Weekend Outlook 10/20/2013

This week the SPX continued its seemingly relentless march to new highs. The index now stands nearly 700 points above the October 2011 low of 1074.77, and almost 1100 points higher than the 666.79 low of March 2009. The range of opinions as to where the market goes from here varies widely; some believe the run from 666.79 has been a corrective wave, with the market soon headed towards zero. Perhaps these are followers of Terence McKenna’s Time Wave Zero (http://www.levity.com/eschaton/waveexplain.html).  Others believe this rally will continue ad infinitum due to FED intervention. I believe the reality lies somewhere in between, with a medium term top near, but not imminent.

My analysis is based on a model I have developed, which I call the 5 Wave Model. Although there are similarities to Elliott Wave Theory, this is not EW. My model postulates that all movements of the market can be broken down into 5 waves, with a specific relationship developing between waves 1, 3, and 5 that indicate the termination of a “wave”, or trend. A specific proportionality manifests itself between these waves at the termination point of a 5 wave sequence.

Last week I mentioned a similarity between the current wave structure from the 1074.77 low, and that of the uptrend from October 2002 until October 2007, so I will start there. In addition to my wave counts, I have also numbered each wave of the uptrend consecutively for discussion purposes. The first thing to notice is that the uptrend consisted of 17 individual waves. The first 5 waves of the structure were 954.28-788.90-1015.33-960.84-1163.23. Since these 5 waves only had a correlation value of .96, it did not signal the end of a sequence. In fact, the first 5 waves that complete a sequence are waves 6-10. This sequence goes 1163.23-1060.72-1217.90-1136.15-1245.86-1168.20, and has a correlation value of .998. Since the impulse waves of this sequence, waves 1, 3, and 5 were to the downside, with the larger trend being up, this considered a corrective wave. With the end point of the fifth wave completing above the end point of the first, I call this an inverted corrective wave. After the completion of this sequence, the SPX rallied to 1326.70. Evaluating waves 2-3, 4-5, and 10-11, my model gives a correlation value of .999, once again signaling the completion of a 5 wave sequence. Then looking at waves 1-2, 11-12, and 13-14, the correlation is .9998, meaning the termination of another sequence, this time an inverted corrective wave. Finally then, from the October 2002 low of 768.63 to 1, 14-15, and 16-17, which takes us to the October 2007 high of 1576.09, my model shows a correlation of .9996, once again giving the end point of a 5 wave sequence.

In my 5 Wave Model vernacular this counts as 1-A-1-2-3-A-B-C-D-E(4)-5(B)-C-D-E(2)-3-4-5. This gives a total of 17 waves in which the first, third, and fifth wave of each sequence show a specific relationship.

Next, I will look at the current wave structure from the October 2011 1074.77 low. Again I have overlaid a consecutive numbering system for discussion purposes. In the last wave, the structure started with a 1-A, followed by a 1-2-3 of one lesser degree. In this case wave 4 was the inverted corrective wave. This wave began with a 1-A, and was followed by a 1-A of one lesser degree. Wave 2 in this example proved to be the inverted corrective wave. In both examples, at the eleventh wave of the sequence, each wave had completed Wave B of an inverted corrective Wave 2 from the starting low. From that point, the current wave has gone on to complete Wave C at 1646.47, and now is at a level that would complete Wave D, or the 13^th wave of what should be a total of 17 waves. As I have previously indicated, I would expect this wave to complete near 1680, and should hold above 1646.47. This would complete Wave2 from the 1074.77 low, and I would expect Waves 3, 4, and 5 to the upside to complete the entire sequence.

Finally, I also suggested last week that the Dow was on the same count as the SPX, but that while I expected the SPX to hold above its previous low, I do not expect the Dow to do the same. Both the SPX and the Dow have so far completed Waves 1-A-1-A-B-C-D-E(2)-3-4-5(B)-C, and possibly Wave D. Both indices are in inverted corrective waves, and these waves can complete in different fashions. For these indices to maintain the needed relationship between Waves A, C, and E of this sequence, the SPX would need to hold above its previous low, while the Dow would have to move below it.

This could all change of course if the current rally from SPX 1646.47 continues. At the moment I would say that this wave will most likely end around current levels, setting up this diverging scenario.

Support is at 1723, 1703, and then 1680.