In the last BullBear Weekend Report on I concluded:
...the likelihood of continued upside in defiance of bearish expectations is high. Whether this represents an intermediate term blip or something more significant is as yet unknown, although there are some long term divergences and indications that point towards a long term bullish conclusion.
We did get that continued updside, though as indicated it was limited by overhead resistance and the exhaustion of the first wave up off the low:
...the short term overbought condition could get even more overbought early this week...Most market observers are already calling for a top and this rally has been greeted with skepticism. In this context I would be looking for a sideways abc formation over the first few days of the week. Traders who are out or looking to add to their long positions could buy the a and c wave lows of wave ii ahead of iii of 3 which should rapidly take the market back to 1131 resistance.
The wave count together with certain technical indicators leads to the conclusion that the first wave is now complete or very nearly so and that we should expect a wave ii pullback this week. Bulls should welcome this as a buying opportunity, particularly fortuitous since most of us likley missed the very rapid rally from the recent low. The ensuing decline should be of sufficient depth and strength to shift sentiment back to solidly bearish in very short order, setting up a powerful iii of 1 of 3 of (3) move back above the downtrend and horizontal resistance.
To sum up the findings of this report: the advance in equities that began near SPX 1040 is most likely the start of a significant bull move, but the first leg of that move is likely at or near its end and will correct soon. Long term, there are a number of developments which auger well for the price of risk assets going forward. We are seeing significant signs of the early stages of a shift from safety back to risk as safe havens such as bonds, Yen and, possibly gold, show signs of topping out. After a brief bout of fear and selling (which bears will misconstrue as the Big Kahuna to the downside), intermediate and long term bullish forces will gain the upper hand and the market will trade higher.
The bullish scenario shows a reverse head and shoulders pattern in the latter stages of development. Although fairly well formed and evident, this pattern has received little if any attention (which increases its chances for completion). Symmetry with the left shoulder may call for a comparable second dip, perhaps even a double bottom. For now we will assume that, as a bullish pattern, the right shoulder will be stronger and the pullback will be more shallow. The 50% Fib retracement level seems reasonable, but rather than specific levels we will be watching for the completion of a clear three wave abc correction to set up a buying opportunity. Indeed, if the above does represent a bottoming pattern, we can see that bulls have been exceedingly patient in their purchases, waiting for a wave of panic selling to step in and buy in size. These patient, strong hands can be seen at the green arrows.
This bearish scenario is now in play and would gain weight on a move back below the downtrend. A move to the lower rail of the triangle would certainly call for a reevaluation of any bullish thesis.
The larger bearish scenario involves a year long head and shoulders topping pattern with the final right shoulder now starting its trip to the 1040 neckline.
Both of these bearish scenarios are valid but at this time the weight of the technical evidence tends to support the bullish thesis. I might also add that bears have had repeated setups handed to them and they have failed to break the market below support. And in spite of the recent swing towards bullish sentiment in investor surveys the overall sentiment backdrop remains overwhelmingly bearish.
Disclosure: Long SPX