Catching the Wave: Ominous Signs from XLF

 | Aug 23, 2011 | 8:22 AM EDT
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Financial sector ETF (XLF) is telling an important story, similar to one from 2007, prior to the broader markets peaking and rolling over into the abyss of 2008.

Don't watch the birdie. Investors must be very careful to keep their eyes on the prize. This doesn't lie about the economic outlook, like some market statistics do. Although currently very oversold on a stochastic basis, XLF is clearly warning of a deeply painful economy if the coming months. Any bounce toward $13.50 +/- .50 should be used to exit losing long positions, as well as be used as a sign of things to come for the members of this particular sector.


XLF -- Monthly
Source: eSignal

Well before the 2007-2009 crash reached our consciousness via the media, the financials peaked, rolled over, and failed to confirm the new highs in the Dow and other indices. The rationalizations were vast back then and they have returned recently, just as the XLF again rolled over in front of the Dow and others. 


In 2007, as XLF ticked a new high, stochastics failed to confirm with a lower high. Notice the stochastics failed to confirm the test of the 2010 swing high early this year, hinting that trouble was brewing again. 

More importantly, the rallies this year and last were stopped cold by the Fibonacci 38% resistance level. This is a sign of weakness when only the first Fibonacci level is tested.

Most importantly, the pattern of the up moves since the 2009 low is nowhere near as energetic as the pattern of the decline into the 2009 low. Elliott Wave is crystal clear on this topic: an impulse NEVER ends a trend by itself. In other words, the declining pattern into the 2009 low is only the first wave down in the new downtrend that begun in 2007, not the finale.

The alternate count allows the 10-12 zone to support prices in the short term, and a rally to follow for a few months toward the 22 area +/-2.  This is supported by the oversold daily and weekly stochastics (not shown).  While this possibility cannot be eliminated under EWT, we would not be wagering in that direction.

The big picture hasn't been this ominous since late 2007, when personal, corporate, municipal, and federal balance sheets were in dramatically stronger positions. There is just no buffer left to survive another downturn of 2008 proportions, and Elliott Wave Theory suggests this time will actually be worse.


Dow Jones Industrials -- Monthly
Source: eSignal

Just yesterday, for the first time ever (at least to my ears), someone commented that if Ben Bernanke acknowledges another quantitative easing program (QE3) this week at his Jackson Hole talk, it'll mean that he believes the economy is in a 1937-type analogy. Being of small mind, I can't even imagine what that means. But Robert Prechter at Elliott Wave International just published some research showing that the long term Elliott Wave pattern that is most analogous to the current chart patterns is that of late 1936 to early 1938.  Back then, the Dow had risen from the 1932 low into late 1936, in one of the greatest rallies in history (quintupling in four years).  Then, it fell about 50% in the next fifteen months.


According to Prechter, whose forecast makes the one I've illustrated in the chart look tame by comparison, the Dow has begun a wipeout pattern that should reach below the 1987 crash-low by late 2016 at the latest. In my chart above, the "reasonably expected" zone is where I'm barely comfortable forecasting, in contrast to the "maximum expected" zone, where the Oracle of Elliott Wave believes is likely. I've seen Prechter call some amazingly prescient moves, so don't laugh unless you have the money to lose. If not, take heed.

Even if my "minimum expected" target is seen, it pays to reduce risk exposure up above 10,500.  My minimum expectation is any break below the 2009 low of 6,488 in the Dow.

Rather than be distracted by the various birdies trying to mask what is really going on, sell now (above 10,500), or forever hold your peace.  At least for a long, long time.

Here's the very-short-term path that ranks as our leading count: 10,000 +/- 300 should be the end of wave '1 of 3 down, followed by a multi-week to multi-month wave '2 of 3 up rally, retracing 38% to 62% of wave '1s decline.  This will be the last stop on the hope and dreams train to exit stocks. In 2012 we should see the main force of wave '3 of 3 down, the Uh-Oh phase, or crash.

Use our wave '1 targets to prepare. Our wave '2 targets to exit. And, our wave '3 targets as warnings to seriously exit during wave '2s rally.

Stay tuned, and good luck.

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