Squawk Morning Briefing: How Far Will This Bounce Go?

More than one analyst is counting out a completed five-wave decline in U. S. equities at Friday’s low and a few of you have inquired about this potential. Our take is the same as it has been since October highs: there are many possible interpretations of the decline from October highs and in order to consider a lasting high in place we need to see a five-wave decline followed by a corrective recovery.

To count a five-wave decline complete (especially in the S&P 500) one needs to assume that the move up into October high actually ended on October 18th with a truncated fifth wave. That is, a fifth wave that failed to move beyond the prior third wave. Truncations are rare and they are difficult to identify in real time. In our experience, many patters which look like they might be truncations as they’re unfolding turn out to be something else. Therefore, before identifying this rare pattern we look for other evidence.

The strongest evidence for a truncation is to see a completed five-wave move down (or up when ending a bear pattern) followed by a completed correction — the exact same thing we have been holding out for. Other strong evidence would come from correlated markets completing a pattern without truncation.

The overall point is that without truncation we cannot count a completed five-wave move down.  While it is possible to count a completed move with truncation, it’s not clearly complete.  That leaves us with a few possibilities:

1. We have truncation and a completed five-wave move down.  If so, we expect that while this bounce might be deep it will be corrective and resolve to the downside.
2. We do not have truncation and while the move to the downside is impulsive, it is not yet complete.  In this case the bounce will still be corrective and lead to a turn down, but the extent of the subsequent decline might be limited until we see a good second wave bounce.
3. The move down from October highs is corrective.  In this case the bounce will not be corrective and will eventually head to new highs.

 

The element which will tell the difference between these scenarios is whether or not the bounce we have started ends as a correction or not. Since the move down isn’t unambiguously impulsive, a corrective bounce is the only thing that can confirm the trend to be down. We need to force the market to demonstrate its intent by letting the bounce play out and assess its structure. The specific things we’re looking for are covered in our videos.

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