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After a breakout we expect prices to correct back toward the point of breakout. We can see that the index is approaching the top of a rising trend channel, and, when that is reached, it would be a logical time for a correction to begin.

However, we noted in our blog earlier this week that a parabolic up move appears to be in progress. On the chart this has been annotated as purple trend lines with ever-increasing angles of ascent. Parabolic moves are signs of mania in the market, and this can cause prices to move higher and faster than would be considered reasonable. These moves can be fun to ride, but it is virtually impossible to know when they will end. When they do end, the reversal is usually abrupt, and the decline breathtaking. The most exaggerated parabolics occur in prices of a single stock or commodity. With an index composed of many stocks, it should be more subdued.

Conclusion: The S&P 500 is in uncharted territory, and the only resistance is the top of the rising trend channel, at which point we would expect a consolidation or correction toward the point of breakout to begin. The long-term breakout implies that prices are going to go higher, and the parabolic nature of the advance implies that it is likely to accelerate.

The following chart shows CEF history going back to 1986, and the bottom panel shows the amount of premium (green) or discount (red) at which CEF shares were selling. It is amazing to see that there have been discounts of lower than -20% and premiums approaching +30%. I suspect that a good deal of this extreme behavior can be accounted for by the fact that some of the buyers and sellers simply did not know how closed-end funds work.

It is interesting to note that in the last two years, sentiment swings have held a much more reasonable range. The extended topping action probably had something to do with that. More to the point is that recent bearish sentiment has been fairly low, considering the sharp decline in precious metals prices. This does not tell us if prices are going to continue lower, but it does show us that bearishness has not reached the kind of extremes that would prompt us to start looking for a price bottom.

The daily chart shows the critical break below long-term support at about 1540. The bounce off the low is unlikely to be the beginning of a new rally, rather we think it is a short-term consolidation, like a reverse flag or pennant.

The weekly chart gives the best view of the trading range that has kept prices contained for over a year and a half. We thought that this was a price consolidation that would eventually lead to higher prices, so the failure of support was disappointing and has very negative long-term significance.

On the charts above you will notice that both the daily and weekly PMOs (Price Momentum Oscillators) are at the oversold side of the range shown on the charts, but a longer-term view below shows that neither PMO is challenging historical lows.

The monthly chart below gives the best perspective for gold's long-term prospects. While the top is broader than usual, we believe that we are seeing a collapsing parabolic. The "parabolic" is the gradually steepening curve as prices rose from the 2001 lows to the 2011 top. Typically, parabolics collapse back into their original basing range. For gold this range (based upon the price history visible on the weekly chart just above) is between about 250 and 500. I agree that doesn't sound reasonable, but it does fit normal expectations for a parabolic collapse.

In our opinion, the most obvious support level at this point is at about 1000. Support could easily be found higher than that, but for now let's stick with the obvious when estimating where a solid bottom could be found.

Conclusion: Long term, the trend for gold is down, and the condition, based upon the monthly PMO, is very overbought; therefore, we have to assume that outcomes will be negative until some improvement is seen.

A quick look at the weekly gold chart shows that the metal is holding above a line of support that goes back over a year.

In contrast, the XAU (gold mining stocks) has formed a bearish head and shoulders pattern, which executed when price dropped below the neckline earlier this year. We can see that the breakdown was followed by a brief snapback before the decline continued. At this point the minimum downside target would be the support line drawn from the October 2008 low.

It would be useful to note how dissimilar the two price lines are. One would think that the stocks would be closely related to the metal, but the charts will quickly clear up that misconception. (Prices are intraday.)

Conclusion: While for the time being gold has bounced off long-term support, the XAU has signalled that there are still lower prices ahead for gold mining stocks.

First, I generally limit comparisons to periods of no more than about a year, because I don't think that comparisons over long periods are valid. For example, I am not concerned that the current volume level has not exceeded the 2007 volume top.

1999-2000: We had mixed signals. Breadth diverged negatively, while volume confirmed the price high.

