Technical analysis in its most basic form is simply nothing more than supply and demand. More supply than demand and prices go down, more demand than supply prices go up. Of course it does get more complicated than this but this is where it all begins. Many years ago we learned from someone smarter than us that volume is the key to the supply/demand equation. Demand overcoming supply needs to occur on bigger volume to make that demand sustainable. For example, a breakout of a trading range would indicate demand overcoming supply. If this occurs on expanding volume, which really measures the extent of the demand, it shows that the demand was strong. If this occurs on average or below average volume it makes the breakout suspect as it implies that the demand as not truly strong. The old saying that "volume precedes price" is one we should keep in mind daily.
To this end, we have noticed a very negative pattern unfolding in the price/volume relationships. Of the twelve biggest volume days with the exclusion of March's triple witching, truly nine of those twelve, or 75% have occurred on down days. A few such as January 4 and 5 and March 9 have occurred right off an important price peak leading to a sustainable decline and validating the negative price patterns. The three that occurred on up sessions, February 1, March 1, and March 23 did not occur at a price low or right after a price low. March 1 for example occurred closer to a top and well after the post January 24 rally began. March 23 did lead to a two day bounce but has subsequently seen those lows broken and on good volume. Remember, "volume precedes price", and what is developing in the first quarter of 2005 is a sign of distribution. Couple this with a massive number of medium and long-term divergences such as the new highs, nearly all of our momentum indicators. excessive sentiment (this is improving short-term), breakdowns in such key indicators as the % of stocks above their 200-day moving averages and last but not least the shift in relative strength from previous leaders such as technology and small cap stocks to the safety of the big blue chip stocks. This last is classic late cycle behavior and all of the above is the type of behavior seen near the end of a bull market or even the beginning of a new bear market.
Now we get to the meat and potatoes of where we are in the cycle. Given all the negatives discussed above and those are increasing daily, we can make a strong technical argument that the post 2002 cyclical bull market is complete and that the next ;leg down in the next leg or wave down in the post 2000 secular bear market has begun. We can support this via the wave structure as well but from this perspective it is not our preferred count. The momentum picture, other than very short-term is also bearish but the problem here is that there is no way to tell whether this particular bearish divergence is the last one or if there will be one or perhaps two more before the rally is over. In other words just as sentiment can move from extreme to more extreme divergences in momentum can persist for longer than one might expect. This again boils down to our view that divergences, not matter how small or large need to be treated as potential divergences until they are confirmed. And while we are getting closer to confirming the big picture divergence's this has not yet been accomplished.
Ok you ask, what would it take to do the job, confirm the divergences as real?. This all boils down to price and what levels would be needed to confirm that the party is over. From purely a chart perspective the 1160 area is beginning to take on some short-term significance. This was the March 2004 peak that has since November of 2004 been tested now three times, early November, 2004, January 2005 and just last week. However, as significant as this level is becoming we do not see a break of this as a all clear bearish signal. As we discussed in the Elliott wave section earlier, the key level to watch on the S&P is 1090 or so. This would break the important 78.6% retracement of the August March rally and in pour view break the back of the post 2002 cyclical bull market.
There is no doubt that we are either in the very late stages of the cyclical bull market or the very early stages of a large "c" wave decline that will take prices well below the the 2002 lows. With this in mind we are favoring the idea that while we are certainly close to the end of the rally we are approaching the market with the idea that there will be one or even maybe two higher price highs over the next few months to complete the counter trend bull market structure. A break of the above mentioned support level would convince us otherwise. However one or even two more higher highs does not change the fact that we are in the very late stages of a cyclical bull market. We think that the bull is a two legged creature not even three and that the risk long-term is nearly as bad as it was in early 2000. This is more important than trying to squeeze the last few percentage points out of a tired and aging bull market but instead it should be used to get as defensive as possible.
Short-term we still see the potential for a rally but a failure here would be extremely bearish. We still see any rally that may develop as a counter trend affair related to the post March 7 decline. Once complete a move back below whatever low may be established is expected. this should complete the post March 7 decline and set the stage for that last rally to complete the post 2002 advance. Short-term we are neutral. Medium-term we remain bearish and long-term we are bearish
