While most of the world’s equity markets have turned bearish again after their 2010/2011 advances. We continue to track what we believe is a bullish US stock market. Now that the recent liquidity cycle is coming to an end. We’ll explain why we have this view, both technically and fundamentally. This week the market continued to rally into the tuesday/wednesday FOMC meeting, with expectations of a new quantitative easing program: QE 3. When the FED did not deliver, extending only Operation Twist, the market became quite volatile on wednesday and sold off dramatically on thursday. Friday we saw an oversold rebound. For the week the SPX/DOW were -0.80%, but te NDX/NAZ were +0.65%. Asian markets gained 0.2%, European markets gained 1.0%, and the DJ World index lost 0.3%. In the end not a bad week. Economic reports again came in heavily to the downside: six down and two up. On the uptick: building permits and the leading indicators. On the downtick: housing starts, existing home sales, FHFA housing prices, the Philly FED, the WLEI and weekly jobless claims rose. Next week Q1 GDP on thursday, plus PCE prices and the Chicago PMI on friday.
LONG TERM: bull market
Technically, we have been tracking a bull market since March 2009. Our historical analysis of Secular cycles suggests a very significant low occurred at that time. The price low of the cycle. What always follows after this event is a bull market. The difficult part has been tracking this one, even though we know where the significant waves began and ended. Our preferred count remains unchanged. We’re expecting a five Primary wave bull market to complete a Cycle wave . The first two Primary waves completed in April and October 2011, at SPX 1371 and 1075 respectively. Primary wave III has been underway since then.
In the DOW we have a clear five wave pattern up from the end of Primary wave II. We are counting it as five completed Intermediate waves ending Major wave 1 of Primary III. The recent, and possibly ongoing downtrend, is/will be labeled Major wave 2. Observe Major wave 1 of Primary I also subdivided into five Intermediate waves. And, Major wave 2 was a bit complex. We are maintaining a slightly different count on the SPX charts, as an alternate count. The SPX failed to make a new high, along with the DOW, in May. So its pattern deviated, somewhat, from the bellwether DOW. This has not occurred in over six years. It’s a more bullish count and we give it a lower probability.
Fundamentally, the markets have been in a FED driven liquidity cycle since late 2008. When the Treasury Department started the $800 bln TARP program in October 2008, the FED initated QE1 at $200 bln. Clearly neither were enough to offset the deflationary pressures as the market made new lows into March 2009. Then on March 10th 2009 the FED expanded the QE1 program to $1.4 tln until June 2010. The stock market soared, rallying from a Mar09 low of SPX 667 to SPX 1220 by Apr10. Anticipating the end of QE1 the stock market began to correct. When the FED failed to extend QE1, or introduce a new program at their June meeting, the market made lower lows into July. From that low at SPX 1011 another rally began. Then on August 27th the FED introduced QE2 at $600 bln until June 2011. The market soared again, hitting SPX 1371 by May 2011. And again, it began to correct in anticipation of QE2 ending.
When the FED failed to introduce another liquidity program, and troubles in Europe widened, the correction steepened. While the stock market was going through this 22% correction the FED introduced a $400 bln Operation Twist on September 21st until June 2012. The market was disappointed and continued lower. In October 2011 the EU introduced a $1 tln EFSF program, similar to TARP. The market then bottomed at SPX 1075 and started to rally. The ECB then introducted LTRO 2 in December and the market continued to rally. In March 2012, anticipating the end of Op Twist in June, the market hit SPX 1422 and began to correct. This month the market hit a low of SPX 1267, then rallied for two weeks ahead of last week’s FOMC meeting. After the meeting the FED expanded Op Twist from $400 to $667 bln until December 2012. The stock market quickly sold off the following day. This is a summary of the liquidity cycle and its effects on the stock market over the past four years.
If one examines the liquidity programs and their results they will discover a pattern. We are fairly certain the FED has as well. When the FED expanded QE1 to $1.4 tln the market closed that day at SPX 720. Before the program ended the SPX hit 1220, for a gain of 69%. When the FED introduced QE2 at $600 bln the market closed that day at SPX 1065. Before that program ended the SPX hit 1371, for a gain of 29%. Then when the FED introduced Op Twist for $400 bln the market closed that day at SPX 1167. The market was initially disappointed as it made a lower low. However before the program was recently expanded the SPX had hit 1422, for a gain of 22%. When the FED expanded the program this week by an odd $267 bln we figured they too had discovered the pattern.
