors point to support in the 112 area. First, broken resistance turns into support here. Second, a 50-62% retracement of the prior advance would extend to this area.
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Chart 2
FINANCE HITS SUPPORT FROM RISING WEDGE TRENDLINE... Finance-related stocks started the month strong, but fell back rather sharply the last 1-2 weeks. Chart 3 shows the Finance SPDR (XLF) surging above 15.5 in early November and then giving most of it back with a decline back below 15. As John Murphy noted on Thursday, XLF found support at two key moving averages, the 50-day SMA and the 200-day. Combined with the wedge trendline, an important support test is at hand. The chart shows the August-November advance retracing 62% of the prior decline with a rising wedge. These patterns sometimes form as corrections within an uptrend. For now, the wedge is rising and the trend remains up. In addition to the moving averages, there is a lot of support from the lows in late September and early October. A move below 14.25 would clearly reverse this uptrend and break wedge support. This would call for a continuation of the prior decline. It hasnt happened yet, but this is something we should keep an eye on as European debt issues surface. The indicator window shows the price relative still trending lower. Even with the early November surge, this relative strength indicator did not break its down trendline.
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Chart 3
Chart 4 shows the Regional Bank SPDR (KRE) with an even weaker rally the last few months. Whereas XLF retraced 62%, KRE has only retraced 38% of the prior decline. KRE remains in an uptrend with a rising channel taking shape. I am marking key support at 22.
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Chart 4
HOME-BUILDER AND HOME CONSTRUCTION ETFS CONTINUE TO LAG... The Homebuilders SPDR (XHB) and the Home Construction iShares (ITB) surged in early November as well, but gave it all back with sharp declines the last 1-2 weeks. Chart 5 shows ITB barely retracing 38.2% of its prior decline with a rising wedge. This is a pretty weak retracement so far. Technically, the wedge is rising as long as the lower trendline and late October low hold. A move below both would reverse the 2-3 month uptrend and call for a continuation lower. The indicator window shows the price relative in a clear downtrend with a new low this week. Relative weakness is not a good sign.
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Chart 5
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Chart 6
Chart 6 shows the Homebuilders SPDR retracing 50% of its prior decline with a rising wedge. After a two week decline, the ETF broke the wedge trendline and is on the verge of breaking support. The early November rally failed. A support break would signal a continuation of the prior decline. The indicator window shows the price relative breaking its prior lows this week. Again, relative weakness is not a good sign here. As detailed in the Market Message two weeks ago, ITB and XHB are quite different. True homebuilders make up the top weightings in ITB (NVR, DHI, LEN, TOL and PHM). Top weightings in XHB, on the other hand, include WSM, AAN, TPX, PIR, AWI, BBBY and SSD. These are more retail oriented.
MATERIALS SECTOR GOES THE WAY OF CHINESE STOCKS... The Basic Materials SPDR (XLB) and commodity-related ETFs were weak in early trading on Friday. Look no further than China. For the second time in as many weeks, the Chinese central bank ordered banks to increase their reserve requirement, which essentially tightens lending and money. While the Fed is trying to increase inflation, the Chinese central bank is trying to reign in consumer inflation. The prospects of slower growth in China are weighing on commodity related stocks and ETFs. Chart 7 shows XLB with the Shanghai Composite ($SSEC). Except for some lag in September, materials stocks and Chinese stocks are positively correlated. Both declined from April to the end of July, advanced from August to early November and declined over the last 1-2 weeks. There is also a positive correlation between Chinese stocks and the S&P 500. This affirms the importance of China on the materials sector, the US stock market and the global economy. Chart 8 shows the Base Metals ETF (DBB) breaking support with a sharp decline this week. Chart 9 shows the Agriculture ETF (DBA) testing support around 28.
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Chart 7
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Chart 8
