Did I call the top of the Dow Jones?

I think we’ve hit a turning point in the Dow’s recent bull run. I have outlined the evidence to date in many recent posts.

If I’m correct this will have major implications, not just for spread betting traders, but for all investors and just about everyone in the world.

And if we have started a great deflationary bear market, most of the commonly-accepted ‘givens’ will be overturned, such as one I hear all the time: “energy prices will keep rising forever”, and “inflation will always be with us”.

Of course, it is always dangerous to make such bold statements – there could be egg on a few faces. Many powerful players have a vested interest in keeping this bull market going.

My advantage is that I am independent and can call them as I see them – and I can take my lumps if I am wrong.

Calling a market top

I previously identified 22 May as the top in the Dow. Has the market confirmed this or not? Let’s see what the market has said since then.

Spread  betting chart

(Click on the chart for a larger version)

The hourly chart shows the 22 May high and the five-wave move down. And then the three waves up to the 95% retracement. Since then the market has fallen in step-wise fashion.

Spread  betting chart

(Click on the chart for a larger version)

From the 28 May high, the market fell and then staged an A-B-C rally (green bars) which turned at the Fibonacci 62% retracement. The decline continued and the relief rally was also an A-B-C which carried to the Fibonacci 62% level. The market is declining off that rally as I write this morning.

A-B-Cs are counter-trend, so the correct stance is now to take short trades. Of course, the 62% retracements were excellent places to enter short trades at low risk.

So how does this fit into an Elliott wave picture? After all, what we all want is a roadmap for the likely way ahead.

Spread  betting chart

(Click on the chart for a larger version)

These dips and rallies are all first and second waves of differing degrees of trend.

These second waves are where investors are buying the dips – a stunningly successful strategy for the past four years.

But all good things come to an end sometime, and when they do, buying the dips will be the worst possible strategy.

On Monday, I showed the extreme bullishness among the specs as revealed by the commitments of traders (COT data), and many will be adhering to the same strategy on the way down.

Yes, a steadfast adherence to a successful method can be admirable – until the game changes, that is. Then it becomes a stubborn refusal to see reality.

And no-one rings a bell to announce the change.

If my labels are correct, we are at the start of third waves of at least three degrees, which is one of the most powerful set-ups there is. Stubborn investors would be forced out, as the market falls.

Incidentally, margin debt at the NYSE has just reached a record high – that is how bullish investors are.

We know that third waves are generally long and strong, and with three working together, the forecast is that the down move should be vigorous.

That is the most likely roadmap, to my mind.

What could change this? A rally back to the recent highs.

Learning from junk bonds

The quantitative easing (QE) programme of reflation has encouraged massive risk-taking in many markets, including the Dow. And one other market that has seen huge risk-taking is in junk bonds. These have been avidly purchased so that yields have been driven to an astonishingly low level as investors have reached for yield.

Junk bonds are one of the riskiest of fixed interest investments (the clue is in the name), so are excellent gauges of the degree of risk-on mentality in all markets. Junk bonds also act very much like equity in a company – they’re the most sensitive to changes in sentiment.

Here is a widely-followed ETF of corporate junk bonds. It tracks their price, rather than their yield:

Spread  betting chart

(Click on the chart for a larger version)

That looks very much like a burst bubble to me. It has taken only three weeks to eliminate the gain from the previous three months. This market reached its high before the top in the Dow, and made its secondary high on 22 May – when the Dow did top. That is a divergence.

Last week, the market has plunged below the 50-day Mmoving average, which looks like panic selling to me.

And this looks very much like a third wave – typically long and strong. But the market is short-term oversold (see Relative Strength and MACD).

Now, the market is trying to get back on its feet, having been knocked sideways, and should be in a fourth wave up, leading to a new low in wave 5 (meeting the 200-day moving average (red line) perhaps?).

So the junk bond market is telling me the risk-on game is over. But what about the near-term?

Recent chatter has been about how much longer the Fed will be printing money and investors will be focusing on Friday’s employment report as a bellwether.

Remember, the daily chart showing the completed five waves up from the November low? Here it is, updated:

Spread  betting chart

(Click on the chart for a larger version)

On 22 May, the market touched the upper line on the nose, and now, it is back down to the lower line and testing support there.

A break of this line will be extremely bearish – and Friday’s report may tip it over the edge.

The pink zone is key.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline trading
Advanced tramline trading
An introduction to Elliott wave theory
Advanced trading with Elliott waves
Trading with Fibonacci levels
Trading with ‘momentum’
Putting it all together

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