DJIA Corrective Pattern...Recovery? So, Buy & Hold?

We witnessed six green days in the market with the market rallying 791 points (~9.8%) from its July 10, 2009 low of 8,057 to today's close of 8,848.

1. As I showed in my June 29, 2009 DJIA Forecast, the first wave is over and we are in the corrective phase of the wave cycle. So does the recent rally mean that the corrective phase is over?


2. Does it reinforce any beliefs of a V-shaped recovery?
   
3. Can you adopt the buy-and-hold strategy and passively watch your portfolio grow?

IS THE CORRECTIVE PHASE OVER? DOES THE RECENT 6 DAY RALLY SIGNAL THE BEGINNING OF A NEW IMPULSE?

I don't know if the corrective phase is over? The only time an Elliotician can call an end to a corrective phase is when a clear impulsive wave begins to form. Perhaps the correction is over because I see a simple A-B-C zigzag (Refer to Figure 1).

Supporting the idea of a continuing rally is the continuation H&S pattern. Clearly, the traditional H&S has failed as shown by the failed breakdown below the neckline. This signals a rally possibly of equal lenght as the rally from March 6 - June 11.

However, the three wave pattern identified as A-B-C may be the 3 wave in the 3-3-5 flat correction. Assuming that the fundamentals are still not improving, then a flat correction is in process (Refer to lower panel in Figure 1) and the recent 6 day rally is merely a corrective rally. The current move may have the momentum to carry the DJIA to 9,021-9,043 (max ~9,088).

Supporting the flat correction is the idea of complex H&S pattern. Two shoulders are evident on the left. Complex H&S patterns tend toward symmetry. Therefore, the recent rally (Wave B of the flat correction) may be forming the second right shoulder.

Figure





V-SHAPED RECOVERY

There are a number of people writing about this topic. I'll just present to you some articles that possibly support a U-shaped recovery. With the possibility of a flat correction identified above, a U-shaped recovery is more likely. That does not mean that traders cannot profit during this whole corrective phase. Will look into how traders can profit in the next segment on Buy & Hold.


Banks Fail to Make Adequate Loan Loss Provisions

By Jon Menon

July 20 (Bloomberg) -- Banks have failed to make adequate provision for the losses on loans and securities they face before the end of next year, Moody’s Investors Service said.


U.S. banks may incur about $470 billion of losses and writedowns by the end of 2010, which may cause the banks to be unprofitable in the period, the ratings company said in a report published

“Large loan losses have yet to be recognized in the banking system,” Moody’s said. “We expect to see rising provisioning needs well into 2010.”

Banks and financial firms worldwide have reported losses and writedowns of $1.5 trillion since the credit crisis began in 2007, according to data compiled by Bloomberg. New York-based Citigroup Inc. has reported $112 billion of writedowns, more than any other firm, the data show.

Any economic recovery is likely to be “weak and bumpy hook-shaped,” Moody’s said. Banks will also be challenged in an environment where government support is replaced by tighter regulation, the report said. Higher credit and funding costs may force a re-pricing of credit, Moody’s added.

“The fundamentals of financial institutions are still traveling on a downward slope,” Moody’s said. “No-one should consider recent improvements as assurance that the current rebound can be sustained.”


The Worrying Wall of Debt

The leveraged loan market got accustomed to big numbers over the past decade. There's $3.6 trillion, the amount of leveraged loans made since 2000, according to Thomson Reuters' Loan Pricing Corp. There's 735-fold, the amount of growth between 2003 and 2007 in the volume of collateralized loan obligations -- the funds that helped fuel the loan market's surge after the tech and telecom bust of 2001. And there's $375 billion, the amount of bank debt used to fund leveraged buyouts completed between 2005 and 2007.

But right now, the leveraged loan market is fixated on one number: $430 billion, the amount in leveraged loans due to mature between 2012 and 2014. Despite the big numbers of the past, this might be simply too big. Indeed, the $430 billion figure is already worrying lenders, borrowers and loan-market investors alike as they struggle with the possibility that a large portion of those loans will neither be repaid nor refinanced, raising the specter of a wave of defaults among the debt-fueled LBO borrowers of 2005 through 2007.

