Thoughts for Tuesday, July 3...

The markets have entered into a period of consolidation. There will be gyrations up and down, but all of them will remain within the larger confines of a corrective wave structure. The more important questions are what formation and what degree.

One possibility is that we are in a sideways triangle formation. If we look back to the end of June on a line chart of the S&P 500, then we can see that we have made what might be counted as four three-wave formations. The current wave up would be wave D of the triangle. Triangles are composed of five three-wave formations. That would imply that our next wave down would be limited in magnitude, and remain within the narrowing channel formed by the last two highs and lows. If we bounce off the lower trend-line around 1490, then that would suggest that we have a final wave to run about 75 points higher.

The second possiblity is that we break the 1490 support and make another lower low. This would suggest that the high in mid-June marked the end of the five-wave structure up from March. It would also be consistent with my hypothesis that we have already entered Wave 4 of a longer-term wave structure. Whether this is Wave 4 of the bull market that began in March of 2003 or Wave 4 of the rally that began in July 2006 remains unproven. Nevertheless, I am of the opinion that the market will need to test the 200-day simple moving average.

I think it is important to reiterate that the markets have seen a marked narrowing of breadth, a definite decline in volume, and unmistakeable divergence between price and momentum oscillators. Since the beginning of June we have also seen a lower high and a lower low on the S&P 500. Our current rally has not gotten close to the 1540 highs, despite greater strength on the NASDAQ Composite. These all support the bearish case.

Over the short-term (1-3 weeks), I am mildly bearish on the S&P 500. Over the intermediate-term (1-3 months), I am also mildly bearish. That said, I remain bullish over the longer-term (1-3 years) and continue to expect a bull market into 2010. The direction of the shorter term price movements will be defined by the magnitude of the next downward movement. If we break the 1490 level, then I expect an eventual test of the 200-day moving average that could even reach the March 2007 lows. If 1490 holds, then the next logical resistance would be 1565.