2002: There was a reversal divergence on breadth and a negative divergence on volume - a thoroughly negative picture.

2007: There were negative divergences on both breadth and volume. Not a good outcome.

2011: A reversal divergence on breadth and a negative divergence on volume.

The down-pointing arrows identify some of the times where a new high was confirmed by one or both of the advance-decline indicators. In those instances the price top was followed immediately by a price decline, or the confirmed top was followed shortly by a slightly higher top, marking the high before a significant decline. (Note: There are many other confirmations that resulted in positive outcomes. I'm only trying to illustrate that this not always the case.)

Conclusion: Indicator divergences should always inject a note of caution into our outlook, and it is best when the indicators confirm new price highs, but a confirmation doesn't always mean that there is no immediate danger.

Textbook dIvergences occur when an indicator fails to keep up with price. For example, a positive divergence is when price makes a lower bottom, but the indicator makes a higher bottom. A negative divergence is when price makes a higher top, but the indicator makes a lower top. In each case the divergence signals a possible price reversal. I call them "textbook" divergences because they are the kind that are typically referenced in any discussion, but there is another kind of divergence, which I will call an "exhaustion divergence," that is extremely useful but rarely mentioned.

Let me first apologize if the exhaustion divergence has been identified and named something else by someone else. I am not the most widely read person you will ever meet. But, since I do not recall ever having seen it included in a discussion of divergences (except by me), I will take the liberty of giving it a name for the purposes of this discussion. Also, I seriously doubt that I am the first to have noticed and remarked upon this type of divergence.

The exhaustion divergence is quite the opposite of the positive or negative divergence. In a rising trend, the price index makes a lower top while the indicator makes a higher top. And in a falling trend, price makes a higher bottom while the indicator makes a lower bottom. I believe it signals the exhaustion of the price move because internals are unable to drag price along with them.

On the chart below I have annotated examples of each type divergence. In 2010 we had a positive divergence which coincides with the price low. In 2011 two lower indicator tops precede the price break in July/August. And finally, the exhaustion divergence occurring at the most recent price top.

The significance of the divergence becomes more obvious when we understand the indicator. The Percent Buy Index (PBI) shows the percentage of Price Momentum Model (PMM) buy signals for all the stocks in a given index -- in this case the Nasdaq 100 Index. (The PMM generates mechanical medium- to long-term buy and sell signals for individual stocks.) At it's peak in January the PBI showed that 90% of stocks in the NDX were on buy signals (much higher than in September), yet price was struggling below it's previous top. it reminds me of a car with its engine turning at high RPM and the clutch slipping.

Since the NDX is a cap-weighted index, the cause of the divergence is that the larger-cap stocks in the index are not doing very well, not a heaalthy situation. In addition to the divergence you'll notice that the PBI has crossed down through its 32-EMA. This is a sign that a price correction may be about to take place.

Conclusion: My observation is that the exhaustion divergence is a reliable tool, probably more reliable than the positive divergence, which tends to be nullified during strong up trends. Currently, there are many indications that a price correction is due. This is just one more.

Downward pressure in gold prices continued as very large funds liquidated substantial portions of their positions in the gold ETF (GLD). (See article.) Naturally, we need to look at the charts to give this story some context. (Charts were made before the close.)

The daily chart shows that price has reached the bottom of the declining trend channel, the top of which is drawn from the October high. This was something we thought likely because price failed to reach the top of the channel before it started down again. Another important event that happened today was that the 50-EMA crossed down through the 200-EMA, signalling nominally that gold is in a long-term bear market. The same type of EMA crossover occurred back in May 2012, so, obviously, the "long-term" nature of the signal is not carved in stone, but it does set the tone for the gold market.

To more accurately assess the long-term picture we need to zoom back to the weekly chart. Here we see the +170% advance from the 2008 low. After the top in 2011, prices have been moving in a horizontal range between 1540 and 1800, in what we would call a high-level consolidation. This is also known as a continuation pattern, which implies that prices will eventually break out of the consolidation and continue higher. That is a nice scenario for gold bulls, but first it appears that prices will have to retest the support at 1540 at least one more time. Obviously, that is a critical support level.

