The analysis of the broad stock market that I gave in last Wednesday's blog is still valid and is relevant to today's update so I would suggest readers go through it again to fully understand the importance of what is happening now as we could be close to a major breakdown in equity markets.
In Wednesday's blog I wrote: "We need a cautious approach in our trading now because of this market's high volatility and strong downward momentum. If today's lows hold and the market starts to rally over the next two days, we will consider a long position and will watch for the DOW to exceed and close above 16,100. This would be a sign that a new cycle has started and a rally could get up into a range between 16,600 and 17,200 in the first half of February." On Thursday and Friday the DOW did indeed rally and briefly broke above 16,100 but then closed on Friday just below that line at 16,093 which leaves things a little ambiguous. That rally into February could be starting now, but there is still a chance of the market turning back down and making new lows over the next several weeks.
There is support for the DOW this week in the 15,640 - 15,740 area so we will try to go long on any dips with a stop loss there.
I also wrote in Wednesday's blog: "If market momentum starts to turn bullish, the rally could go even higher, but right now it looks more likely that such a rally towards 17,000 would soon turn down again, and we would probably be looking to sell short the peak of any surge into the second week of February." So even if we see a rally now, there is a good chance it will peak in early February. The target for this peak could get to 17,000 or even higher, but it doesn't have to. Timing is more important here, and whatever high the market is making by the second week of February we will look to sell short. If that high is below 17,800, there is a strong possibility that the correction that follows will be the start of a major market meltdown similar to or even worse than the one in 2008-2009. A sign that this is happening would be if the DOW starts closing below 15,370 and especially if the S&P 500 starts closing below 1800.
For those who doubt that such a serious crash could happen now, I would like to point out that in the chart for the S&P 500 a gigantic and very symmetrical "dome top" has been forming since early 2012, and that dome is now rounding over and pointing down. This means that unless this index breaks above the dome soon, the market is heading down, possibly in a dramatic fashion because a breakdown from the right side of a dome top is usually erratic (as it is driven by panic) and not as symmetrical as the left side. There is also a huge "head and shoulders top" chart formation positioned directly underneath this dome which any chart analyst will tell you is an ominous bearish sign. This "head and shoulders top" is nearly complete and therefore ready to turn south which further makes the case that a severe downturn in this market is imminent. On top of all this (no pun intended), the chart of the DOW has been forming a giant "megaphone" pattern since early 2000, and this index has now rolled over at the top edge of this "megaphone" (around 18,000). If the "megaphone" pattern is valid (i.e. if the market does not start making new all-time highs above 18,400) then the DOW is now poised for an immense fall, possibly down to the 6000 area ! I apologize for not including chart pictures to illustrate these formations, but most of the charts I am analyzing are copyright protected, and I do not have the time to create my own. Anyone interested in seeing these current patterns can just google the terms "S&P 500 dome top", "S&P 500 head and shoulders top" and "DOW megaphone pattern" and find many pictures and descriptions.
We can summarize the current situation in the broad stock market with three possible scenarios:
1) The market rallies into the first half of February and the DOW stays under 17,800. The market then turns down and falls to new lows that possibly lead to a "meltdown" and severe crash.
2) The market turns back down now and makes a new monthly low (or double bottom to its 15,400 low) in the first two weeks of February and then reverses to begin a new medium-term cycle with a strong rally.
3) The market continues to rally and turns bullish with the DOW closing above 17,800, and the DOW, S&P 500 and NASDAQ all start making new all-time highs.
At the moment it seems like scenario 1 is the most likely with scenario 2 a close second. Scenario 3 seems very unlikely right now, but we should never underestimate the power of market manipulators (overt and covert) to keep equity markets buoyant if it serves their political or personal agendas. I don't think the Federal Reserve expected their recent minuscule rate hike to have the negative impact on the stock market that it may be having now so it is possible they might resort to desperate measures such as another round of QE to stem a potential crash. Last week European Central Bank president Mario Draghi announced that he would provide more QE stimulus to Europe's floundering economy as early as March if it seems necessary to do so. His statement made on Thursday seemed to trigger a rally in equity markets, but will this just be a short-term reaction? Will the U.S. Federal Reserve take a cue from Draghi and roll out another round of QE to buoy the stock markets? We will have to wait and see.
Still on the sidelines of the broad stock market.