THE FIVE WAVE ADVANCE IN THE NYSE COMPOSITE INDEX SINCE 2011 SUGGESTS THE COMPLETION OF THE THIRD WAVE IN A BULL MARKET -- THE MARKET APPEARS TO HAVE ENTERED A PERIOD OF CONSOLIDATION OR CORRECTION WITHIN ITS MAJOR UPTREND
NYSE INDEX APPEARS TO HAVE COMPLETED A WAVE THREE... They say when you start to feel seasick you should focus on the horizon. Daily market swings are starting to make me feel seasick. So in line with that nautical theme, I'm going to focus on the market's long-term horizon by using Elliott Waves to try to put things into perspective. I'll explain what that is as I go along. Chart 1 plots weekly bars for the NYSE Composite Index since the 2009 bottom. It looks to me like the six-year rally has completed three major upwaves. Hence the three blue numerals. Elliott Wave Analysis holds that a bull market is comprised of five major waves -- three up waves (1,3,5) interrupted by two corrective waves (2 and 4). It seems clear that the first major upwave ended in 2011. Hence the number 1. A nearly 20% correction that year certainly qualified as a wave 2 correction. The market rallied for four years since late 2011 with only minor corrections. I believe that four-year rally has traced out a five-wave pattern of its own. If I'm right about that, the market has completed its three wave and is due for a wave four correction. Let's take a closer look.
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Chart 1
NYSE HAS COMPLETED FIVE WAVE ADVANCE... Chart 2 shows the four year rally that started in October 2011. It looks to me like that upwave has itself completed a five-wave advance identified by the red numbers. That would mean that the downside correction during the second half of last year was a wave 4, and that the record high reached this spring was a wave 5. If that interpretation is correct, that would mean that the four-year rally (wave 3) has run its course (red wave 5 coinciding with the blue wave 111). That suggests that the market is due for a wave 4, which is either a corrective or a consolidation phase. That's the bad news. The good news is that a wave four correction is usually followed by a wave 5 into new highs. There's more. The "rule of alternation" holds that a wave 4 correction is usually different than the wave 2 correction. If major wave 2 is a downside correction (which it was during 2011), that increases the odds that wave 4 will be more of a consolidation. That may also be good news. More good news is that any downside correction would be limited to the bottom of wave 4 (1v), which was last October's low. Timewise, the 2011 correction lasted for six months between May and October. That suggests a possible time frame for this year's sideways action. In other words, a correction or consolidation from this May into the autumn. That also fits the normal seasonal cycle of May peaks and October bottoms. The blue "zig zag" line identifying market moves of at least 10% (using intra-day prices) appears to confirm my wave count.
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Chart 2
WAVE 5 DIVERGENCES ARE IMPORTANT... Since the completion of a wave 5 signals the end of a market rally, that's when "negative divergences" start to show up on technical indicators. And they need to be respected. Chart 3 overlays weekly MACD lines on the NYSE over the last five years. Notice the "negative divergence" on the weekly MACD lines in early 2011 at the completion of that upwave. That divergence led to six month correction of nearly 20%. This year's wave 5 has a much bigger negative divergence with the MACD lines. I've shown many other negative divergences in recent messsages. That means the May record high was on weak technical footing. Negative divergences, when combined with completion of a wave 5, are especially dangerous.
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Chart 3
LEVELS OF NYSE SUPPORT ... The daily bars in Chart 4 show the entire wave 5 from last October to this May for the NYSE Index. Notice the converging trendlines forming a "bearish wedge" pattern, and the breaking of the lower support line. That's often another sign that a wave 5 has been completed. Three levels of underlying support are shown on Chart 4. The NYSE has already reached its first level of support at its March low (for a drop of -5%). If that doesn't hold, the next support zone ranges from its December to January lows (a drop of -7% to 8%). The worst case scenario would be a drop all the way to last October's low (a loss of -10% to 12%). Assuming this is a consolidation instead of a correction, the most likely downside risk is to the December/January lows. A consolidation pattern is usually shallower than a full-blown correction.
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Chart 4
WHERE THERE'S OVERHEAD RESISTANCE ... The daily bars in Chart 5 show the recent breakdown in the NYSE. The waves I've drawn show the downtrend in a third wave decline. If that reading is correct, any rally attempt shouldn't move higher than the bottom of wave 1 which coincides with last Thursday's intra-day peak near 10900. It also coincides with the red 200-day average. If my wave count is correct, that should contain any rally attempt. If it doesn't, I'll have to do some recounting. Here's my summary. The stock market appears to have completed three major upwaves from its 2009 bottom. That means the market is due for a period of correction or consolidation. Of those two, consolidation appears to be the most likely scenario. An 8% to 10% correction, however, wouldn't be surprising. Stocks are overdue for one. Timewise, that market "time out" could last into the autumn when things should start to look better. The fact that so many negative divergences are appearing on weekly charts also adds to the need for more caution.
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Chart 5
WEEKLY RSI LINE SHOWS POOR MOMENTUM ... My final chart is intended to do two things. One is to show the entire six-year uptrend in the NYSE Composite Index since the 2009 bottom. The rising green trendline shows that there's plenty of room for a correction without disturbing that uptrend. The flat black line shows where major support exists if a correction materializes. That's the good news. The potentially bad news comes from the falling 14-week RSI line. If you study the chart, you'll see that previous stock rallies have been accompanied by a rising RSI line well above its 50 (dashed) line. Drops below the dashed line have accompanied downside corrections. Notice also how the RSI line hovered near its upper 70 line during previous moves to new highs. Not this time. The red arrow this year shows a huge "negative divergence" between the 14-week RSI line and the NYSE as it hit a new high this spring. That the biggest divergence that I've seen in the last six years. And it's another reason why I've come to believe that the market uptrend is due for a period of correction or consolidtion. Not necessarily a major top. But a much-needed "time out".