The most striking aspect of gold's behavior since the 2011 top, is that it is not following "the script", which is that the Fed printing press will drive gold prices higher. With the Fed printing money at unprecedented rates, why, we must ask, have gold prices stalled for almost a year-and-a-half? When our assumptions are not confirmed by actual price movement, we must reassess our assumptions. A possible alternative would be that the Fed's actions are not causing inflation, but deflation, at least in that part of the economy that affects gold prices. To better understand how this could be true, I recommend that you read the Quarterly Review and Outlook, Fourth Quarter 2012, by Dr. Lacy Hunt of Hoisington Investment Management.

Conclusion: Gold could be in the process of consolidating a massive up move, and it is currently headed toward a retest of the bottom of the consolidation range at 1540. Failure of that support level would suggest that assumptions about the Fed causing inflation (and an increase in gold prices) should be questioned.

CARL'S ANSWER: The first reason is that we don't have access to spot prices on commodities because of the expense of getting a data feed from the commodities exchanges. What we have available are futures-based indexes, such as $USD (Dollar Index), $USB (30-Year T-Bond), and $WTIC (Crude Oil), which report daily prices for the near futures contract. The problem is that, as the near contract nears expiration, the index begins tracking the next nearest contract, which is normally has a different price. These monthly rollovers cause a lack of continuity in historical prices, similar to stock prices that are not adjusted for splits and distributions, and the usefulness of these indexes for the purpose of technical analysis is somewhat degraded to say the least.

The other reason we use ETFs for our analysis is that an ETF most accurately depicts that actual cost of trading the commodity. It includes transaction costs, the cost of rolling from one contract to another, etc. Also, basically, you can't trade the index, but you can trade the ETF.

The following charts illustrate the differences. The Dollar Index presents a more optimistic picture...

... than the ETF (UUP).

Conclusion: We prefer to use ETFs instead of futures-based indexes because they more accurately reflect the the results of running a fund for a given commodity. Most important, the technical analysis we apply to the ETF has practical value, since the ETF can be traded.

I have long been a cheerleader for equal-weighted indexes versus cap-weighted ones, and now seems like a good time to demonstrate why. In a cap-weighted index stocks influence the price of the index based upon their market capitalization (price time number of shares). For example the top 50 stocks in the S&P 500 Index represent about 70% of the index value, with the remaining 450 stocks providing only 30%. With an equal-weighted index all stocks carry the same weight -- all the horses are pulling the wagon.

Decision Point follows a number of equal-weight indexes, with the chart below showing probably the most prominent -- the Guggenheim (formerly Rydex) S&P 500 Equal Weight ETF (RSP). As you can see, RSP is making new, all-time highs and exceeded the 2007 top two years ago; whereas the SPX is still struggling to reach the level of the 2007 top. SInce the 2009 low the SPX has advanced about 114%, but RSP has advanced 175%.

Of course, RSP does not always out-perform the SPX, but the relative strength line (bottom panel above) shows that it mostly does over time.

The table below the mechanical signal status on various market/sector indexes paired with their equal weight counterpart. Note how, when both indexes have the same days elapsed, the equal weight index usually has the largest percent profit. It is particularly notable in the case of the Technology sector, where the problems of a few large-cap stocks (AAPL, IBM) weighed heavily on the weighted index (XLK), but the effects of those stocks were muted in the equal weight ETF (RYT).

Equal weight indexes are not always the best choice -- they tend to move faster to the downside than their cap-weighted counterparts -- but in a bull market they should receive close consideration.

Obviously, the Four-Year Cycle does not repeat at exact intervals -- the last one lasted almost six years from trough to trough -- and it appears that the current cycle is going to be extra long. A "normal" downside for the cycle is about 18 months, so an educated guess as to when the price low might hit is about mid-to-late-2014.

