A FIFTH WAVE FOR THE S&P 500 -- BUYING PRESSURE WEAKENS AS LONG UPPER SHADOWS FORM -- BEARISH ENGULFINGS FORM IN RETAIL AND HOMEBUILDING SPDRS -- SHANGHAI COMPOSITE FAILS TO FOLLOW WALL STREET -- CHINA IS THE ASIAN ANOMALY
A FIFTH WAVE FOR THE S&P 500 ... Link for todays video. Even though some Elliott rules and guidelines dont fit, the advance from the October low to the September high shows a clear five-wave structure. There are three rules for Elliott Wave. First, wave 2 cannot retrace more than 100% of wave 1. Second, wave 3 cannot be the shortest impulse wave. Third, wave 4 cannot overlap wave 1. Chart 1 shows the S&P 500 with a five-wave count and a problem with the third rule. The low of wave 4 in June overlaps the high of wave 1 on late October. However, it is possible that S&P 500 simply overshot during the October surge and May-June decline. Technical analysis mixes art and science. The science part is objected and based on rules, but the art part is subjective and based on interpretation. I am willing to overlook this overlap and keep the five-wave count. Such a count indicates that a correction is the next step. Corrective wave sequences typically form as zigzags with three waves (ABC). Wave A is down, wave B is a bounce within the correction and wave C is down. At this point, the overall trend is clearly up and there are no signs of material weakness. Broken resistance in the 1400-1425 area turns into first support. A break below the late August lows would provide the first indication that a bigger corrective sequence is unfolding.
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Chart 1
The indicator window shows the Percent Price Oscillator (PPO) with three yellow areas marking three impulse waves (1,3 and 5). Momentum during this fifth wave has yet to exceed the momentum peaks from the first two waves. I would not read too much into this divergence because momentum from July to September was certainly not weak. At this point, I am simply watching the centerline (0) for clear signal from Percent Price Oscillator. A break into negative territory would turn momentum bearish and signal that a correction was underway. Chart 2 shows the S&P 100 ($OEX) with a similar count and overlap between wave 4 and wave 1 (on a closing basis).
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Chart 2
BUYING PRESSURE WEAKENS AS LONG UPPER SHADOWS FORM... Several ETFs and stocks formed candlesticks with long upper shadows on Friday. There are two parts to a candlestick: the body and the high-low range. The open and close form the body. The body is filled when the close is below the open and hollow when the close is above the open. The high and low are then drawn as thin lines above and below the body. A candlestick with a small body, long upper shadow and small or nonexistent lower shadow is called a shooting star, which is a bearish candlestick reversal pattern. As a one-candlestick pattern, confirmation is required to confirm a short-term bearish reversal. Confirmation comes with further weakness within a few days. Such confirmation would provide a short-term bearish signal that could lead to a correction.
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Chart 3
Chart 3 shows the Consumer Discretionary SPDR (XLY) surging above 47 and then forming a shooting star on Friday. There is a small consolidation marking first support around 46.6 and a bigger consolidation marking second support in the 45-45.50 area. Also note that the Commodity Channel Index (CCI) moved above +200 for the first time since late April, seen of the most recent peak. There is overbought and then there is OVERBOUGHT. CCI readings above +100 are quite frequent and suggest strength. CCI readings above +200 are relatively rare and suggest some serious overbought conditions. Chart 4 shows the S&P 500 ETF (SPY) with a shooting star and CCI moving above +200 twice this month. Chart 5 shows the Oil Service HOLDRS (OIH) with a similar situation.
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Chart 4
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Chart 5
BEARISH ENGULFINGS FORM IN RETAIL AND HOMEBUILDING SPDRS... In addition to Fridays shooting stars, we are also seeing some bearish engulfing patterns take shape today. A bearish engulfing forms when the current open is above the prior close and the current close is below the prior open. The resulting candlestick engulfs the prior with a filled candlestick. This represents a failed rally. Buyers were in control on the open as prices moved higher in early trading, but sellers took over during the day and pushed prices below the previous open. Chart 6 shows the Retail SPDR (XRT) with a bearish engulfing working as of 3PM ET. Even though the bigger trend is clearly up, the ETF is overbought after a 12% advance since early August. Also notice that CCI moved above +200 this month. Broken resistance levels mark a support zone in the 61.5-62.5 area. Chart 7 shows the Homebuilders SPDR (XHB) with a bearish engulfing pattern working after a 20% surge. The late August consolidation marks first support in the 23-23.5 area. Keep in mind that I am not calling for a major trend reversal here. The bigger trends are clearly up. Stocks are simply overbought after big runs and downside risk seems to outweigh upside reward. Playing pullbacks in a strong uptrend is quite difficult because the bigger uptrend could pull trump at anytime.
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Chart 6
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Chart 7
SHANGHAI COMPOSITE FAILS TO FOLLOW WALL STREET... Even though the US and Chinese markets are separate entities, one must wonder how long these two can diverge. The S&P 500 turned up at the beginning on June and advanced over 10% in less than four months. The Shanghai Composite ($SSEC), in contrast, moved sharply lower at the beginning of June and is down over 10% in less than four months. Chart 8 shows the Shanghai Composite surging above 2100 the first week of September and then forming a pennant. This surge was promising, but follow through was required to insure that this move was not a one-hit-wonder. Pennants are typically continuation patterns that represent a rest after a sharp move. The index did indeed rest, but moved lower instead of higher on Monday. The inability to follow through on this early September surge speaks volumes, especially when markets around the world surged last week. With this decline, the downtrend remains in place and key resistance is at 2150.
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Chart 8
CHINA IS THE ASIAN ANOMALY... PerfChart 9 shows the performance for the S&P 500, Shanghai Composite and five other Asian stock indices. The India Sensex Index ($BSE) is leading the way with a 13.19% gain since May 30th. The Shanghai Composite is clearly lagging because it is the only index with a loss since May 30th. The Hang Seng ($HSI) even shows a gain, and a strong one at that. Even though the Shanghai Composite and Hang Seng Index ($HSI) are Chinese indices, the Hang Seng is heavily weighted towards the finance sector and real estate industry. The Shanghai Composite, on the other hand, is a more evenly balanced index based on stocks from mainland China.
