STOCKS HAVE ENTERED WAVE 4 CORRECTION -- 2015 DOWNTURN CLOSELY MATCHES 2011 CORRECTION WHICH BOTTOMED IN OCTOBER -- TO KEEP THE LONG-TERM UPTREND INTACT, LAST OCTOBER'S LOWS HAVE TO HOLD -- VIX INDEX SURGES TO NEW 2015 HIGH
AN ELLIOTT WAVE UPDATE ... My market message from July 9 offered my Elliott Wave analysis of the NYSE Composite Index. Chart 1 is an updated version of that view. The five red numerals show a five-wave advance from its 2011 bottom. My view was that the May peak in the NYSE Index (and, by proxy, the rest of the U.S. stock market) had completed a five-wave advance from its 2011 bottom which suggested that the market was due for a period of correction or consolidation. That's because a five-wave advance signals the completion of a major upwave. The three blue numerals, however, suggest that the May peak was the end of a three-wave advance that started during 2009. Since major bull markets usually have five waves, that suggests that there may be another upwave once the wave four period of correction/consolidation is over. The market has entered a correction since then. Let's take a closer look at it.
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Chart 1
NYSE INDEX HEADED TOWARD LAST OCTOBER'S LOW... My Elliott Wave analysis offered both good and bad news. The bad news was that the stock market was vulnerable to a correction of at least 10% which was long overdue. The good news was that last October's low should contain that correction. After the completion of a wave 5, the subsequent correction shouldn't drop below the bottom of wave 4. That means that stock prices could drop as far as last October's low, but should hold there. Chart 2 shows the NYSE Index falling below its January/December lows which puts it on track to reach its October low. Because the NYSE includes all stocks traded on the NYSE, it's a much broader measure than the more narrowly-based large cap indexes which usually hold up better at market tops. That's reflective of weak market breadth and explains why the NYSE is falling faster than other stock indexes.
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Chart 2
COMPARISON TO 2011 CORRECTION ... The last major stock correction took place during 2011 when the market lost around 20%. Notice how closely that year's downtrend matches this year's, both from a price and seasonal standpoint. Chart 3 shows the 2011 market peaking that May, as it did this year (see Chart 4). The "sell in May" rule worked in both years. After forming a 2011 June bottom, stocks bounced into the first half of July (as it did this year) which is a normal seasonal bounce. In both years, prices started falling again during the seasonally weak month of August. The blue 50-day average fell below the red 200-day line during both Augusts as well (forming the bearish "death cross"). That's the bad news. The good news is that most of the damage during 2011 took place during August. A late 2011 August bounce led to a lower low during during September which led to an early October bottom. Stocks recovered from there. That offers the potential for another autumn bottom this year from somewhere around last October's bottom. The 2011 correction lost about 20%. A drop to last October's low would result of losses ranging from -12% to -15%. That assumes that the current selling is a "wave 4" correction within a longer range "wave 5" advance. Any serious violations of last October's low would call that longer-range bullish interpretation into doubt.
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Chart 3
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Chart 4
DOW AND S&P 500 HEAD TOWARD OCTOBER LOWS... Charts 5 and 6 show where the Dow Industrials and S&P 500 are in relation to their October lows. The Dow has already undercut its December/January lows, having lost -10% from its May peak. A drop to last October's would represent a loss of -13%. A similar drop by the S&P 500 would result in a loss of -15%. [That would make this year's correction smaller in percentage terms that in 2011, which is often the case in a wave 4 correction]. Those projected losses are within the realm of normal correction parameters, and wouldn't change the market's long term uptrend. That is, as long as those October lows hold.
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Chart 5
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Chart 6
FALLING DOLLAR BOOSTS GOLD... Two of the markets that generally benefit from heavy stock selling are Treasury bonds and gold, as they did this past week. Treasuries benefited from a flight to safety out of falling stocks and global deflationary pressures. Gold got an added boost from a falling dollar. Chart 7 shows the U.S. Dollar Index falling to a two-month low and threatening its (red) 200-day average. Dollar selling is most likely tied to diminished expectations for a September Fed rate hike. Gold benefits from from lower rates, falling stocks, and a weaker dollar. Chart 8 shows the price of gold jumping to the highest level in a month. It still has a long way to go to reverse its major downtrend. But it is attracting some safe haven money moving out of stocks.
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Chart 7
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Chart 8
VIX SURGES TO NEW 2015 HIGH... With stocks falling so hard this week, it's no surprise to see a jump in the CBOE Volatility (VIX) Index. The size of the jump, however, was impressive. The daily bars in Chart 9 show the VIX surging 46% to 28 which is the highest level since last October. Readings over 20 usually accompany market corrections. It will be important to see what the VIX does when it approaches last October's peak at 31. For longer range perspective, Chart 10 shows the VIX climbing all the way to 48 during the 2011 market correction. Its current reading of 28 seems low by comparison. That may be a hint that this year's setback won't be as bad as in 2011.
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Chart 9