To summarize, the ten-year trading range of the S&P 500 Index suggests that a major price top should be arriving sometime in the first half of 2013, maybe within three months. After that the Four-Year Cycle low (price low) projection would be for the last half of 2014, unless the decline is exceptionally accelerated.

About a month ago I wrote an article stating that I thought that gold was resuming its long-term up trend, but that belief was conditioned upon price moving above the October top. That did not happen. Instead, after putting in a lower top in November, price has dropped below the November low, establishing a three-month down trend.

The weekly chart shows that price has dropped below a long-term rising trend line, but I think the trading range (consolidation) between 1540 and 1800 is the dominant feature on the chart. It has held for over a year, and is considered to be a continuation pattern. The technical expectation is that price will head higher once the consolidation is complete. If the bottom of that range is violated, then gold would be in serious technical trouble.

Because of the down trend since October, technical weakness is expressed through the PMOs (Price Momentum Oscillators) in the daily, weekly, and monthly (not shown) time frames, which are below their EMAs and falling. The Trend Model is NEUTRAL, which is appropriate for a trading range.

After testing that support, price has reversed upward, and this week made a strong move upward, signalling that the rally that began this summer is probably resuming. The weekly PMO (Price Momentum Oscillator) turned up again, which is a very positive sign.

Conclusion: Gold has completed its post-breakout pullback and appears to be resuming its long-term advance, but this will not be "official" until the October top is exceeded. It needs to overcome resistance in the area of 1800, and finally the resistance at the all-time high around 1900.

The following chart of the Ratio shows that sentiment has been becoming less bullish, and the Ratio has reached a level that marked an important market bottom in June. If the bull market is still viable, we could be near an important low.

Looking deeper into the composition of the Ratio, the chart below shows that cash has been flowing out of Bull and Sector funds, and it has been flowing into the Money Market Fund. Virtually no cash has moved into Bear Funds in the last three months. The bears are in hiding.

Conclusion: Earlier this week we observed that Investors Intelligence percentage of bulls has become significantly smaller, but the percentage of bears has not increased to a level we would normally see at an important low. The Rydex Cash Flow Ratio confirms that observation.

Important bottoms can appear when we don't expect them, so we will not be so bold as to say it can't happen about now; but bottom picking is a dangerous game, and we would want to see the bears becoming much more aggressive before we seriously begin to expect an end to this decline.

One thing that some analysts like to do is to note the similarity of past price patterns to current price patterns, implying that the current pattern will resolve similarly to the historical example. In 1987 we have an example of how dangerous such assumptions can be.

On the chart below I have circled two price patterns that are remarkably similar. Each has a double top, then a double bottom, then a rally out of the double bottom, which fails, then a pullback to the support level. At that point what follows is radically different. In example #1 prices rally to new, all-time highs. In example #2 prices dive into one of the worst crashes in history. Lesson: Just because history rhymes doesn't mean that the ending will be the same.

Next, one might ask if there were any technical warnings? For the answer, let's look at a chart of our Intermediate-Term Breadth and Volume Momentum Oscillators (ITBM and ITVM). On the price line there is a top in August 1987 that is higher than the previous top in June. Corresponding tops on the ITBM and ITVM show a negative divergence, a bearish indication.

A more serious negative signal occurs at the final top in October before the crash, when the ITBM and ITVM both top below the zero line (see arrows).

To be fair, in hindsight the signs are always obvious, and there is a lot of ambiguity in real time. Nevertheless, negative indicator signs viewed in the context of the final breakdown of price below support just before the crash is pretty strong evidence, and there was adequate warning to take action.

According to a news clip I just saw, there is a gas station in the Los Angeles area currently selling regular gasoline for $5.58/gallon. Some gas stations are shutting down because the owners don't want to buy gas at these prices for fear that they won't be able to sell it. Prices have been moving higher over the last few months, but the recent increases have fallen like a ton of bricks on consumers.

My immediate response was to check the charts for crude oil and gasoline. We can see from the weekly charts that crude is about midway its five-year range, and has most recently been trending downward.

