Plan A and Plan B comparison scenarios
The Plan A scenario is that the next move in the DJIA and other equity indices is downward, testing the November lows (i.e., near 741 in the S&P500) or even dropping below those lows (such as testing the 664 or 554 levels in the S&P500). This is a scenario I've been describing here, and I know that Tony Caldaro is depicting this possibility in his charts for the DJIA. Curiously enough, this scenario can have a bullish twist, because one of the possibilities afterward is that the markets would have cleared the way for more positive action ... but let's not get ahead of ourselves.
Plan B sees the DJIA and other equity markets moving upward, at least for weeks if not for months into early or even mid-2009. (Possible levels in the S&P500 for such a move could be in the range from 1060 to 1198.) What happens after that, well it could be bearish [actually there's a primary view that the equity markets roll over into much deeper lows, and a secondary possibility that doesn't happen] - but again let's take this one step at a time.
As for the banking sector, I'm bullish because it hit a major target I had for a low to manifest. This doesn't mean that I think ALL banks are survivors and will do well. Keep in mind an index like the BKX is only that - an index. It's entirely possible for some components (especially components already worth only a few dollars per share) to flame out or be absorbed into other companies, while the other components turn the corner and rally upward. (Let's face it - it's also possible that if some components of an index drop out, the index itself may be re-calculated or may have new companies added to it.)
So ... I'm positive on the banking sector because its index, the BKX, hit my Elliott Wave and Fibonacci low target depicted in the following chart:
In this chart I did my best to analyze the Elliott Wave correction in BKX, the banking index. As I started showing here some time ago, that analysis showed a diagonal for which the logical Fibonacci target was 26.64. On Tuesday this past week, the BKX poked that target, and swiftly rebounded with a whopping 14% increase the next day. Then Thursday and Friday price consolidated, with the result that the weekly chart doesn't yet show bullish movement on the technical indicators. If this is indeed a bullish movement (that can be followed with an ETF such as KBE, backstopped at Tuesday's lows or with a trailing stop), then the next logical step is for price to move above the high of this past week's action, during the upcoming week (and preferably closing above it), along with the indicators improving.
Elliott Wave diagonals have a way of leading to a retracement of all or almost all of the move down within a relatively short amount of time. The critical question is going to be, was this an ending diagonal or a leading diagonal? If it's an ending diagonal, then we'd expect to see the BKX back up to the low $80's in a couple of months. Along the way, we'd expect to see a swift movement up to or a little over $50, with an orderly pullback (wave 2 or B) followed by a persistent movement (wave 3 or C) toward $83.43 which is where I mark the diagonal to have started. (You can learn more about Elliott Wave ending diagonals at my "No Bull, No Bear, No Bias" site (see link at right side of page) where I posted a tutorial on these.)
Comparing banking index to broad market action
How would this fit with Plan A for equities? Well first of all, remember that the banking and financial sector led the broader equities markets in the move down, so we could expect this sector to bottom out and begin a recovery before the rest of the market do likewise. Second, purely from a fundamental perspective - many other sectors have taken a while to suffer the secondary effects of the financial malaise, the housing sector trainwreck, and the credit market's freeze. So we could expect it will take a while before these other industries and other sectors shake off the ripple effects of these financial problems and turn the corner. Bottom line: the banking sector - at least those banks that will be the survivors forming the index - can start to recover, even while other sectors finish feeling their pain. So a new low can form in the DJIA and broad markets, even after the BKX marked its low.
Some analytics on the financials within the DJIA
Here's some pertinent information passed along by my trading buddy "Joe" (and it apparently comes from Jim Bianco as source). This info is fascinating on its own ... and it may even support the idea that a move upward in the financials won't have huge positive effect in the DJIA right now (just as the recent devastating drops in BKX didn't have the same percentage impacts on the broader equities markets). The stock quotes cited are a few days old but still good for this explanation:
"The Dow Jones Industrial Average (DJIA) is a price weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company's market capitalization.Thanks for passing this along, Joe! What a sobering but informative set of data.
"Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last nightʼs close (January 20), the DJIA had the following stocks less than $10...
Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35
"If all four of these stocks went to zero on today's open, the DJIA would lose only 157.3 points.
"The financials in the DJIA are...
Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09
"If every financial stock in the DJIA went to zero on today's open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).
"If you want to add GE into the financial sector, a debatable proposition, then:
GE (GE) = $12.93
"If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points.
"The reason the DJIA is outperforming on the downside is the index committee is not doing its job and replacing sub-$10 stocks and the financials are so beaten up that they cannot push the index much lower.
"So what is driving the index? The highest priced stocks:
IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56
"For instance if all the sub-$10 stocks listed above, all the financials listed above and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points.
"If IBM opens at zero, it loses 652.95 points. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE and Alcoa combined.
"The DJIA is not normal as the Index committee is not doing their job during this crisis, possibly because to the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighing in financials and autos."
Now, one point I draw from this (and I invite comment as to whether I'm on track or off base with this) is that, just as the drops in the financials have not had a commensurate effect on the DJIA - having the financials move up by the few pennies or dollars that would be a large percentage (%) impact for them, also would not have a hugely bullish effect on the DJIA. And probably wouldn't do so much to offset large declines in its other components (IF that happens).
More comparison analysis as to equities
How about my views on the BKX comparing with the Plan B scenario? The BKX having bottomed would fit with this also, because the initial move up toward the $50 area could go along with the markets swinging higher to those levels I mentioned above. Then an orderly pullback in the BKX could occur - even to a deep level, but not new lows - while the DJIA and broad markets moved into deeper levels.
And what if the BKX diagonal is a leading Elliott Wave diagonal? While I think it "looks" unlikely that it is, I've got to be prudently cautious and account for the possibility. In the short term it wouldn't matter much for traders, because it would still lead to a handsome move upward over a period of days or even weeks. But once the rally faded, it would give way to another painful move down to new lows in the banking sector. I suppose this could go with either Plan A or Plan B, for the reasons I've mentioned above about timing and the fundamentals rippling through the various industries; but it would probably "fit" better with the Plan B scenario.
Now - one more sobering thought: if you studied the Elliott Wave ending diagonal information, which I posted at my trading education site I mentioned - you'll pay attention to the point that even ending diagonals sometimes add one final, whiplash move downward (or upward if it happens to be an upward ending diagonal), before being "finally done." It doesn't happen every time, but often enough to be very wary of the possibility.
I don't "like" the idea one one final wave down to complete an ending diagonal in the BKX, but just have to mention it and let's remain aware of it. The main reason I don't like it is because the index already poked my Fibonacci target and moved swiftly above it. So I don't see a "reason" why a last wave would need to go there again. But obviously, it would go well with the "Plan A" scenario (though could work with Plan B due, once again, to the non-symmetry reasons I posted above). Let's not count on the possibility of the BKX needing another low ... let's just use our normal trade (stop loss) and money management to guard ourselves in case it does.
As always - be careful out there, and happy trading all!
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