S&P 500 Elliott Wave Analysis

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Includes: IVV, QQQ, SPY, VOO, VTI
by: ESI Analytics Limited
Summary

US equities are probably in a bear market rally.

Historical evidence and a diagonal pattern suggest more downside correction during the months ahead.

Another advance into the 2,685-2,785 area sets the stage for an asymmetric trade setup.

This article is an update to the view that we expressed here on Seeking Alpha during Q4/2018. Equities rebounded sharply and it is reasonable to question our bearish outlook.

To recap briefly, we forecast a cyclical reversal for US equities on October 16th, 2018. Thereafter, we focused on potential alternatives for the current market environment. We concluded that Silver and the Swiss Franc are likely to perform positively. Our analysis has been spot on regarding all three themes. Equities corrected sharply into the end of the year. Silver rallied and the Swiss Franc gained versus most other currency pairs. The S&P 500 recovered swiftly from its late December 2018 lows. As of now, the equity index cuts deep into the area of wave 1, which is graphically depicted in the chart. Therefore, it is best practice within the Elliott wave framework to suspect a completed A-B-C correction at the December 2018 low. That implies that the bullish cycle from 2009 is incomplete or another bullish cycle started in December 2018. However, we do not rely on Elliott wave technical analysis only.

Historical evidence paints a different picture. Comparable cyclical trends to the one, which unfolded since the financial crisis in 2009, triggered longer corrections. A trend break of the respective cycles resulted in at least a year of corrective price action. The only exception to that within roughly 150 years of S&P 500 data occurred in 1987. Therefore, it is unlikely that a couple of months of downside action corrects an entire cycle, which lasted for almost ten years. Instead, it is most likely that a negative price feedback loop to the downside just started to unfold. Hence, a leading diagonal scenario is the base case to describe price action at this point in time.S&P 500 Leading Diagonal

Source: tradingview.com

The most plausible path of a leading diagonal pattern is depicted in solid black. The swing from the late December 2018 low is a bullish impulse. A bullish impulse at this stage requires some form of upside continuation within the Elliott wave framework. A corrective drop presumes the upside continuation and is probably unfolding as we submit this article. The subsequent swing to the upside, which is marked as c(circle), is likely to fade. A reversal will probably occur within the area of 2,685-2,785 index points. That opens the door for an asymmetric trade setup. An expanding leading diagonal will target at least the 2,300 points mark on the downside. The invalidation to this analysis occurs at 2,818.15, which is the previous minor wave 2 high. Setting the target at 2,300 and a stop loss at 2,818.15 amounts to roughly a 4 by 1 risk/reward ratio.

The overall conclusion is that the bearish cycle is at an early stage. Historic evidence suggests more correction ahead of us. US equities are likely to fade within the next upside swing of a leading diagonal. The pattern is tradable. Some patience until reaching the target area results in an asymmetric trade setup.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This idea has been distributed to our clients on January 22nd, 2019.