The chart pattern for gasoline is not suprisingly similar to crude; although gasoline is closer to the top of its five-year range. Nevertheless, it too has been trending down recently. So on a national basis it is not the price of oil or gas that is the culprit behind California's gas crisis.

The problem it seems is that the fragile infrastructure for gasoline production and delivery in California has taken a few hits that have put a crimp in the figurative pipeline. Primarily supplies are drying up because of refinery outages. 

Of all the articles I have read on this subject I have not seen a single chart. My purpose in writing this article was mostly to present the charts to people who may be following this story. A lot of inorrect assumptions and conclusions can be avoided by simply looking at the charts first. And we can clearly see that the price increases for gas in California are not related to a sudden rise in crude prices.

On the following chart we can see that readings above 80% are not a magic number or an automatic sell signal; however, when sentiment reaches that level, we should begin looking for at least a brief correction. (Note that we have not identified every reading over 80% but have placed markers to provide points of reference.)

This spike of optimism comes as we are entering the September-October time period, the most seasonally negative two months of the year. We do not view this as a happy coincidence.

* NAAIM sentiment polling is conducted by The National Association of Active Investment Managers (www.naaim.org). Cutoff for the poll is Wednesday, and the results are released Thursday.

Approximately 40 NAAIM member firms who are active money managers are asked each week to provide a number which represents their overall equity exposure at the market close on Wednesday. Responses can vary widely as indicated below. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group.

Range of Responses

200% Leveraged Short
100% Fully Short
0% to 100% Cash or Hedged to Market Neutral
100% Fully Invested
200% Leveraged Long

Decision Point keeps track of this percentage for the S&P 500 Index, and it indicates that there are fewer stocks pushing the SPX to the current highs than there were at the April highs. Also, we can see that the percentage in April was lower than it was at the 2011 highs.

Taking 2011 by itself, we can see the rapidly erroding percentage at the July 2011 tops just before the sharp decline in July and August.

Of course, we must note that as of this writing both price and the indicator are making new highs since the June bottom, so it is possible for the appearance of weakness to be remedied if the rally continues.

Conclusion: The percentage of stocks above their 200-EMA shows fewer stocks participating in the advance than there were at the 2011 top and the March 2012 top. This is not a healthy condition, and will probably result in a correction fairly soon; however, the market needs to stop going up before it can go down.

Decision Point publishes a daily Tracker report of our 152 Blue Chip list. This list is composed of the stocks in the S&P 100 Index, the Dow 65, and some large-cap Nasdaq stocks. We also track the Top 10 stocks in ths list, ranked by relative strength measured by Decision Point's proprietary PMO (Price Momentum Oscillator).

I have observed this list over a long period of time, and my impression has been that the top stocks do exceptionally well during a bull market, and extremely poorly in a bear market; however, I wanted to develop a more objective way to measuring the performance of these top stocks.

To do this I constructed a "Blue Chip Top 10 Index". This is done by calculating the daily change of the Index as being the daily average percent change of the securities in the Blue Chip Top 10 list. Stocks are tracked from the day after they enter the Top 10 list through the day they drop off the list.

The Top 10 Index is equally weighted, so theoretically one could only replicate the performance of the list with real money by reallocating an equal amount to each stock each day (and somehow avoid transaction fees in the process). More to the point, the Top 10 list are a good place to look for securities that will out-perform the market, but it will be impossible for you to duplicate the Index. You could also lose a ton of money if you are long these top ranked securities during an extended market decline.

The primary purpose of the 152 Top 10 Index (BC Top 10) is to how see well these top ranked large-cap stocks are doing in relation to the broader market. Specifically, in a bull market or extended rally we expect the Index to out-perform the broad market. This is because, when stocks reach the top of the list, they tend to stay on top due to persistent upward momentum. This is a healthy condition. In an unhealthy market, stocks tend to rotate through the Top 10 rather quickly, and the performance of the index poor in relation to the broad market.

