Due to mixed signals and inconclusive data, it has become progressively more difficult to develop short-term market views in recent weeks. It appears as though the market is finally throwing the trading constituency a bone though as the preponderance of technical data right now seems to favor a continuation of the advance off the December 19th low.
An examination of price action in non-equity asset classes offer validation to the rally thesis. Gold is an example. The upper pane of Exhibit 1 shows the daily chart of near-term, continuous gold futures; the pane in the middle illustrates my preferred measure of momentum; the bottom pane demonstrates the rolling 30-day correlation between changes in gold prices and that of the S&P 500. The red portion of the momentum series (the middle pane) reflects my estimation of the forward path for the daily Coppock Guide (momentum) based on my static-price approach. Momentum for the yellow metal is likely to bottom tomorrow, which suggests that a support to gold prices is on the horizon. Bollinger Band analysis confirms that daily momentum for gold is indeed oversold and likely to reverse course soon.
Per the lower pane of Exhibit 1, the direct 30-day rolling correlation between gold and equities is quite strong right now (in fact, current readings are in the proximity of the high water mark for recent years). Thus increasing gold prices likely imply rising equity prices.
Changes in the trade-weighted US Dollar Index have historically demonstrated a substantially higher correlation with equity price changes than gold (the correlation between the greenback and stocks is generally inverse rather than direct though). At present, the rolling 30-day correlation between the two is -0.77. Static price analysis predicts USD momentum to roll over within the next couple of days-which confirms the conclusions drawn from the gold market.
Additionally, some volume-based indicators suggest that the recent low was of near-term significance. Exhibit 2 shows the S&P 500 along with the 10-day moving average for TRIN. The December 19th plateau in TRIN at an oversold extreme on the same day as the low in price suggests a short-term bottom was forged.
Further, and perhaps most importantly, from an Elliott Wave perspective, Tuesday’s sharp rally eliminated imminently bearish wave counts from contention. Now, in my opinion, the two leading remaining counts allow for either strength up to somewhere shy of the December 6th high of 1,267.06, or perhaps as high as the low-1300’s (see Jason Haver’s “SPX & VIX Update: This Rally Won’t Last” for the details).
Importantly, there is still a body of data that argues against further gains. For one, several short-term sentiment gauges registered overbought extremes recently. Also, contrary to the case for gold, the daily Coppock Guide for the S&P 500 is worsening. Interestingly though, it now looks like stock price momentum will reverse in three days. I expect eight days of improvement in this measure to follow the inflection. Thus, at best momentum poses only a modest near-term threat.
So, in aggregate Elliott Wave Theory, volume patterns and cross-market analysis all endorse a rally into year-end, while only sentiment suggests the run is extended over the short-term. The path of least resistance for equity prices throughout the remainder of 2011 now appears to face north. Accordingly, I am inclined to give the run-up the benefit of the doubt.
I would look to the December high (1,267 on the S&P) as an initial attraction zone, with trendline support at about 1280 offering a secondary layer of resistance. If these two levels are exceeded, the October high at 1,293 is the next likely to contain strength.
Stay nimble and stay safe.