Sun 10/31/10. The Spooky Path Ahead.

(Update Mon 11/1/2010 11:15AM EST)
VIX is hanging in there above its 20dSMA despite the gap up. Youknowwho is lagging again...banks and financials and semiconductors. SSDD. Income down, spending up is not good. The high today could be a truncated 5th completing the structure from 1040 or it could have been a B/X/2 wave 99% retrace...too early to tell. I'm not sure if most Elliotticians allow a truncated EDT 5th leg with EDT originating from from 1132, but if SPX drops rapidly down near 1132, that would support that count. Industrials and transports diverged at the high again today. Tech may be leading the charge down which combined with financials would not bode well. Hourly support rises to 1182 and the rising low trend line 1132-->1160-->1172 now sits around 1180-1182. There is a large gap to fill down below 1183. Daily support is technically still at 1172 but came within pennies of rising to 1177 and the 20dSMA is rising to 1175, so 1172-1177 is solidified as important with 1180 a warning shot. Is anybody still reading?


(Update Mon 11/1/2010 10:50AM EST)
System buy signal closed today with 1/2 profit at 1192 and 1/2 profit just shy of 1196. Profit is 1.1%
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When I was a young boy, my family had a white cockapoodle that I named Spooky. When it came to chores, I used to toss his droppings over the neighbor's fence with a shovel rather than take the extra few minutes to bag them. Eventually, Spooky crapped in the house one too many times and then dug out of our fence for the umpteenth time at which point my dad decided not to help find him. When I was even younger, my parents often asked me to show my Spooky face when friends came over at which point I would make a scary face that is forever captured in pictures. So, I guess you could say I had a Spooky uprbringing. My past. The stock market's future.

Let me list the primary reasons I believe the stock market is forming a major top.
1. Taxes: Likely best case, all Bush and Obama tax cuts are extended 1-2 years but not permanently. Next best case, most tax cuts for the lower and middle classe are extended. People and businesses will act accordingly over the next 2 months. Congressional gridlock likely eliminates the best case scenario.
2. 99ers: Hundreds of thousands of unemployed people have been and will continue to lose their benefits into spring 2011 as the layoff massacre from fall 2008 to spring 2009 has entered its 2-year elapsed time window. Those that can will prepare for that inevitability before it happens. Congressional gridlock makes further unemployment extension less likely.
3. Discretionary spending: Discretionary near-real-time spending as tracked by http://www.consumerindexes.com/ reached a 1-yr low in 3 of the last 4 months and formed a signficant pivot high 5 months ago. Since 2007, both of those conditions have individually led to 15-20%+ turning points lasting 2-4 months in the time window SPX is currently in (October/November).
4. Government spending: Thus far, any government programs that initially showed positive results like housing credits and cash for clunkers ultimately led to worse conditions after the sugar high wore off. Citizens are fed up with Wall Street-targeted stimulus, higher cost of living due to huge energy, food, health and education price inflation without corresponding COLA, congressional pork, unpunished fraud, wasteful unsuccessful wars and empty promises without vision. So, there is little appetite for more stimulus and the Fed weaponry is increasingly unstable risking a backfire. People know the economy must endure pain while asset prices stay lofty which will be a self-reinforcing scenario. Congressional gridlock makes less stimulus very likely. People will prepare accordingly.
5. Sentiment: Many sentiment indicators like AAII and VIX show high complacency, and I'd say the blogs seem split on bullish and bearish scenarios.
6. S2EW: Using dynamic RSI-based S2EW rules, the March 2009 to April 2010 rally was corrective, and the current rally from SPX 1011 is also a corrective 3 waves thus far. Even if SPX reaches 1220+, it will likely end a double zigzag but of course we'd need to evaluate dynamic RSI if that occurs.
7. Housing: The next massive ARM reset wave is underway. Foreclosure fraud and legal actions are creating massive bank costs, diversions, image problems, SEC and reserve issues and potential implosion. Foreclosure delays have created a humongius backlog of foreclosures ready to flood the market in 2011. Congressional gridlock will make it more difficult to fix. People will prepare for getting kicked out of their houses by saving.
8. Jobs: Weekly initial claims dipped this past week but are still at a level signifying job contraction. Goldman Sachs and others have released historical charts supporting higher 10% unemployment next year. Many companies are still tightening due to economic uncertainty, health care costs, shareholder demands, decreased spending, tax issues, peak inventory cycle and small business neglect. Congressional gridlock makes large productive jobs bills unlikely and they usually cause more displacement anyway.

So far, I believe government spending, inventory building, extreme sentiment lows, fraudulent accounting and the US dollar have supported the SPX rally from 2009. Government spending (especially at state and local levels) is likely to decrease, not increase. Inventory building has peaked and appears to be in a downturn as consumer demand has waned. Sentiment is once again bullish or at least mixed. Fraudulent accounting is being exposed through legal battles and is likely to at least partially unravel. The only thing left to help our economy is the US dollar, but that has not always historically helped SPX and asset prices at current lofty levels will already crimp margins and jobs, so the Fed might be able to alleviate the short-term economic damage at the expense of longer-term economics but that's not even assured. What's left? It would require some radical change such as the Fair Tax or bank resolution to put a floor under our stock markets, and I just don't see that happening until a depression hits if ever.

My first chart below revisits discretionary spending turns as a leading indicator for SPX turns. Using a conservative view of the last spending pivot peak, SPX has rallied 22 weeks since then. The longest rally since 2007 after 5 previous spending downturns was 22-23 weeks. 4 previous spending upturns witnessed 14-25 week rallies. By any measure, the current SPX rally is on its last legs. There are 2 short-term spending pivots (one up, one down) that are counteratcing each other well into November. So, a 15-20% downturn is imminent, but there could still be a little more upside and the rug is not likely to be pulled out for 2-4 more weeks.

Assuming SPX pulls back early this coming week, I have drawn 4 potential scenarios with consideration for S2EW, trend lines, Fib support zones and typical 8-10 day downlegs. The most bullish scenario is in dark blue with the most bearish scenario in dark red. I see SPX 1150-1160 and 1123-1137 as key zones of support, and the reactions at those support levels will eliminate scenarios quickly. My 4 projections will obviously need to be adjusted if SPX makes a new high next week. Good luck.