Comparing three-year charts of the SPX and BC Top 10 Indexes we can see that the Top 10 have been underperforming for the entire time. Since the June low the BC Top 10 has advance only 5.9% versus 9.5% for the SPX. And while the SPX has been trending up for the period shown, the BC Top 10 has been trending down since the February 2011 top.

Conclusion: In spite of upward movement of the SPX, the Blue Chip Top 10 Index tells us that the leadership of the market has been rotating too rapidly, which suggests confusion and weakness. By the time a stock reaches the Top 10, it loses momentum and drops right back out again. This is evidence that for a long time the internal condition of the market has been turbulent and confusing, in spite of generally rising market prices.

These are levels typically seen at market bottoms, not during price advances. Looking at the chart we can see that the percentage of bulls is much lower in the last three months than it was during the first quarter. And even though the market has been rallying for about seven weeks, confidence lost during the April-June decline has not rebounded at all.

The traditional interpretation of sentiment readings is contrarian, meaning that AAII Investor Sentiment is giving a bullish signal; however, we think we should also consider that investor confidence is lower than it ought to be in the context of a rally.

(*Sentiment data is provided courtesy of the American Association of Individual Investors (www.aaii.com). Polling is conducted on the AAII web site with a Wednesday cutoff and Thursday release.)

My problem is that, being a person who likes things to be nice and neat, I wanted the right shoulder to be more even with the left shoulder. But no. What we have is a formation that is very lopsided, but I think it is close enough to be considered a completed reverse head and shoulders pattern. The neckline has been penetrated, so the minimum upside target is about 1430.

Unfortunately, the bullish breakout on the price chart is contradicted by the Climactic Volume Indicator (CVI) chart, which spiked to a level that usually signals a short-term top.

Conclusion: It is possible that Saturday's upcoming elections in Greece may have triggered some short-covering ahead of the weekend, resulting in a rally that may prove to have no legs. The breakout is far from decisive, and the CVI indicates a possible exhaustion climax, so I remain skeptical of the rally.

To be honest, the actual "soaring" for bonds began last July when bonds began an advance of about 33% in two months. After a five-month period of consolidation, another up leg advanced prices about 18% off the bottom of the trading range, making a total advance of about 41% since last July.

This surge was a big surprise to most people, including us, because we wondered why anybody would want to lend money to a country so deep in debt and which was borrowing 42 cents of every dollar it spent. The answer is that the U.S. is the least pathetic of the world's debtor nations. I have this picture of the sinking Titantic where one end of the ship is lower in the water than the other end, and people are moving toward relative safety on the high end of the ship. The trouble is that we're all in the same boat and the whole ship will ultimately be under water. It reminds me of an old pilot's joke. Question: What is the first indication that you have flown into the side of a mountain? Answer: You lose pitot-static pressure. (The pitot tube is that pointy thing that sticks out of the nose of the airplane, and would be the first part of the airplane to make contact with the mountain.) But I digress.

This week TLT punched through the top of a long-term rising trend channel and moved to new, all-time highs. We can see on the weekly chart that price movement is nearly vertical. The PMO is rising and has plenty of room before it reaches the overbought level of its trading range. The picture is very positive, but another period of consolidation will probably begin soon.

As for the upside potential of bonds, let's take a look at interest rates, which, of course, move in the opposite direction of bonds. In 2009 rates hit their lowest point in over 50 years, and that low is now close to being challenged. We think that rates have the potential to dip down to 2% (the low in the 1940s) and possibly lower. With that in mind, we would guesstimate that bond prices have the potential to move around 20% higher.

Conclusion: Our timing model has us on a buy signal for bonds because the model is driven by prices, not our perfectly rational (but wrong) view of what bond prices ought to be doing. Also, the technical picture for bonds is excellent, although there is probably some correction or consolidation not too far ahead.

Take care everyone,
Carl Swenlin  

The current correction is creating very oversold conditions on intermediate-term indicators, like the ITBM (breadth) and ITVM (volume). While oversold indicators often signal final price lows for a correction, extremely oversold readings are a sign that the price low for the correction probably won't arrive until weeks after the extreme indicator lows.

