Thoughts for Thursday, May 22...

I would have to say that the primary closing price target for the S&P 500 that I have discussed in recent weeks was that of the 1420-1425 area. I was not certain if the high on May 6 of 1418.26 was close enough. The eventual closing high of 1426.63 set on May 19 would suggest that it was not. That said, the failure swing created by divergent RSI after the May 6 peak was never negated in any manner. We have since seen the markets sell-off to again test the 1390 area.

I believe that it is also important to note violation of the trend channel formed by the closing lows of March 17 and April 14. The S&P 500 broke down below this support level on Tuesday. It would not be uncommon to see the markets meander higher for a day or two to test this trend-line, which now runs around the 1405 area. Should this resistance hold, then I would expect another thrust downward. 1390 remains the significant support, but I find myself intrigued by the possibility of a low around the 1375 area.

Thoughts for Sunday, May 11...

I think that we have reached a good point to revisit the wave structure that unfolded since the lows of March 2003. There is a great deal of debate over the future course of the S&P 500. The bearish argument asserts that we have completed a long-term corrective wave higher and resumed the bear market cycle begun in 2000. The bullish interpretation sees the decline from October as Wave 4 in a five-wave structure that began with the lows of late 2002 or early 2003.

While there are some elements to this wave structure that support the notion that the last four years were merely a corrective formation, I believe that there are some subtle points that are consistent with the five-wave, motive formation. It is my belief the notion that we have been witnessing a corrective formation up from March 2003 has been invalidated.

One aspect of the longer-term rally appears consistent with a corrective formation. The rally up from March 2003 can be viewed as two primary waves higher. The first wave began in March 2003 and ended in December 2004. The total length of this wave was 370.77 points over a 21-month period. The second wave began after October 2005 and ran until October 2007. This wave assumed a length of 342.37 points as it unfolded over a 24-month period.

If this were a three-wave Zigzag formation higher, then we would expect to see Waves A and C assume a roughly equal length. The two waves higher differed in length by less than thirty points and in duration by only three months. This proportionality is consistent with what we would expect within a corrective formation.

The evidence that suggests this wave is not corrective can be found in the actual structure of the waves themselves. If we strictly count all moves higher and all moves lower using the closing price at the end of each month, then the rally after October 2005 unfolded in nine waves higher. This gives the wave an extended structure.

This point is of crucial importance because R.N. Elliott wrote in his book "Nature's Law" the following: "Extensions occur only in new territory of the current cycle. That is, they do not occur as corrections." If we accept this strict nine-wave interpretation of the October 2005 to October 2007 rally, then we must also accept the reality of this extended structure. If we accept Elliott's observations in their original form, then we must also accept that this structure invalidates the possibility that the rally from March 2003 was corrective in nature. We must also accept that this formation invalidates the assertion that we are in a larger, long-term correction.

Please understand that I write these words with a great deal of respect for Robert Prechter and his entire body of work. Everything that I know of the Elliott Wave Principle comes from his publications. Past clients have laughed at me when I have pulled out one of his texts in the middle of a discussion. I am that much of a devotee to his work. Nevertheless, I became convinced in late 2002 that the cycle had one more wave higher before completion. It is my opinion that we now stand near the beginning of the final rally in that fifth wave higher.

Thoughts for Thursday, May 8...

The selloff that we saw on the S&P 500 presents us with what appears to be a classic reversal situation. We discussed previously the notion that we were in the third wave up of a rally from March 17. We also discussed the 1420 to 1425 area as a potential area of price proportionality and resistance. In addition to this, we have also considered the possibility of a divergence on the 10-day relative strength index. It appears to me that all of these issues have been relevant over the last few days.

If we look at the chart below, we can see what might be described as a narrowing trend channel . We typically see trend channels narrow as a price move nears completion. We can see that the S&P 500 closed at the upper limit of this trend channel on Tuesday, and then broke down below the lower range of this narrowing channel on Wednesday. This represents a potential completion of what I have been calling Wave C.

It is not insignificant that this price pattern completed around the area of proportionality and resistance that we have discussed previously. Among other things, this area represents the 50% retracement level of the decline from October to March. It also gives us a fair amount of proportionality between the initial wave up from March 17 to April 7 and the final wave up from April 14 to May 6. I would have preferred to see the S&P 500 close above the 1420 level, but what we have seen may be good enough.

The final issue of interest is the 10-day relative strength index (RSI). Last week, we discussed a possible divergence that was forming on the technical indicator of price momentum. We have seen this divergence continue to develop over the last week. The sell-off on Wednesday dropped the RSI below its previous lows. This was what Welles Wilder, the man from McLeansville, NC who developed many of our technical tools, called a failure swing. Failure swings are not always reliable predictors on their own, but they can prove helpful when coupled with other tools. I view the failure swing that completed on Wednesday as a bearish occurrence.

All of this lead me to believe that we may be due for a week or two of downward price movement. My initial primary targets are 1300 to 1325. We will see if this plays out.

Thoughts for Thursday, May 1...

The S&P 500 is finally showing some signs that the recent rally is drawing to a close. I have previously expressed my skepticism about the strength of this rally. Those feelings have not changed, though it has required a bit of patience to wait for things to unfold. Nevertheless, there is some evidence that the underlying momentum of this rally is failing.

If we look at the chart below, we can see the 10-day Relative Strength Index for the daily chart of the S&P 500. The high set on April 28 for the S&P was accompanied by a peak of 84 on the RSI. This is a decidedly overbought level. Sometimes overbought levels mark the end of a move, but often times it is worth while to wait for a divergence to occur. Such a divergence began to appear today when the S&P 500 rallied to a new high, but the RSI did not. This failure to confirm the rally suggests that a possible price reversal lies ahead. Should we see the S&P 500 rally on Friday without a corresponding increase in this short-term RSI indicator, then my bearishness would increase.

I find this intesting to see a divergence beginning to occur at these levels, because the S&P 500 is beginning to reach several levels of potential resistance. One of these levels can be derived from the length of the initial wave formation up. This wave began with the closing low of 1276.60 on March 17 and ended with the closing high of 1372.54 on April 7. That gave the completed wave a length of 95.94 points.

The Elliott Wave Principle tells us that Wave C of a structure tends to assume an equal or proportional length to that of Wave A. Let us assume that the March 17 to April 7 rally was Wave A. Let us also assume that Wave C began with the closing low of 1328.32 on April 14. If Wave C were to rally 95.94 points then, that would put the S&P 500 at 1424.26. Interestingly enough, we are almost at a period when the duration of the rally from April 14 is also equal to the duration of that March 17 to April 7 rally.

So... I did not discuss breadth in this post, but it remains terrible. We have a potential momentum divergence in the RSI. We also have a considerable amount of resistance around the 1420-1425 level on the S&P 500. It could be that a rally on Friday just might be what the S&P 500 needs to place itself in position for a reversal.