The Stock Market Spring

A couple of weeks ago I wrote an article for Green Faucet entitled “Channeling Past Stock Market Declines.” In that article I highlighted several patterns in the previous bear market which were similar to the pattern currently formed on the stock market charts.  

In the previous bear market, trading ranges were consolidation patterns, followed by continued stock market declines. Three weeks ago that happened again. The trading range broke on the downside, as I expected. However; the decline did not follow through. In fact, the past two weeks has brought an immense rally. And what has formed is a somewhat rare chart pattern that has turned the prospects quite favorable for the stock market. I will show you that below.

First: the story behind the charts

There are some markers that are very news driven and some markets that completely ignore what’s going on in the background. Over the past year or more, massive Fed intervention in the markets and low valuations encouraged the bulls, and European turmoil and US political disappointments brought out the bears. There has been no shortage of volatility, and the stock market has responded, seemingly, to every piece of news. There are changes in the wind, however.

First, the stock market seems to be becoming invulnerable to the European situation. Spain was downgraded last week three steps below AAA, along with many European financial institutions. The stock market barely flinched before driving upward. This is what happens when markets advance on a “wall of worry”. Bad news fails to bring sellers; so it brings buyers. This is definitely a tone change for market participants, and one that should not be ignored.

Next, since 2009, while the dollar collapsed, gold soared and the EU seemed to be ready to fall apart, treasuries marched steadily higher (yields lower). Bernanke and the Fed and the administrations would like to think they influenced this to combat the recession and current slow growth; they have had little to do with it. The U.S. treasury market, simply, because of its depth and the backing of our massive economy, has been the parking place for a world desperate for safety. That pushed yields on treasuries down to historically low levels. Well the parking lot has gotten quite full.

So two weeks ago, with the Fed “twisting” its holdings out the yield curve and Greece teetering, contrary to what would have been expected, the bond market began a retreat. Now, with stocks gaining strength and the bonds weighted heavily in positions, fund managers, mostly underperforming, must look at what again looks like an imbalance in their asset allocations and adjust. This shift is what we’re seeing in the markets now. I’ll show you in the charts below why I think this trend change of money moving out of bonds and into stocks has just started.

I want to look at both a short-term picture and the long-term trends. Please look at the daily S&P 500 chart below.  This chart has a wealth of information. You can see that the S&P 500 has been trading in a range between 1100 and 1225 for the past two months. Two weeks ago brought the aforementioned breakdown in the S&P 500 below 1100 and the current rally; right to the top of the range.

 

 

Daily S&P 500 – Chart courtesy of TD Ameritrade

There is a rare formation on the charts, that when happens, offers opportunities with great reliability. When a market has been rising for a period of time and then goes into a trading range, it is often a consolidation, followed by further advances. However, if that range is broken on the upside and then fails; it’s called a “thrust”. What happens is bulls get hooked in that final advance which sets up a major declining trend change.

At market lows, the opposite happens. The trading range is violated on the downside and then quickly reverses. This is called a “spring”. Look at the chart again of the daily S&P 500. This is exactly what happened two weeks ago, making a bullish “piercing pattern” and exploding on the upside.. The odds are high that the stock market has made a major low, ending the correction that began nearly six months ago.

So now the stock market has rallied to the top of the range. It is obviously a place for the rally to struggle. This level is certainly big, as there is a confluence of resistance here. You can see the resistance at the top of the trading range, the 89-day moving average and the 50% Fibonacci retracement all come in around 1224 on the S&P 500. That just starts the resistance zone, which extends upward to the 61.8% retracement at 1258. This is certainly a spot for the stock market to struggle.

Next, look at the chart of the Monthly S&P 500. I used this in my previous article; now slightly revised.

 

 

Monthly S&P 500 Chart – Courtesy of TD Ameritrade

This nine-year chart has the past bull and bear market, the present bull market and the correction of the past six month. You can see a clear repeating cycle pattern of 16 to 18 months. Cycles are measured from low to low. If you look at the 2004-2007 bull market, you can see a clear “Elliot Wave” 1 to 5 count. Looking at the market from the 2009 low, you can see a clear 1 to 4 count. That means rising wave 5 is coming, often the strongest on the upside. The fact that wave 4 looks to have bottomed above the low at wave 2 is what makes this a very bullish pattern, just as happened in 2005. The 15-month count is a bit short. Often very bullish charts are in a hurry to bottom.

As a confirmation to the bottom in stocks, let’s look at the chart below of 30-year treasury bonds. This chart illustrates that the bond market made a top, which was then confirmed. It created a “tweezer” candlestick pattern; it’s the two long tails on the bars at the top. It’s also called a double top. Also notice the weekly cycle counts at the bottom; very consistent at 20-23 weeks. The current cycle is 15 weeks old. So bonds are in a declining phase with another 5-8 weeks to fall in this cycle. The current decline has fallen to the 13-week MA, which has offered support for bonds in the past. So this nicely matches that the S&P 500 has moved to resistance, as the two markets often move in inverse correlation to each other.

 

 

Thirty-year bond chart – courtesy of TD Ameritrade.

These cycle patterns, especially on the weekly and monthly charts, are the best picture of the “flow of money” that I know. And this looks like the flow of money is just starting to change, with money now quickly moving out of bonds and into stocks.

So in summary: The stock market, which was poised for downward resumption two weeks ago, moved quickly to the top of its range instead and sits at resistance. The longer-term trend in the stock market is just turning upward. Coincidently, in a confirmation to this trend change, the bond market has topped, declining over the past week to a level of support. These two conditions will most likely bring some consolidation now, with stocks pulling back and bonds rising. However, because of what looks like a very significant change of trend, pullbacks in stocks (rallies in bonds) should be shallow and short-lived.

It wouldn’t surprise me if the stock market begins to chop around here; with the S&P 500 trading between 1165-1235 while it digests this advance. However, the nature of the advance over the past week looks to me like the start of a buying stampede. It won’t be long before stocks are again rocketing upward. Based on the monthly DJIA chart above, odds are now high that the stock market will approach 13,000 on the DJIA and 1350 on the S&P 500 by the first quarter of 2012.

As a follow-up to this article, as the market pulls back a bit over the next week or so, I’ll post my favorite long-side stock plays for the bull-market resumption.