Update for Wednesday, January 27, 2021, 4:54pm, Eastern.

In Monday’s Update we noted the bullish extreme in the National Association

of Active Investment Managers Exposure index. We didn’t have an
opportunity to put a chart together for that Update, but the level of optimism
toward equities is so rare that we thought a chart is needed to convey the
sentiment. The top graph is the weekly Dow Jones Industrial Average, while
the middle graph is the NAAIM Exposure Index, plotted with a 10-period
average to smooth away outliers. The Exposure Index measures the average
equity exposure reported by the association’s members. Any reading above
100 means that, on average, managers are leveraged long stocks. Last week,
the number jumped to 112.93, the second highest reading in the data’s
history. On a 10-week basis, the Exposure Index is at a record extreme, above
100 for the first time in the Index’s history. But probably the most telling
measure in the NAAIM survey is shown in the histogram at the bottom of the
chart. The most bearish group of managers typically has a net-short position
averaging 80%, according to NAAIM. Last week, the most bearish managers
were 75% net-long equities (see red arrow). When even the bears are bulls,
sentiment has reached an extreme that is compatible with a rally that is late
in development.

The DJIA rallied to 31,121.40 yesterday (Jan. 26), 19 points above 31,102.20.
Today, the index gapped lower at the open, quickly declining 584 points
where it met the bottom trendline of the channel from early November. The
Dow bounced near term and then broke below the channel line later this
afternoon. The NYSE advance/decline ratio was solidly negative with nearly
five stocks that closed down for every one that closed up, and yet the NYSE
Trading Index (Trin) closed at .27. As we noted Monday, a strongly negative
a/d and a low Trin usually mean that a great deal of buying power is used to
keep stocks from declining even further. If buying power exhausts, stocks
should decline even further.

The decline to fresh new lows today indicates that the selloff from 31,272.20
to 30,564.00, January 21 to January 25, is a five-wave pattern. The rally to
yesterday’s high is three waves, retracing an exact .786 (sq.rt. of .618) of the
prior selloff. The decline today is another five-wave pattern. The above chart
shows the wave labels: the January 25 low is wave (i) and yesterday’s high
(Jan. 26) is wave (ii). Wave (iii) down is progressing. This afternoon’s low, or
the next one, may be wave i of (iii). If there’s a short term snapback rally it
will be wave ii of (iii). The next downside target is 29,755-29,882, with much
greater bearish potential.

The alternate interpretation is shown at the bottom of the 15-minute range

chart. This less-probable scenario labels the decline from January 21 as
a zigzag pattern (see text, p.42). The implication is that the index will rally to
new highs. If the odds were to increase toward this outcome, we’ll discuss it
in Friday’s STU.

The McClellan Oscillator and the Summation Index plunged further into
negative territory today. The S&P’s closing high at 3855.36 (Jan. 25) is 57
trading days from the October 30 low and the intraday extreme at 3870.90
(Jan. 26) is 58 trading days. The STU first published the above S&P daily
chart on Wednesday, January 20. If the time relationships discussed last
week are valid, this week’s highs should mark the end of the rally from at
least October 30 and likely from March 23.

