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Thursday, 12 January 2012

The Bull Case

I'm going to take a little time today to put the case for the new bull market from the October low. Negative divergences against equities here are very numerous, and for that reason bear market continuation looks more likely to me, but it would be a mistake to think that the bulls have no case here, and I'll be outlining what I see are the main planks of that case from a technical perspective.

In the short term support on the ES rising channel is clearly still holding, and until that breaks there's not much to see on the bear side here. The upper trendline of the channel is in the 1312 area, and ES has moved up an impressive nine points in the hour since I capped this chart to beat the last high. There might be more coming. Channel support is at 1282.5 this morning:
If the move up overnight can be sustained, then the next upside target after the potential double-top area that has been tested in the last two days is declining resistance from the 2011 high in the 1315-18 area, with a nod to the top of the weekly Ichimoku cloud in the 1303 area on the way there. You should note that this resistance area would correspond well with ES channel resistance if that should be reached today or tomorrow. The ES rising channel is rising at about four points per day so ideally any hit would be today. Worth noting also on this chart is double-trendline support in the 1245 area on SPX. That would be the key target on any retracement down from here and for the bear market continuation case, that would need to be broken:
What is there to support a move on SPX into resistance here? Well I posted the 30yr treasury futures chart yesterday, noting that the next obvious move was into declining resistance to establish a falling wedge. I gave falling wedge resistance in the 144'10 area, and the peak yesterday was 144'06. Close enough, and the falling wedge is now established. That falling wedge is a 69% bullish pattern, and could break up at any time towards a retest of the last highs in the 146'10 area, but short term the next obvious target is now falling wedge support in the 140'30 area. If we see that, it would be a big move and would support a short term move up on equities:
Copper has been forming a triangle since the October low, and has now broken both the triangle resistance trendline and (on the futures overnight) the important 200 DMA. Copper is still heavily negatively divergent from equities here, but a run to the triangle top at the October highs is the obvious next move for copper, and that would help equities along too:
There is also some potential short term support from EURUSD, which made a marginal new low yesterday on 60min positive RSI divergence. A short term double-bottom may be forming with a bounce target in the 1.295 area. If that plays out then that would also give equities a boost here. I have drawn a falling wedge type pattern on EURUSD here but it isn't a falling wedge as the upper trendline is too much of a mess.:
While we're on the subject of forex it's also worth noting that GBPUSD has broken down yesterday through the neckline of the very large H&S indicating to long term support in the 1.40 area. There are signs that the positive divergence on the daily RSI may be breaking down and this is a very nice technical pattern that may well play out. GBPUSD is also in a perfect declining channel from the last highs, and only on a break about the upper trendline on that declining channel, currently at 1.573, would I write off this H&S. In the very short term GBPUSD is likely to follow any bounce on EURUSD of course:
On to the bull case here. The bear case is clear enough of course. Serious problems in the Euro zone, with sovereign debt generally compromising the solvency of the world financial system, and a sluggish world economy groaning beneath the burden of ever increasing debt. Technically in a new bull market we'd expect to see positive divergence from copper and emerging markets, which are showing sharp negative divergence here, and we'd also expect to see negative divergence from bonds and USD, which are both showing sharp positive divergence here. You don't need all of these to support equities, but to have none looks very bearish.

The bull case should not be dismissed however. The October low formed a decent quality rising channel from the 2009 low, and that needs to be taken seriously. There are still two major resistance levels above, but if SPX can clear the declining resistance trendline from the 2007 through the 2011 highs in the 1315-18 area that would look pretty bullish, especially as SPX has already recovered above the important bull/bear dividing line at the 200 DMA and held it for a couple of weeks. If SPX breaks up through declining resistance from 2007 and 2011, the next major resistance would be at the 2011 high, which was almost precisely at the double-top neckline for the 2007 high and is therefore very strong resistance. A failure there would set up a double-top on SPX indicating to the 780 area. A break above the 2011 high with confidence would set up a run to 1440 and over that rising channel resistance is currently in the 1490 area:
One thing I have heard regularly is that any new bull market is dead in the water without support from financials. However I posted the XLF chart on Monday showing the very significant looking break over declining resistance from the 2007 high. XLF is now testing the important 200 DMA and over that would need to take out the last high at 14.08. If XLF does that however, the setup would then look very bullish and a lot of the individual financial sector names have very bullish looking bottoming setups:
There something else to consider as well and that is SPX earnings. There is obviously a serious question mark over whether current SPX earnings levels can be maintained, and in the case of the financial sector, under current accounting rules, whether current earnings exist at all. That aside however, let's consider earnings performance against the performance of the SPX in the last two calendar years. In 2010 earnings increased by 30% and the SPX rose 15%. In 2011 earnings increased by 15% and the SPX was flat. I have a close for 2009 in the 1115 area, and if earnings and the SPX had increased at the same rate since then, SPX would now be in the 1666 area. Thought for the day.

As I write ES is now in the 1296 area and the RSI is in overbought territory on all of the 60min, 15min and 5min timeframes. There is a significant chance that we will see some retracement early in the session and a gap fill might be possible though it is starting to look ambitious. As I've mentioned earlier, we may have a perfect bull setup today, with equities supported by rising copper and EURUSD on one hand, and falling bonds on the other. A trend day up may therefore be on the cards and a very strong push could see us testing ES channel resistance in the 1312-14 area, which would also be at declining resistance from the 2007 through 2011 highs. That would be a likely area for at least an interim top and very possibly a rally high. There is a lot of detail on the charts today that hasn't been covered in this write-up, so if you want to see that just click on the charts to expand them.

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