"All human activities have three distinctive features: pattern, time and ratio - all of which observe the Fibonacci Summation Series" (R.N. Elliott - "Nature's Law - the Secret of the Universe" - 1946)

Saturday, April 6, 2013

US stock markets: scenario analysis; "make" or "break"?

This post is the translation of a post published on my  Italian  blog http://chartpatternstrader.blogspot.it/ last Tuesday and  on Wall Street Italia blog  where I collaborate as a news analyst from several months ;
Wall Street Italia (WSI) is a leading independent website in Italy , specialized in business, financial, political news and analysis aimed to institutional and private investors (in 2012 , 4,172,369 Unique Visitors (+8.45%) and 90,726,253 Pageviews).
Charts have been updated but what show does not change.


Closed the first quarter of 2013, it is useful to analyze the situation of the stock markets and outline the possible future scenarios.
The major US stock market indexes have reached all-time highs (S&P500) or have overcome them (DJIA), only the NASDAQ is still far below, although there are some sectors, such as Biotech, HealthCare and Insurance, which have also already exceeded the previous tops.
With the help of fundamental, technical and sentiment analysis, we can try to understand if we are near a Top Reversal (so-called "make") or close to a resistance that will become breakout in acceleration ("break").

From the fundamental point of view, the United States entered the 4th year of expansion of the economic cycle, the GDP in 2012 grew by 2% and estimates for this year include, maybe a little optimistically, an improvement of 2.3% - 2.8%, and even in 2014 to 2.9% - 3.4%.
After the crisis of 5 years ago, the U.S. unemployment fell to 7.7% (the lowest value since 2008) and is expected to further decrease (7.3% - 7.5% in 2013 and between 6.7% and 7% in 2014), although not at the level identified by the FED as a "watershed" to stop its ultra-expansive monetary policy (6.5%), which unlike the ECB, is no longer set mainly on the inflation rate, which remains under control (2.2% in 2012).

The Consumer Confidence Index, however, after the top to 144 in February 2000 (one month before the top of the Nasdaq) and the bottom in February 2009 (one month before the bottom of the 3 major Indices) remains at a low level and does not show positive signs.
sentimentrader.com/ (under permission)

The rise of the U.S. stock markets in recent months has been generated, among others, by two factors:-by the positive trend of the last three seasons of EPS quarterly reports, and on the last in particular in which about 75% of S&P500 company has been helpful beyond expectations;
- by the accommodative monetary policy of Federal Reserve, which since the Lehman crisis has injected into the system 4,000 billion Dollars (!), while at the same time, has kept interest rates to very low levels (0 - 0.25%) and thereby inducing investors to borrow to buy shares in leverage (most recently by selling bonds that have negative real returns) creating the conditions for a new financial bubble. In fact, now as then, companies with low credit ratings are easily able to dispose of its claims due to excess liquidity.

Not even the Sequester has weakened the momentum of the U.S. indices, that with its automatic cuts to public spending is estimated to produce a reduction in the GDP growth of 1.5%.

However many respected analysts and economists (even the FED) will begin to question whether to continue the last Quantitative Easing program, which currently provides for the purchase of 85 Billion Dollars per month in bonds, aware that these extraordinary measures have been so helpful to prevent the collapse of the system in 2007-2008 and reactivate a recovery, but also lead to serious side effects such as "post-doping": the first is the habituation of the financial markets, willing to climb until "the injection of the drug" continues, to enter into crisis when the drug delivery is halted.

Some analysts believe, however, that the recent increases beyond the tops are a symptom of an excess of optimism, compared to the previous market top in 2007:
>  U.S. GDP is to 2%, lower than the 2.5% of the time;
> Unemployed are over 12 million, were 6.7 million,
> debt / GDP ratio is 74%, whereas it was 38%, with U.S. debt rating that has lost its AAA.

And the road, however, is still rising;  an Obama-Congress agreement is need because the ultimate target is to reduce the deficit by 4,000 billion dollars over ten years taking it from 10% to 4% of GDP;  2,500 were cut but still 1,500 are missing.

