Decision Time For the Market?

After three months of a trading range and two months of a slow decline, is the market finally ready for a big move?

If it is, the first few days of next week could be the time to make that move.

As we’ve been saying for some time, a number of important cycles are lining up in the August 6-8 timeframe. For starters, the Bradley cycles will both be in strong trends for the first time since April. One or both Bradleys called both the January top and the April bottom this year. Whichever way the market breaks next week could be the major trend until October or November.

Second, Tuesday will be the 55th trading day off the May 22 top on all the indexes, an important Fibonacci turn date. Fibonacci was a 13th-century Italian mathematician who attempted to ascribe mathematical laws to nature. For some reason, 55 comes up repeatedly throughout market history as an important turn date: the market crashes of 1929 and 1987 came on the 55th calendar day off the top, and the panic of 1946 began on the 55th trading day off the top (more on that in a moment).

Third, tomorrow is the full moon marking what some are calling another Puetz crash cycle, which does not guarantee a crash by any means, but is just the start of a window in which one could occur. All told, some pretty big cycles converging next week.

So which way could the market turn next week? Our best guess is down, but we will begin with the bullish arguments, which seem to be the consensus right now.

First, the NYSE advance-decline line has remained flat since the May 22 top, meaning that most stocks are holding up. Since declines often begin with erosion from the bottom, that’s a good sign. Second, the Nasdaq indexes broke out of bullish falling wedges this week, giving the Nasdaq upside potential to 2300-2600 (see chart below). We would note, however, that a falling wedge usually produces a slow, meandering rise when the pattern works.

But those positives are masking some worrisome signs. First, the move down off the May top has barely put a dent in bullish sentiment, which isn’t good because it means that there’s not a lot of new money looking to get in to this market. One uncanny predictor of market trends is the commercial index futures positions. The commercials, the smart money, remain short in record numbers, while non-commercials remain long by more than 2-to-1. Notice the huge drop in commercial shorts at the bottom of that chart before the April rally. We are witnessing nothing of the sort here, but will check again tonight when the new numbers come out. When the commercials go net long and the non-commercials go net short, the bottom will be in.

Second, leading stocks like Microsoft and Cisco are forming worrisome topping patterns. It’s hard to imagine a significant rally in the indexes coming without its leading stocks. Cisco reports earnings Tuesday, right in the middle of the turn window.

Without sentiment or leading stocks behind it, it’s hard to take that bullish pattern in the Nasdaq index seriously. And the market is entering the turn window in a short-term overbought condition, with signs of distribution the last few days, not the greatest development because it increases the likelihood that the turn could be down. We could be wrong about direction, or the cycle turn could also turn out to be a big nothing, but the convergence of overbought/distribution conditions in the indexes with the cycle turn is worth noting.

We’ll close by looking at the other pattern that formed in the indexes off the April lows, the head-and-shoulders tops formed in all the indexes at the May 22 tops. Here’s a look at the S&P 100 pattern again:

That pattern has appeared in the indexes at some great turning points in market history, both to the upside and to the downside. This is admittedly very subjective, and is for purposes of examining potential direction only.

First, a look at the Great Bear of 1929-1932: The Dow formed a head-and-shoulders top at the end of its great bear rally in April 1930 – with the worst of the decline still to come. But it also formed a head-and-shoulders top off the July 1932 bottom that produced a great buying opportunity.

The panic of 1946 was a head-and-shoulders top that broke down on the 55th trading day off the top. Unlike the 1930 pattern, however, the bottom of the 1946 panic produced probably the greatest buying opportunity of the 20th century, with nothing but smooth sailing for years afterwards. Investors feared that the end of World War II would drag the U.S. economy back into depression, and they turned out to be very wrong.

The Nikkei also formed a head-and-shoulders top before another big decline in 1990.

In short, there are some tremendously powerful forces at work in what may appear to be a boring market. Whichever way the market breaks from this trading range could produce a move that is anything but boring.

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