On the chart below I have annotated two very good examples of this process. The red arrows show where indicator lows occurred, and the green arrows show the correction price lows, which arrived several weeks later after prices bounced out of the first low.

While a simialr circumstance seems to be setting up at present, in order to replicate the two previous examples I think the ITBM and ITVM need to go down a little more, and the PMO (Price Momentum Oscillator) needs to go down a lot more.

Conclusion: Current oversold indicator readings may offer hope that we will soon see a low for this correction; however, oversold conditions are approaching such extreme levels that we should anticipate that the correction will continue for several weeks before a significant low is reached.

We should also note that the two examples cited occurred during a bull market advance. If a bear market has begun, the resolution could be much more severe.

May 1 marked the beginning of a 6-month period of unfavorable seasonality. Research published by Yale Hirsch in the Trader's Almanac shows that the market year is broken into two six-month seasonality periods. From May 1 through October 31 seasonality is unfavorable, and the market most often finishes lower than it was at the beginning of the period.

The period from November 1 through April 30 is seasonally favorable, and the market most often finishes the period higher. (See Sy Harding's book, Riding the Bear, for an indepth discussion of this subject.) While the statistical average results for these two periods are quite compelling, trying to ride the market in real-time in hopes of capturing these results is not always as easy as it sounds. Below is the one-year chart that that shows the most recent two six-month periods. It begins on May 1, 2011 and ends on April 30, 2012.

The left half of the chart shows the unfavorable May through October period and the right half shows the favorable November through April period. The green line marks the beginning of the favorable period, the red line marks the beginning of the unfavorable period.

As you can see, the last two seasonality periods turned in textbook performance, with the unfavorable period closing lower, and the favorable period closing higher. However, in the members area of the website we have a series of these charts going back to 1950 (when the seasonality tendency first appeared), and we can see that, regardless of how the market performs on average, every year is different and presents its own challenges, and there is no guarantee that any given period will conform to the average. In fact, it is our observation that bull and bear market pressures will override seasonal tendencies more often than not. 

Conclusion: Be aware of current seasonal tendencies, but first and foremost follow the primary trend. Currently, we are in a bull market, but it appears to be forming a top, which coincides nicely with the change to unfavorable seasonality. This does not mean that the bull will not reassert itself, but seasonality will not be assisting the bull in that endeavor.

A subscriber brought something to my attention that I wish I had thought of before. We think (at least I did) that the SPY (ETF) and SPX (S&P 500 Index) perform pretty much the same except for some minor tracking error. However, this is not the case because the SPY historical data is adjusted for dividends, whereas the SPX is not.

For all practical purposes, the SPY is a stock, and when the SPY pays a divdend, its historical data must be adjusted so that it maintains the correct relationship with the current dividend adjusted price. This happens on all stock, ETF, and mutual fund data. (To learn more, click here.) While it may be technically possible, historical data for an index like the SPX is not adjusted for dividends, so the effect of dividends is not considered for indexes.

Let's take a look at what this means. On this SPX chart we can see two major tops, 2000 and 2007, challenging the same level of overhead resistance at about 1550. The top of the current bull market is still about 200 points below this resistance.

Now, looking at the SPY chart, which has been adjusted for dividends, we can see that the 2007 top exceeded the 2007 top by about 15%. And of more immediate interest, the current bull market top is virtually equal to the 2007 all-time high. This encounter with long-term resistance could spell immediate trouble for the bull market.

There is a new index, the S&P 500 Total Return Index ($SPXTR), that appears to accommodate dividends by using a positive adjustment to the current price, but there is not even a full year's data collected on it yet, so it is not likely to be a useful technial analysis tool during my lifetime. Besides the SPY already does the job and we have nearly 20 years of data on it.

Conclusion: The fact that indexes are not adjusted for dividends can cause them to present a different technical picture than their ETF counterparts. While many of our timing models are driven by indexes, one should always use the chart of the trading vehicle (ETF) to finalize a trading decision.