Stocks unmoved by Yellen – so far

Despite the well-flagged announcement by the Fed on Wednesday of their plan to soon start to reduce their mammoth hoard of assets, markets’ reactions were quite sanguine.  Of course, they did not want to frighten the horses and are only taking baby steps along that path.  So the burning question is: Has this change in the Fed stance deterred the stock market bulls from pushing shares even higher?

I have been bullish for some time as I recognised that in Elliott wave terms, the entire bull run at least off the 2009 lows has likely not finished.  There was still a final fifth wave to complete – and the final top could be closer to the Dow 23,000 area.

Of course, even if that materialises, there would likely be severe declines along the way.  One of my valid counts has the market in a third wave up – and these can carry far further than many would credit.

But the bullish sentiment needle remains hard right – here is the latest COT of the mini-Dow

Hedge funds are over 8:1 bullish while the smart money trade has taken the other side.  This is a most definite warning sign – as is the latest Market Vane survey of professional Commodity Trading Advisors which shows a bullish reading of 71%.  The last time this measure has been this high was back in the summer of 2007 – just as stocks were beginning their worst slide since the Great Depression.  Hmm.

Last time, I showed the sudden rush to the bullish side by retail investors from the AAII survey, and that stance has been held in the latest week.

But because this will be a once-in-a-hundred- years high, these extreme bullish sentiment measures will likely stay that way for some time.  Remember, they are not precise trade timing indicators.

So stock markets are not only trading at exceptionally high valuations as measured by the CAPE P/E ratio, but also at exceptionally bullish sentiment and COT readings.  When the market finally turns, this will be a lethal combination. But for now, trends remain up.

Here is my reading of the waves in the Dow:

The wave labels are pretty clear and today, we are in wave 3 of 5 of 5.  The top will arrive when I see the end of wave 5 of 5 of 5, but for now, odds are that we will have one more dip in wave 4 and then a push to new highs for the final top.

Note the  precise beauty of my blue tramnlines – they are textbook.  According to that book, you first draw a line between the highs of waves 1 and 3.  Then draw a parallel line from the low of wave 2 – and wave 4 should bottom out on that line – as it does with uncanny precision, despite the spikes.  So that trading channel has enclosed all trading from March – and will continue to do so until one of the tramlines is broken.

Back to the burning question – how far will this third wave carry?  One clue can be gleaned from looking closely at the purple wave 3, which has an extended fifth wave (it was about twice the length of the third wave).  If this pattern repeats here, the small red wave 5 will be about twice the length of the current third wave, which has not yet completed unless we see wave 4 down start very soon.

So here is my best guess:

If the market dips next week in wave 4, it will rally in the final wave 5 for about a month, taking the high to late October/early November – and if it touches my upper tramline, it will exceed the 23,000 level.

If wave 3 extends into next week (and beyond?), wave 4 will be delayed, as will the wave 5 top.  But my best guess is The Top will occur this year.

And if this pans out, it will present the greatest short in stock market history (at least in our lifetimes).

Gold follows my roadmap – down

Last time, gold had started a correction off the recent high that I believed was not finished.  Here is the chart I showed last week:

I noted the extreme bullish position that hedge funds had taken and suggested the market was due a hefty correction.  My wave B targets were marked.  And here is the chart updated:

As forecast, the lower line was broken and the market quickly hit my first target.  But with hedge funds still stubbornly bullish, I expect a bounce in  a small wave B and then a new low to one of the other two targets.  If I see a momentum divergence there, that will be my signal to start trading long again.

The market has declined by $60 from the high and this must be giving sleepless nights to the managed money guys.  Latest COT data does show a slight move away from the bull side but I believe we need a lot more before the low is in.  That’s why I currently favour the Fibonacci 62% at around $1260 as my preferred target.

Until next time…