For every $20 bln the FED purchases in long term debt the stock market rises 1%. QE1 was $1.4 tln: expected rise 70%, actual rise 69%. QE2 was $600 bln: expected rise 30%, actual rise 29%. Op Twist was $400 bln: expected rise 20%, actual rise 22%. Op Twist expanded to $667 bln: expected overall rise 33%, actual rise yet to be determined. In summary, when the FED introduced Op Twist for $400 bln they were expecting the market to rise 20%. Despite the decline after the introduction at SPX 1167, the market rose 22% to SPX 1422. Now, with the expansion of the program to $667 bln they are likely expecting an overall rise of 33.3% from the time the program was first introduced. Or, a rise of 13.3 % from the time it was extended. A 33.3% rise from SPX 1167 equals SPX 1556. A 13.3% rise from SPX 1356 equals SPX 1536. The all time high for the SPX is 1576. Mission almost accomplished!
MEDIUM TERM: downtrend likely resuming
The recent downtrend began in May with the DOW high, or in March with the SPX high if you prefer. We prefer the bellwether DOW. From the May high the correction clearly took on the form of an ABC:  1291-1335-1267. After that low the market had a fairly good rally to SPX 1363, or better than a 61.8% retracement of the decline. We also received a WROC buy signal along the way, which are 90+% reliable that an uptrend is underway. The internal wave count of this rally, however, looks more corrective than impulsive. We tried to fit various potential impulse counts into this rally with little success. This leaves us with two potential alternatives. First, either the downtrend is still underway. Second, this is a corrective B wave uptrend.
This bull market has had B wave uptrends before in 2011. However, when we factor in the recent liquidity injection by the FED. This would appear to be an uncharacteristic response to the expansion of Operation Twist. The most probable scenario, considering the correctiveness of the rally, would be to retest the lows at SPX 1267 or make a lower low. When Op Twist was first introduced in September 2011 the market sold off about 100 points into the October low. Another 100 point decline, this time from SPX 1363, would retest the early June lows and likely end the correction with a Major wave 2 flat in early July. We have updated the SPX/DOW charts to display this most probable scenario.
Support for the SPX is at the 1313 and 1303 pivots, with resistance at the 1363 and 1372 pivots. Short term momentum ended the week around neutral. The short term OEW charts remain with a negative bias with the swing point around SPX 1337.
The recent rally from SPX 1267 to 1363 started off impulsively as it was unfolding. We were expecting the rally to reach either the 1363 or 1372 pivots in a five wave sequence ahead of the FOMC meeting. The pattern, unfortunately, looked like three waves on tuesday as the FOMC began. After tuesday’s high, and wednesday’s volatility, the market sold off on thursday to SPX 1324. This selloff overlapped the first rally from SPX 1267 to 1329/36. This made the entire June rally look corrective. As a result we have labeled the SPX 1267 low as a wave A, and the recent rally as a wave B. The most probable scenario suggests a wave C is underway to either retest the June lows or make a lower low in early July.
Should the market exceed SPX 1363 before this occurs, we would assume the market is in a corrective larger B wave uptrend. Until this occurs the path of least resistance appears to be lower. Short term support is at SPX 1324/27 and the 1313/1303 pivots. Short term resistance is at SPX 1334/38, 1342/47 and the 1363 pivot. Short term momentum rebounded to neutral from extremely oversold. Should the market break the first support zone we’ll assume the downtrend is resuming. Best to your trading!
The Asian markets were quite mixed for a gain of 0.2%. No confirmed uptrends yet.
The European markets were all higher for a gain of 1.0%. Still all downtrends.
The Commodity equity group were all lower for a net loss of 2.0%.
The DJ World index is still downtrending and lost 0.3% on the week.
Bond prices appear to be downtrending after their early June high. They lost 0.6% on the week. Corporate Bond risk has been declining rapidly suggesting the risk spread is narrowing.
Crude made another new low for its downtrend this week at $77.56. Crude declined 4.7% on the week. The lack of any QE programs are certainly impacting the commodity markets.
Gold lost 3.5% on the week as it appears its downtrend is continuing. For the first time since 2001 the long term pattern in Gold is starting to look negative.
The USD gained 0.8% on the week as stock market uncertainty fueled a one day spike in the USD. It is still officially in an uptrend.
Monday kicks off an important economic week with New homes sales at 10:00. On tuesday we have Case-Shiller and Consumer confidence. Wednesday Durable goods orders and Pending home sales. Then on thursday Q1 GDP, estimate 1.9%, and weekly Jobless claims. On friday Personal income/spending, PCE prices, the Chicago PMI and Consumer sentiment. The FED has nothing scheduled. Best to your weekend and week!