The S&P’s short-term chart shows a progressing five-wave decline from

yesterday’s high. This morning’s extreme of 3767.10 is wave iii of the five-
wave pattern. This afternoon’s extreme at 3732.48 is wave v or part of wave
v. A complete five-wave decline from the high should be the first of many
five-wave declining patterns as the structure develops to the downside. As
the pattern continues to develop, an initial target is at 3627-3663, with
greater bearish potential thereafter.
The NASDAQ Composite traced out five waves up from October 30, pushing
to 13,728.90 on Monday, January 25. This high has the strong potential to
complete the impulse pattern of the past three months. If the high is in place,
the decline from Monday will tracing out a five-wave decline. Prices should
work below 12,950.00 initially, with greater bearish potential thereafter. If the
index fills the gap at 13,626.00 from the close yesterday (Jan. 26), the rally
would be too large to maintain a bearish stance. Instead, a push toward
13,829-13,849 would be in the offing.
Wave 2 up started at 167^11.0 on January 12 in [U.S. Treasury long bond
futures]. With this morning’s push to 170^25.0, prices have carried to our
cited target range at 170^11.0 to 171^01.0. Today’s high met the “a-b-c”
channel and there is a clear “five up” from 168^07.00, the low on January 21.
If the rally is complete, wave 2 formed a single zigzag (see text, p.42) from
January 12. The implication is that bond prices will now decline well below
the January 12 low as wave 3 down progresses. A break below 168^07.0
would eliminate any remaining bullish potential, enhancing the bearish case.
The top alternate view is that Minor wave 2 is taking the form of a double
zigzag, not just a single one. In this scenario, today’s high is wave (a) of the
second zigzag, or most of wave (a). When wave (a) is complete, prices will
decline to approximately 169^25.0 to 169^06.0 in wave (b) of y (circle). Then,
a rally will develop for wave (c) of y (circle) that carries above the wave (a)
high. That push will complete Minor wave 2 and lead to Minor wave 3 down.
In either case, the larger trend for bonds remains lower.

The [Euro] carried to 1.2190 on January 22, tracing out a three-wave rally in
the process. The rally adhered to an (a)-(b)-(c) channel, which prices broke
below today. The breakdown is either the start of Minute wave iii (circle) or it
is wave (b) of ii (circle), which is tracing out an upward flat pattern, shown by
the Alt. line on the chart. In the first scenario, prices will continue lower near
term, eventually reaching the next downside objective remains at 1.1863-
1.1889. In the second scenario, the euro will first rally to meet and modestly
exceed 1.2190 to complete wave (c) of ii (circle). Thereafter, prices will be set
to decline in Minute wave iii (circle) down to the aforementioned initial
objective. As long as the euro remains below 1.2140, the immediate bearish
potential retains the upper hand: wave iii (circle) down is underway now. A
rally much above 1.2140 (we’ll give it a few ticks leeway) would
create overlap between corresponding waves, suggesting that today’s low is
wave (b) of ii (circle). This would elevate the odds toward the second
scenario.

The short-term path is not as clear for the [U.S. Dollar Index] as it is for the
euro. There remain several options for the progressing structure. If the index
can rally above 90.951, the high on January 18, prices should continue to at
least 91.155-91.238. The bullish potential is even greater. Another possibility
is that today’s high is wave “d” of a triangle pattern (see text, p.49). Wave “e”
will be a modest pullback that holds above 90.048. Then, a sharp
upward thrust to new recovery highs will develop. As soon as we can
eliminate options, we will become more definitive in our short-term forecast.
There is no new information to add to our recent forecast for [Gold]. The high
at RM7593.21 ($1875.33) on January 21 is wave (ii) or it’s wave w of (ii). In
either case, the next multi-week move should be wave (iii) down toward
the RM6599.87 ($1630)-RM6761.83 ($1670) range. If wave (iii) has started,
the decline will gather momentum tomorrow and/or Friday. If the January 21
high is wave w of (ii), gold will first rally toward RM7660.71 ($1892)-
RM7705.25 ($1903) to complete wave y of (ii). Then, wave (iii) down will
start. The January 6 high remains key to the bearish case and break above it
would rescind the forecast.
[Silver]’s rally to RM105.64 ($26.09) on January 21 is either wave (ii) or wave
a of (ii), the latter shown by the Alt. line on the chart. Wave (iii) down will
eventually draw prices to RM80.98 ($20.00) or lower. If wave (iii) has started,
prices should soon accelerate lower. If the January 21 high is wave a of (ii),
silver will rise to RM106.29 ($26.25)-RM107.54 ($26.56) in wave c of (ii).
Once wave (ii) is complete, wave (iii) down will commence. In either case,
silver’s main trend remains lower. As before, it would take a rally above the
January 6 high to void the forecast for wave (iii).

Next Update: Friday, January 29, 2021.

--Steven Hochberg, Editor.