From the technical point of viewanalyzing the US index charts using the Elliott Wave Principle implemented with some algorithms, the following results:

DJIA - Intermediate and Long-term scenarios
(monthly and weekly charts)

the Preferred Scenario is bearish;  
DJIA should be in the wave [IV] of SuperCycle degree, starting at the 1999 top after "the long run" of '80-'90 years and still far from its completion.
This wave could develop in two variants, with the same implications:
like a "Three" pattern W-X-Y ; in this case the bottom of 2009 would be the end of wave W of Cycle degree and the uptrend in topping the wave X , after would start the third bearish wave Y (maybe the last if it's not a double three);
> like an Expanding Triangle  pattern A-B-C-D-E ,  where wave of Cycle degree is ended in 2002,  B in 2007, C in 2009, and now we would be close to the top of wave D , after which starting a Cycle Bear Market to test a new bottom below those of 2009.
According to this scenario, the potential final target of the upside move in progress (or in topping) could be the16,000 -16,500 area, at the intersection of the prices with the up-trendline, probably between the 2nd and 3rd quarter of this year, with the possibility (but less likely) extension to 16,800 up to July 2014.
The Alternate Scenario is bullish , and considers that wave [IV] SuperCycle is finished in 2009 with an Irregular (or Expanding Flat) pattern Alt:A-B-C; since 2009 , we would already be in the fifth wave of SuperCycle degree that, hovewer, having a corrective and not an impulsive structure, would be an  Ending Diagonal pattern; now we could be in the Alt:[3] Primary wave of Alt:I Cycle wave.
Now, the price / time target of this alternative scenario are undeterminable.

DJIA - Short-term scenario (daily chart)
The Preferred Scenario considers the hypothesis of a Three (w)-(x)-(y) of Intermediate degree of wave [Y] Primary in progress, with wave a minor   of (y) just finished , so a market retracement is starting.
The first Alternate Scenario; we are in the Alt:iii extended wave of  a minor , so up again for 1-2 months.  


S&P500 (SPX) - medium and long-term scenarios (weekly chart)
The Preferred and Alternate Scenarios are very similar to DJIA (a Three or a Triangle "not" Expanding, or an Ending Diagonal) with the major difference that here we are testing a resistance area much stronger, as in the second top of 2007 this index did not exceed the top of 1999.

S&P500 (SPX) - Short-term scenario (daily chart)


NASDAQ 100 - NDX / Medium and Long term scenarios (weekly chart)


> Preferred scenario; NDX is in wave [IV] SuperCycle , but still in wave B Cycle , with the completion in progress of wave [Y] Primary of a complex bullish corrective pattern, where testing a Fibonacci price cluster; even here, the Cycle top seems close.
> Alternate Scenario ; wave [IV] SuperCycle has ended in  2009 with a flat pattern A-B-C and we are in wave [V].

NASDAQ 100 - NDX / Short term scenario (daily chart)
The count on the daily basis is more complex and disjointed, but the main hypothesis is that we are in the final wave 5 of minor degree that closes the intermediate wave and the Primary wave , generating the Cycle Top.
The alternate count is that the Top has already been reached in September 2012.

Finally, with reference to Sentiment analysis (sentimentrader.com/ by Sundial Capital Research, Inc ), in the short-term there are no significant signals, while in the medium-term, of the nine groups of classic indicators (volatility, options, breadth, surveys, COT, shorts, cash, insiders, Rydex), four (the red ones) reported an excess of complacency / optimism; typically this situation would indicate a proximity to a top of the market and a good chance of bearish reversal over 1-3 months.

Among the most interesting indicators, the NYSE MARGIN DEBT and NYSE NET MARGIN are reaching the same excesses that preceded the top of 2007, a further confirmation that we are in "leverage bubble".
Currently, the risk / return ratio is not in favor of an equity investment on the general U.S. stock market (for example in a equity mutual fund).
> Any long positions of medium-long term in portfolio should be progressively reduced or closed (each will evaluate that according to his exit models), and it would be appropriate to refrain from opening new ones;

> Very dynamic and experienced traders, operating with a reversal approach, with a high degree of risk tolerance and therefore aware that they can undergo a burst of consecutive stop loss (which if added up can be very poor) , may consider to opening short positions;

> The conservative investor or trader with a medium-high degree of risk aversion, should be out of the market and do not open any position (neither long nor short);

> The active traders, with a medium level of risk tolerance and capable of a careful and costant monitoring,  wishing to still take advantage of the relative strength of a stock market in a strong uptrend, albeit potentially close to a top-of-cycle, may open long positions on leading stocks following a  swing trading and breakout approach, i.e. investment horizon of no more than 5 days with entry on the possible breakout of stocks that have formed a flat base pattern in a strong uptrend with very tight stop loss (the first under the intraday low of the day breakout, and the second, however, to 3%), modest target (8%) and stop profit to climb (from +3% if closing down 3%, and so on).
Best wishes for your trading!

and have a great weekend ;-)



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