Indicators and levels to watch in the precarious S&P 500 index to verify if downtrend is done for now

Andre Gratian has opinions about the stock market's strength and probable direction that we always want to know! He's a unique analyst who incorporates classic technical analysis with cycles, Fibonacci work, and even point-and-figure (P&F) projecting. Here is Andre's weekend report for the S&P 500 index (SPX) from his Turning Points subscription service. Andre's website is at Market Turning Points (always included in the sites list at right side of the page here). He provides his intraday updates also to his subscribers.

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May 31, 2010
Turning Points
By Andre Gratian

The coming week should clarify whether the SPX has reversed its short-term downtrend at 1040.78, or if the rally from that level is merely a pause in a decline of intermediate proportion. Some “green shoots” have begun to appear in the form of minor divergences in the daily and weekly indicators, but these are very precocious and will have to grow into much more positive signs before the bulls can declare victory.

Let’s look at some charts and begin with the Weekly Chart.

The medium-term bear market came to an end in March, 2009. The bull market which started on that date is outlined in green. A short-term downtrend started 5 weeks ago and has found support on the midchannel trend line at a level which corresponds to the February low.



The indicators are in a downtrend and do not look ready to reverse. However, the lower one has developed some minor positive divergence which could be a sign that prices will hold and consolidate at that level. The cycles that lay ahead makes this unlikely, but if the index can gather some upside momentum over the next week or two, it will improve the odds in favor of the bulls. If it does not hold, the SPX may reach 1051 by the time the 2-yr cycle bottoms.

Note that the market will also have to deal with a cluster of cycle lows -- including the 4-yr cycle -- in October. At the end of its last phase, the 4-year cycle had a marginal effect on the market. If it also has a weak bottoming phase this year, upward pressure provided by the rising 2-year cycle could avert a strong market decline in the Fall.

Now, let’s turn to the Daily Chart for more refined analysis.

The bottom divergence is more noticeable on this chart. It appears mostly in the lower (A/D) indicator. The divergence is not easy to discern in the middle (momentum) indicator, and is non-existent in the MACD. Only the bottom oscillator is back in an uptrend -- and just barely.

The index tried to move out of the purple channel, but was stopped by the 200-DMA resistance. If it manages to rise above it, it will have to overcome the upper trend line of the red channel, and then the 50-DMA. All that will have to be accomplished while two dominant cycles are bottoming over the next
month.



The attempt at moving higher will be assisted by extreme sentiment readings, as you will see below. But will that be enough to ensure a successful reversal?

The Hourly Chart will help us to refine our analysis even further and will give us some important clues about what to expect.

The uptrend from the last low at 1040.78 overcame the 1090-95 levels -- which was a positive, but may now be developing into a wedge pattern. The most logical time/price objective for this move is to reach about 1113 (pink bar) on Wednesday (red asterisk). If this happens, it would complete the 5th wave of the wedge pattern just under the top of the red channel and this would call for a retracement. On the nature of this retracement hangs the fate of the SPX for the near term.

Note that 1040.78 marked the completion of the second downward phase from 1220. These phases are outlined in heavy black. Starting another move down from about 1113 would theoretically send the SPX down to just above 1000 and complete the move from 1220 (5 waves). This is only ONE possibility which could bring an end to the decline from 1220.

The difficulty with this scenario is that, unless the final phase is a long, drawn-out process, the low would be made about 10 days ahead of the 17-wk low which is estimated to be around 6/20. So it is a little too early to determine with a high degree of confidence how the decline will end.

Estimating that the current green phase will be completed in a couple of days is more reliable because of the hourly indicators’ profile. Unless the next near-term up-move is very strong and nullifies the wedge pattern, a near-term top should be confirmed in the next couple of days.




The SentimenTrader gauge (at left, courtesy of SentimenTrader.com) is the last chart that I want to show you.

The long-term reading remains at its positive extreme, and that normally signifies that the market is not expected to continue its bearish inclination much longer.

It may even be a warning that the final wave down to about 1000 will not take place, but that some other bottoming pattern will form and bring about a reversal.

This sentiment reading is telling me that another three weeks of decline into the 17-week low (around 6/21) is unlikely to occur, and that is the dilemma we are facing.


As always when the analysis is uncertain, we’ll have to wait for the market to clarify its intentions.

Andre