Monday, February 1, 2010

Countertrend Rally

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S&P Hourly

On Monday, the S&P 500 had its best day since the first trading session of the year with a rally of 1.4%. Breadth was positive by 9:2 and up volume outpaced down volume by a 17:2 ratio. However, total volume fell by over 27% from Friday’s level.

The lower volume, which puts a bit of a damper on Monday, continues January’s propensity for lower volume on rallies and higher volume on declines. During January, the S&P rallied 11 times and fell eight times. Volume was lower for seven of the 11 rally days, while seven of the eight down days were accompanied by higher volume. Thus, despite the strong start to the year, the overall bias has been to distribution, not accumulation.

That said, near term momentum is oversold and there has been evidence of positive divergences. For example, the daily Coppock Curve is still weak for 21 of the 24 S&P industry groups, but this compares with 22 late last week and all 24 early last week. Moreover, it is our expectation that a majority of the groups will have a bullish near term momentum bias by the end of this week.

This combination of oversold and diverging momentum suggests that Monday’s rally could continue for a while, perhaps for much of February. The oversold 10-day CBOE put/call ratio buttresses the idea of further near term strength. However, we continue to count January’s decline as a five-wave pattern, meaning that it is the first leg of a larger decline. Moreover, the intermediate indicators are weak enough that they should be able to withstand a near term rally. Thus, the risk is that surprises are more likely to be to the downside.

Our basic view is that Monday’s rally is part of a wave 2 or a wave “B” within a larger unfinished downtrend. As such, this countertrend rally should be a Fibonacci relationship to the just completes wave 1/A. There are several ways to count the five wave pattern, but a 38.2% retracement is in line with the fourth wave of prior degree, so 1102-1103 is a reasonably important first resistance area. Beyond that we would look to 1111-1120.

We continue to believe that the decline from January’s high will be at least a 38.2% retracement of the July-January rally. This suggests further weakness to 1043, intervening rallies notwithstanding. Such a move could well put tactical support at 1029-1020 under pressure.

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