ECB Comments Spur Violent Rebound in Stocks

| July 26, 2012

Today, European Central Bank President Mario Draghi pledged to keep the European Union together, spurring a violent, emotional rally in equities around the world. As a result, the S&P 500 index closed sharply higher, returning to the congestion zone in the 1,360 area and approaching recent highs of the volatile uptrend from June. However, nothing has changed from a big picture perspective and it remains likely that a long-term top is developing. The violent price behavior that has accompanied the oversold reaction off of the short-term low in June is indicative of a market in turmoil and this type of volatile advance is typical during the formation of a cyclical top. The rising wedge breakdown that occurred earlier this week continues to favor a return to the early June low sometime during the next few weeks.

With respect to cycle analysis, the sharp rebound today caused both price oscillators to experience bullish crossovers, creating a cycle low setup. A close well above current levels during the next session would generate a cycle low signal, indicating that the latest short-term cycle low (STCL) may have formed on July 25. However, a short-term cycle of only 21 sessions in duration would be highly unusual, so it remains possible that the beta phase decline is still in progress.

As always, it is important to remember that chart analysis is a tool, not a crystal ball. We are always dealing with possibilities and their associated probabilities, never certainties. The violent price swings that have characterized market behavior during the rebound from early June have made the unambiguous identification of temporal inflection points difficult, requiring us to wait for additional price data to provide renewed clarity. A short-term environment of fast and furious whipsaws can be challenging to navigate psychologically, which is why it is important to remain focused on the long-term view during these time periods. At a current duration of 40 months, the cyclical bull market from 2009 is overdue for termination and it remains likely that the April high was a long-term top.

Therefore, as we have emphasized often during the last several months, the risk/reward ratio of the stock market remains extremely poor from both long-term and intermediate-term views, so we remain fully defensive from an investment perspective.

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