15 Points Corrections

The rally that began in December corrected 15 points before going higher 2 times. It seems it is going for the 3rd:

Yesterday I thought this pattern would be broken but in bull markets the path of least resistance is always up.

However, weakness is more and more evident. The VIX usually diverges from the market before bigger corrections:

This along with other evidence makes me hold my belief that we will see a bigger correction very soon.

Analogy

Here are two previous cases which hint to what today might eventually look like:

> July 2010

> August 2010

In both cases the market sold off after a small range day and a first attempt at selling off.

The market looks similar now:

A big gap down at the open today would confirm the assumption of a trend day down.

Go Short?

Here a very reliable signal of a top: the turn in the 5 day ema of the total put/call ratio.

This signal given before the employment report with everybody having positive expectations (amplified by the ADP number yesterday) is not a good mix for the short term longs.

With other indicators suggesting bigger corrections, even the intermediate term longs are in a bit of danger:

> Gallup Consumer Confidence (previously commented on here):

> 3 month average of the monthly percent change in real retail sales (last analyzed here):

Will I short?

The thing holding me off is the expectation of a good retail sales number for December which would prolong this rally a couple of weeks. There is little excuse for losing in a bull market on the short side because you simply should not short a bull market.

However, the market is nicely set up for a top around these levels and if ES rallies after the open above the recent high at 1277 I may give it a try and go short.

Close to a Top

The market has started to be shaky (moving violently up, then down, then up again) before an important event: the employment situation. This suggests a bigger correction will follow with a top today or tomorrow. The pc ratio will probably form a pattern often associated with tops:

If today gaps up strongly, the more aggressive can short around the overnight highs. The employment report tomorrow does not represent a big risk for the shorts with the market already this high. The more conservative way of shorting would be on an initial spike up after tomorrow's report.

I think that after an initial correction next week, the market will go up again into the retail sales report. I expect an intermediate term correction after that.

Outlook for the Short Term

With the market still overbought at yesterday's close, today is very probable to sell off hard and close at its lows.

This correction may end after about 25 points to the downside around the 20 DMA. From there I expect the market to start going up again but be weak. Here is how things might unfold before this bull leg ends:

The above is market action from Jan - Feb 2007.

If conditions seem right, I will go long after such a correction. As usual, I will mainly time the trade using the total put/call ratio.

Market Outlook

Yesterday the market was weak after lunch time even if, earlier in the day, the ISM number was strong. This suggests yesterday was more of a capitulation day than a break-out.

Judging by the big spike, the total put/call ratio also suggests the bears have given up:

With SPX 1270 touched, the expected spike in NYHL which is still showing weakness and the diverging 5 day EMA of the total put/call ratio reaching again the overbought level, the market looks ripe for a bigger correction. The employment report may mark this inflection point.

> NYHL (52 weeks New Highs - 52 weeks New Lows):

> 5 day EMA of the total put/call ratio:

Happy New Year!

The market is lifting the ball nicely today for a possible short. Patience pays indeed!

Even if the market is ripe for a correction, I will refrain from selling for two reasons:

> The total put/call ratio:

I have previously seen the market top with the ratio spiking like this but I like to fade bullish spikes especially when I go against the trend.

> The bullish outlooks for the economy have reached everyone's ears by now and I think the majority of market players expect a positive surprise from the NFP number on Friday. This means they will buy or postpone selling until then.

These reasons in the context of a strong uptrend make me stay on the sidelines for now. For those that choose to sell, a rally into ES 1264 on the ISM number looks tempting.