Markets Should Continue Decline

In order to measure market sentiment we are going to use the commitments of traders reports. Market sentiment is a useful basis from which to form a contrary opinion. The non-commercial traders were net long 22,435 contracts of the Dow Jones industrial average $5 contract trading at the Chicago Board of Trade on October 23, 2012. We have clearly seen a sentiment shift to bullish. Non-commercial net longs grew from 7,559 on July 24, 2012 to roughly 34,000 on August 28, 2012 and reached 44,271 October 2, 2012. Sentiment is confirming the bullish trend, however, net longs are declining after forming a bearish divergence with the price of the index.

Financial Markets and Business Cycle
The economy is expanding and that is bullish for equity prices. General business conditions are good. We have seen revenue growth and earnings growth over the past few years. However, the pace of growth has slowed, particularly the pace of sales growth. We could be nearing an inflection point in general business conditions. The ISM Non-Manufacturing PMI is trending higher, however, the expansion's increase in pace may be priced into the market.




Three Important Trends
There are several trends operating at one time in financial markets. The main trends technical analysts study are the primary, intermediate and minor trends. The primary trend typically last between 9 months and roughly 2 years. Intermediate trends typically last between 4 week and 9 months. And minor trends last less than 4 weeks.

Primary Trend
The Nasdaq-100 is currently in a primary uptrend that started in May 2009. As such, we continue to see higher highs and higher lows. The Nasdaq-100 is trading above the rising 200-day simple moving average. The market is trending towards higher prices and the signal is reliable.

Intermediate Trend
The Nasdaq-100 is currently in an intermediate down trend. The wave off of the April high to the June low is considered an intermediate down trend. The move off of the June low to September high is considered an intermediate up trend. I am expecting a primary top: we could see a price pattern form in the weeks to come. In other words, we could see a rectangle, head & shoulders top, double top, etc... form.

The Nasdaq is trading below the declining 50-day simple moving average: the trend is towards lower prices, and the signal is reliable. Further, the Bollinger bands are suggesting prices will decline. The market is lower than it was 12 weeks ago and the difference is increasing.

Minor Trend
The Nasdaq-100 minor trend is towards lower prices, a minor high formed last week. The minor trend made a lower high and lower low. The market is trading below the declining 20-day simple moving average: the trend is towards lower prices and the signal is reliable. In terms of the rate of change, the Nasdaq-100 is lower than it was 12 days ago and the difference is increasing. Also, the market is lower than it was 25 day ago and the difference is increasing.

Longer Cycle
There is order to financial markets. Typically at the beginning of a bull move investors buy bond, then equities, then commodities. Bonds are the first to be sold, then, as interest rates rise, equities are sold. Finally, commodities are sold. Interest rates rose the past several weeks.

Dow Theory
Equity markets remain in a bull market as defined by Charles Dow in Dow Theory. The problem remains, the transportation average isn't confirming the industrial average. If goods are being produced they should be being transported. The lack of confirmation of the transportation average suggests weakness in the economy and the potential for a Dow Theory bear market.

Elliott Wave
The wave off the June low to the September high is being interpreted as the second corrective wave or wave B of a larger corrective wave. My current interpretation is that the market is forming a flat (3-3-5) corrective wave with wave A being the decline from the April high to the June low.

Conclusion -- Neutral
Investors would want to be neutral on the U.S. equities. Traders could take a short position.

Disclosure: Short the S&P 500.

Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.