After making a dirty new low on Monday stocks roared back with a vengeance ($NDX rallied over 8% off the bottom) reaching some of our target zones we outlined last weekend before retracing a bit on Friday. By Wednesday Wall Street predictably trampled all over itself calling a bottom in markets accompanied with predictions for a massive year end rally in many cases calling for new highs to come. Never mind that many of the same bottom callers did not call for a $8 trillion global market cap wipeout to come in October. But thanks.

From our perch the bull case, while it may pan out, is not that clear cut, but let’s look at the data and evidence and then assess.

Firstly, and always important: Context

In last weekend’s Positives, I outlined a number of positive divergences that were forming in context of lower risk remaining and that a large rally was increasingly likely:

“There are positives to be found in the charts that suggest there is ample firepower building for a sizable bounce once a bottom confirms itself. Whether a bottom was made last Friday I can’t say yet. I don’t like bottoms on Fridays. They are rare, most Friday bottoms get retested on a Monday or even pierced to the downside. But they do happen and we will know a lot more on Monday. But a rally is coming and whether the next rally will lead to a lower high before a full blown bear market emerges or new highs are still to come, I remain open minded about it. There’s a lot in the charts that suggests that a major top has formed, but from my perch it’s too early to confirm this”.

Let’s follow up on some of the charts:

Firstly I pointed to bullish descending wedges with positive divergences outlining target zone (in pink).

For example this was the $ES chart I outlined:

Monday’s new low pierced the lows, but saved the wedge pattern on each close before then rallying hard into our lower target zone, specifically reconnecting with the daily 200MA before retreating on Friday:

And we saw similar moves in $NDX, $RUT and other key index charts as well as many individual stocks.

Case in point on Monday at the lows I pointed out that $AMZN had hit key confluence support:

Here’s the updated chart:

These were monster moves and I hope many of you caught them, these type of moves don’t come that often.

Note the new lows on Monday were consistent with the risk profile I outlined last week.

I had stated:

“..don’t think I’m blind to further downside risk despite all these positive divergences. Indeed looking at the original risk zone chart we still have room lower until markets confirm a bottom”

The next key level I had pointed to was the .382 fib at 2612:

Here’s the updated chart:

Very important: Note how last week’s rally reconnected price with key moving average resistances before rejecting (see yellow arrow).

Why lean long into a 2600 retest? Well frankly it helps to have had a specific technical pattern price target outlined well in advance (see also Trading The Big Call):

Let me summarize: Outlined downside risk levels in context of bullish chart configurations, positive divegergences and signals suggested a big bounce was coming and it did.

The big question is now what?

On Friday I outlined some thoughts on context in this CNBC interview:

Can the rally roll on? from CNBC.

Following up on this discussion let’s assess the context and charts.

In the clip I mentioned positive seasonality and buybacks coming back. Indeed there are a number of charts floating about that point to a 100% positive track record for markets for the 12 month period following mid term elections:

That’s a pretty solid historical track record.

Coupled with the numerous examples of October bottoms I pointed out last week I can certainly see the point and have to acknowledge this possibility.

After all key signal charts that bounced off their bottoms show potential for still much larger moves ahead.

$BPSPX (A Bullish Chart) bounced hard of its 5 RSI level and has plenty of conceivable room to go higher:

USHL got drowned last week with a -1000 read also consistent with a major low in progress:

And equal weight just bounced off of its 2007/2015 highs as support with the RSI also having a lot of room to go higher:

And given that potential firepower left in these charts one can make the case that there’s room to fill the open gaps above:

Indeed on the chart above one can see a potential inverse forming (unconfirmed) that points toward this upper gap zone.

Bottomline: These charts suggest that while a retest is possible we may have either seen a meaningful low or are in process of making a meaningful low. That’s the Wall Street line.

But here’s the big BUT and there’s a lot of buts and I want everyone to be aware of the counterarguments, because I did not see them outlined by the bottom calling teams and from my perch investors and traders should be very much aware of them.

In the interview above and last week I outlined the similarities to previous major market tops. What we are currently witnessing may simply be the counter rally we’ve seen following the initial drops from new highs on negative divergences.

Case in point, $WLSH:

If the topping script plays out we may see this counter rally extend above the monthly 5 EMA before reverting lower again.

And while many monthly trends were saved at the end of October they are all still hanging by a thread here:

There’s not much room for error or retests here.

And don’t forget the 2016 trend line has been broken:

So any further rally will find this trend line to be resistance.

The October correction has left a lot of technical damages in its wake leaving much significant resistance ahead:

Example the banking sector:

Example $NYSE:

These are not bullish charts. These are broken charts and to simply assume we easily rally to new highs seems a bit of a stretch.

Indeed for all the trend line saves into month end there was one notable and perhaps critical, failure.

The industrial sector:

That one is broken. $XLI fell below the 2009 trend and remains below it, very similar to 2007. Back then it managed to rally for a few months, but remained below the broken trend line, formed a rising wedge and then everything fell apart.

It’s a big chart to watch because it suggests that even a larger rally from here could follow a similar path into early 2019, meaning strength is an eventual sell. A big sell.

So you see, all is not as well as is advertised.

Significant downside risk remains and a break of larger trend lines to the downside could change everything in a hurry.

Next week we have the mid term election which is viewed as a key seasonal market pivot.

It is currently a market uncertainty that will turn into a certainty by Tuesday night. In 2016 we’ve seen how quickly and dramatically the process of repricing can change perception. During the US presidential election we saw a lock limit down in futures only to see market move to green the next morning. While I can’t predict a repeat of such volatility one must certainly be aware that major price moves may occur.

I think it’s fair to say that many participants are looking forward to a bullish interpretation especially if the historic script plays out, which is that the ruling party will lose the House.

If markets price in a bullish outcome we can certainly see the rally extend into the next price levels of my target zone which could imply a move into 2775-2850:

But one can’t dismiss a negative interpretation at least initially and this again opens up the larger lower risk zone I’ve been pointing out:

This immediate risk zone extends all the way down to 2460 at the moment with major support zones at 2581 and the range of February lows before that.

Last week’s call for a larger rally was more clear cut. For next week the outlook is more grey as markets will be subject to at least one political risk event.

Bottomline: Signal charts and technicals have room for higher prices still, but must pass last week’s resistance points to make progress.

On a negative reaction to the US midterms buyers must step in quickly to avoid new lows. A retest (i.e. overnight) is technically acceptable, but a sustained drop below $ES 2684 would have to be viewed with extreme caution as then monthly trends are at very high risk of breaking for good and then the lower risk zone would be a clear and present danger. A move toward 2460 for example (while a likely massive bounce zone) would break the long term bull market trend.

And I leave you with a couple final charts to consider as we are being told that the bottom is in and next year is guaranteed to be an up year because of mid term seasonality.

Firstly here is the $NDX yearly chart:

It’s up 10 years in a row and still vastly disconnected from its yearly 5EMA. To say that next year is an up year is to say that $NDX will be up 11 years in a row in the face of slowing growth and reduced central bank liquidity and no new artificial stimulus program being on the horizon.

It’s one thing to see markets go up 10 years in a row with 10 years of global artificial stimulus in a row. It’s another to see a market go up 11 years in a row without any such stimulus for the first time in 11 years.

Secondly, yields. Perhaps people didn’t notice last week, but that 10 year came screaming back right back to its descending trend line:

Both $SPX and $TNX are right at key multi decade trend lines. If either of them break everything changes. If not, bulls have room to run.

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Authored by: Sven Henrich