Click Here to read the entire article


SO WHAT DO YOU DO NOW? BUY AND HOLD?

January 6, 2009 Low: 8,868
July 20, 2009 Close: 8,848

Your portfolio is still in the red (solely considering capital appreciation). You would have missed the 27% correction from Jan 6 and the subsequent 35+% rally from March 6 lows - June 11.

I'm certainly not tell you to time the market. But, rather than being 20 points low for the 7 month period, you could have done well to trade the market and eke out some magnificent gains. You define what magnificent is for yourself.

So, the question is do you now buy and hold or do you trade? We have to go back to the first two questions of whether the corrective phase is over and whether we will witness a V-shaped recovery.

Based on my expectations outlined in the first two segments, I am expective a flat correction because the fundamentals are still relatively feeble. The current economic/market climate is more conducive for an active trading strategy rather than a passive one.

So, with a 2 year horizon in mind, I would not recommend a buy and hold strategy 'yet'. I expect the DJIA to complete its flat correction at around 7,450-7,600 (CLICK HERE to visit my June 29, 2009 DJIA Forecast) Anytime DJIA reaches 7,450-7,600, Buy in!

You ought to consider that my analysis is based on the assumption that a regular flat will be the most likely occurence. By reading some extremely bearish outlooks, a double/triple three is likely as well. Supporting this scenario is the failed H&S where prices continue to consolidate within a trading range. In this case, I would be keen on identifying a trading range and actively executive trades around these overbought/oversold price extremes.


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Technical Analysis Base Website at http://www.technicalanalysisbase.com/ and
Technical Analysis Base Blog at http://technicalanalysisbase.blogspot.com/

Sanjeet Parab
____________________________

Signs of Wave 2- Consumer Confidence Slides

It appears as though the US equity markets have been correcting since June 11, 2009 after recording a 30% rally over 3 months. If someone had bought DIA with $200,000 at the bottom, he or she would have made $60,000 in 3 months. Let's say a person only caught 20% of the rally. Then the person made $40,000. That's one good news. And the other one is that you can still make money as the DJIA retraces in the second wave.

I outlined the wave personality of each wave in the wave cycle on technicalanalysisbase.blogspot.com. CLICK HERE to go directly to the post.

Second waves- Second waves often retrace so much of wave one that most of the profits gained up to that time are eroded away by the time it ends. This is especially true of call option purchases, as premiums sink dramatically in the environment of fear during second waves. At this point, investors are thoroughly convinced that the bear market is back to stay. Second waves often produce downside non-confirmations and Down Theory “buy spots,” when low volume and volatility indicate a drying up of selling pressure.

Just look at the recent economic news and you'll know wave 2 is here.

Today, consumer confidence unexpectedly declined and delinquencies on the least-risky mortgages more than doubled. I'm staring at 'unexpectedly' right now. First we see a huge 30% rally propelled by better than expected earnings. 'Better than expected' ... or better yet, "Unexpectedly better than expected": analyst were so pessimistic about corporate profits/performance that their expectations were a lot lower than normal. Earnings kept beating expectations and the market continued to rally. Seeing that, consumers felt more confident. Even economic reports started releasing positive news indicating improving fundamentals. Everything happened as if we didn't go through the worst recession since the Great Depression.

All this is characteristic of the first wave when people believe that the worst is behind us. In reality, the worst is actually behind us but all is not over. Wave 2 is when fear creeps in again. Its a good shorting opportunity and also a time to prepare for wave 3. Write calls or covered calls. Writing calls in wave 2 season is far less risky. Even a person with a low risk tolerance can risk writing naked calls. But only after careful consideration. For more on this topic, refer to Writing Naked Calls using Warren Buffett's Philosophy.

Wave 3- one of the wonders of the long investor's world only if it is extended, which it usually is. I'm glad we're in wave 2. It'll give me some time to gear up for wave 3 and lock in some huge returns. BUY LEAPS!

Don't forget to visit my website at http://www.technicalanalysisbase.com/ and my other blog at http://technicalanalysisbase.blogspot.com/

Sanjeet Parab_____________________________