In a couple of 5/3 posts [Short the Banks and Follow Up on Financials] I suggested XLF — then at 16.40 — was due for a drop to the mid-15s.  It hit 15.67 on the 17th and has been in a what I think is a rally in a ongoing bear market for financials.  Those who didn’t take profits a few days ago may be wondering whether the worst is over.

Short answer is NO.  The banks are dead meat; they just don’t know it yet.  Rising interest rates, investors and cash-strapped governments looking to win the legal lottery, ugly balance sheets (their most craptastic assets not even listed), worsening credit quality — take your pick.  That’s an oncoming train, not a light at the end of the tunnel.

IF they can arrest today’s decline, they MIGHT rally up to 16.05-16.10 before the bears take control again, driving XLF down to 15.50 in short order.  But, that’s just the start.  From there, we finally lose the channel altogether and head for single digits.

Financials led off the last market crash; I believe their collapse in the next week or two will be the final straw for this market, too.  I wonder if it’s too soon for Vikram to renegotiate his contract?

If a pattern I’m studying plays out, the SPX should reverse its (currently) 9 1/2 point drop and close positive on the day, leaving a big, fat bullish hammer candle going into the weekend.

Will be working on it throughout the day… more later.

UPDATE at 11:45am

 SPX fell as low as 1330.67 and appears to have bottomed out just above The Trendline That Just Won’t Quit and is rebounding.  In the process, it completed another half-baked bullish Gartley that indicates an upside to 1360.  Not looking for all of that today, just 1342 or better — setting up a big Monday.   VIX is backing down and should close at 16 or so.

UPDATE at 3:15pm

SPX recovered to its daily high of 1342, is now at 1335.50.  It’s now caught in the OPEX tractor beam.  Easy call would be 1335, but I think we get one last bump to 1340 on the day.  A nice recovery designed to shake out anxious bears before Monday’s 10 point advance.

JNK, the junk bond ETF.  In the crash, it fell from 48 to 28 in a month.  It’s been rebounding with the rising market and lower rates, but has barely moved in the past 6 months.  Except… that it’s crawling along in a little rising wedge that’s about to play out. 

I don’t know anything about this particular ETF.  But, it’s trading at 40.85, a measly buck from where it crashed.  Since I expect a big selloff, a credit crunch and rising interest rates — not necessarily in that order — this could be a decent way to participate.  The June 39 puts are trading for .10, Sept for a little more.

Quick update before the open…

VIX call per the bearish Gartley was dead on.  VIX fell another 8% since the call, closing at 16.23  — down from 19.09.  The hourly charts confirm a continued fall over the near term.  My original target of 15.10 looking safe for the moment.  Very bullish for a continued rally in stocks.

SPX performed even better than expected per the falling wedge and the bullish Gartley, up strongly yesterday with scant pauses.  We should get one this morning after a few points on the open.

If we continue to trade at the fib levels, we should open at 1345, run up to 1348-1350, then pull back to around 1338-1340.  Good level to buy in, IMO.  If there’s enough time left in the day, we should resume climbing past 1350, backtest that trendline for a few, then onward and upward.

My original target remains 1381.50.  But, a note of caution is in order.  Anytime you’re dancing on a razor’s edge, as is this market, the slightest slip could be disastrous.  We’ve had many unforeseen disasters over the past few months, each of which sent the bulls scurrying.  And, Gartley patterns don’t always reach their targets.

We could see a major top within the next 10 days.  My inclination is that the 3% pullback we got last week wasn’t THE 87-day cycle low; a larger one awaits.  If we can reach 1381 (or the vicinity) before the end of May, we still have time within the 105 day window to start a  10% or more correction.

Tight stops are essential as we continue on.  Raincoat and umbrella time.

While it would be easy to jump on the P[3] bandwagon right about now (and it wouldn’t take much convincing) a note of caution is in order.

A pullback that stalls in the low 1320’s on SPX would leave a pretty well-formed bullish Gartley Pattern (Point B should be 4 points lower, allowing a fuller CD extension to .786, but these things are rarely perfectly formed.)

Why should we care?  A bearish Gartley Pattern accurately forecast the 80 point drop starting March 4 — after the market had nearly recovered from the action of the previous 8 days.  It’s estimated to ‘work’ about 70% of the time — house odds, if you will.

A bullish Gartley Pattern that plays out successfully from 1321 could be expected to boost the SPX by a quick 24 points to 1345, with an ultimate target of 1391.  I don’t believe in coincidences (unless CNBC tells me to), but 1391 also marks the upper bound of the rising wedge from Mar ’09.

It’s also only 10 points north of the .786 Fibonacci (off the Mar ’09 lows) levels at 1381.50.   If we don’t turn down from here, I expect P[2] to finally die between 1380 – 1390 sometime in the next 10 trading days.  It coincides perfectly with my 87-day cycle of downturns, but these cycles have taken up to 105 days, so it could be as late as June 3.

