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Is This The Much Awaited Correction? at Trader’s Narrative

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Although I recently summarized the bullish case for the intermediate term, the short term was and has been rather precarious for some time now. Specifically, pointing to the industry breadth chart, I wrote: “…a spike high does generally correspond to a short term correction but the primary trend is up.” And even Ned Davis Research made no bones about being wildly bullish also made it clear that in their view a short term correction is imminent.

You have no doubt spotted the obvious head and shoulder topping formation in the S&P 500. It is clearer if you switch from a daily to an intra-day interval (say the 60 minute chart). In any case, here’s an annotated daily chart:

S&P500 head and shoulder May 2010

Today’s carnage closed the index below the downward sloping neckline around the 1180 level. That puts the completion of the formation at 1140 which would be appx. a 6.50% correction from the recent top. Since we’ve been waiting for a short term correction of 5-10% for a few weeks now, this isn’t really surprising.

Breadth, as measured by cumulative advance decline, is holding well. The S&P 500 index’s own cumulative advance decline line is still above April 27th levels even though the market is trading below index levels since then. So for now, breadth is showing a bullish divergence.

As a quick follow up to last week’s commentary on volatility jolting back to life, the VIX is now trading 27% above its 50 day moving average. That’s higher than the spike in April (corresponding to the April 27th decline).

Had the VIX closed at its high for the day (25.70) this would have been much higher, approaching the sort of volatility conditions - relatively speaking - that we saw in late November 2008. Keep in mind that the VIX is coming from a very depressed level with the 50 day moving average not having been this low since August 2008. So likewise, it can potentially spike much higher.

If the S&P 500 continues to fall and has a 10% correction, which would be par for the course, then we can expect it to fall to the 1100 handle. If this correction is only as deep as the previous correction in February, then we could see it fall to 1125.

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3 Responses to “Is This The Much Awaited Correction?”  

  1. 1 Andrew

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    The market needs to be dip much more in order for there to be a correction, in my opinion. The government is throwing everything at the government except for the kitchen sink, therefore, the market will rally. There were trends throughout the Great Depression of highs and lows but ultimately the market will need to go down a lot more because of all the malinvestment, fraud and wasteful spending.

    However, I do agree with Faber when he says the market can go up all it wants but the dollar will just devalue and be worthless, like the way it’s going now.

    Also the big banks are going to benefit from the supposed finance reform where they’ll be given permanent bailouts and crush the smaller banks!

  2. 2 Steve

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    The slope of the advance as identified by a trendline connecting Mar09-Feb10 places the S&P500 at 1575 in Dec 2010. There is no fundamental valuation that makes this a likely scenario. Based on the speed and size of the advance since Mar09 the only way I’d anticipate the slope of the advance flattening is by a larger than average correction (25-30%) or by a multi-year trading range. A move from 666-1220 will almost certainly retrace. A 38.2 puts us at 1,009 and a 50 puts us back 943 (the double top broken through in summer 09). I would be utterly shocked if we don’t see these levels within 12-16 months. On average it takes the S&P5 6 years to return 132% following a bear market bottom…we’re on pace to do it in less than 2 years among the worst fundamental backdrop in decades. The odds are not in the bulls camp whatsoever, and the fact that nobody believes it makes it even more compelling.

  3. 3 TG

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    Reportedly Lowry’s is now suggesting a market correction because buying power has fallen significantly and selling power has risen

    The Ned Davis MarketDigest from Monday was still at maximum overweight stocks.

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