Could a decline stall at 1321?   1321 is the level of the trendline beginning on 8/27/10 at 1039.70.  Haven’t talked much about it, but this is a big, bad trendline of support that stopped single-day freefalls of 30 points (3/16) and 20 points (4/18) cold in their tracks.

But, for now, it appears that the “trendline that just won’t quit” from the Oct ’07 1576 level will continue to support the market.  Today, it stands at 1333 and seems to have rebuffed today’s running of the bears. 

If the decline resumes, however, keep an eye on the low 1320’s.  Any stall there is likely to begin a very strong rebound and will catch many off guard.

Next post: the Gartley Pattern that REALLY matters.

Happy Trading!

…  “everything looks like a nail” is the old saying.

Harmonic patterns aren’t too hard to spot.  Look for a big W, right side up or upside down, where each leg is a partial retracement of the previous one except for the last, which extends the previous leg but ends as a retracement of the first.  The retracements should be in accordance with harmonic numbers (usually .382, .5, .618, .786.)  http://www.investopedia.com/terms/g/gartley.asp

The good news is, they work pretty darned well — indicating a significant reversal with 70% certainty.  The bad news (besides the 30% wrong calls) is that once you start looking, they’re everywhere. And, because they’re harmonic they often nest inside one another in different degree, even morphing into one another where a CD leg feeds into a XA leg, etc.

As a (slightly autistic) guy who sees patterns everywhere, I get excited when they confirm other harmonic patterns and technical analysis.  I believe that’s the situation we’re now facing.

Among Elliott Wavers, there is some disagreement as to whether we’ve finished P[2] or not.  There are “problems” with various counts.  My favorite analyst and blogger, Daneric, remains open to alternative counts.  He’s been doing this forever, so that’s good enough for me.  One road leads to SPX 1380, the other to 1200.

So, what’s an investor to believe?  For me, that’s where Harmonics come in.  I’m following three patterns:

(1) a bullish pattern on SPX indicating a short-term upside of 1380 (the next week or so.)  The alternative is that the decline has already started (see below.)

(2)  a bearish pattern on VIX, also indicating a short-term rise in stocks  (VIX collapsed 8% after this chart was printed at 9am this morning.)

(3) a long-term bearish Gartley pattern on SPX indicating 1281 is the end of our road after rebounding from the Mar ’09 lows.  This chart shows the 87-day cycle lines as well.

The SPX daily chart ties everything together pretty well.  Note the rising wedge, overhead resistance with the Supercycle line and the .786 Fib, and the 87-day cycle date of May 16 (past cycles have varied by up to 15 days, or June 3.)

I’m clueless about the wave count.  But, I wouldn’t be surprised if we bounce off the RISING WEDGE (chart 3) to complete the ST BULLISH GARTLEY (chart 1), thereby completing the LT BEARISH GARTLEY (chart 2) at around SPX 1380 sometime before June 3 (105 days on the 87-day cycle.)   The falling VIX is icing on the cake.

Once caveat: it may have already started.  At 1318 earlier today, the SPX was off 3.8% from its highs.  It’s not much, but it could easily be the 87-day cycle decline in progress — or even the whole enchilada.  But, the Gartley patterns on VIX and SPX tell me we have one last bump up before it’s time to stick a fork in this thing.

Bottom line, I’m not going to heap on the puts if we drop a little in the morning.  I’ll see if we bounce off the rising wedge and start back up.  If we break decisively through 1310…forget I said anything.

VIX just completed a very well-formed bearish Gartley Pattern [see last post – Are We There Yet?], indicating it MIGHT have topped at 19.09.   In addition, VIX just bounced off its upper bollinger band, and there’s a shooting star on the 30 minute candle. 

SPX is also a few points from completing a bullish Bat Pattern (this chart is from last week — will update when I get the chance).

Lastly, we’re clearly in a falling wedge since May 12 (easiest to see in eminis.)  The apex is tomorrow at 1313.   Importantly, 1313 is also the .786 retrace of the 1370 high — a logical spot to arrest the decline IF that’s going to happen.  It’s also marks the bottom of the rising wedge since Mar ’09.

At 1318.51, SPX was off 52 — 3.8% from its high.  If we do reach 1313 on SPX tomorrow, that would be a 4.3 decline from the top, on the lower end but within the range of declines recorded by the 87-day cycle over the past 4 years.

I remain open to the possibility that 1370 was the P[2], and that the bounce up ahead (if it happens) is a corrective wave on the way down.  If so, we should see SPX contained below 1370.

All to say — the market’s ST direction is very much a toss up at this juncture.  But, for those bearishly inclined, keep one eye on the VIX.

It was supposed to be a great turnaround story, a good cause and a profitable investment, too.  After going public again post taxpayer bailout, GM dropped like a rock

despite research report puffery that would have Shakespeare drooling with envy

http://in.mobile.reuters.com/article/rbssConsumerGoodsAndRetailNews/idINN1824469820110419?irpc=984

While it would be easy to get caught up in P[3] fever, here’s a note of caution.  A pullback in the SPX to 1321, if it isn’t

Saying today’s PPI numbers were great — except for food and gas prices — is like saying your flight was great — except for the highjacking.