Learning from old charts; Hindsight Analysis

I have attached a chart of the Dow Jones Utility Average. This chart I created a few years ago to track the relationship between Utility stocks and Bonds. The old saying goes that the two move in tandem with the thought being that Utilities are highly levered and their prices move in tandem with bond prices. However, the chart evolved into more than that once the credit crisis hit in 2007.

You can see where I have drawn the vertical black line my original chart and annotations in blue and black on the left from early 2009 and prior. Everything to the right of the black line and in pink and green are the annotations I added today.

There are a lot of things we can learn from this chart that may also help us find the top of the current rally and retracement expectations for the Utility Average.

I will first speak of the original annotations and what they foretold...
1) Probably the most important thing on the chart is the very bottom text box that stated "Divergence will show bottom". Markets are notorious for showing momentum divergence from price at turning points. This is supplemented by the fact that third waves in elliott wave theory are almost always more powerful and faster than fifth waves; essentially thirds have more momentum. So, when I labeled that a divergence would show the bottom earlier this year, I was expecting the MACD to fall again but not make new lows even though the market should make new lows. Without a MACD divergence, it is usually not a good idea to call for a major bottom (or top), and even though the market was down almost 50%, there had yet to be a divergence and thus an ultimate bottom. This led me to believe there would be another fall in prices, before downside momentum had been worked out.

2) The Head and Shoulders top I saw back in June of 2008 was spot on. The target was hit 2 months after the breakdown and continued on to a parabolic fall. Head and shoulders are pretty mainstream now, but they still can work if all the correct rules are followed. This one worked wonderfully.

3) The triangle over the 2008 winter on the Utilities helped to count the waves of the overall market and also point to another decline in stock prices. Triangles are consolidation patterns and when prices break out of them, they are often in the direction of the original trend (which in this case was down). In early February when prices broke down, that was a sign the market was on its way to new lows.

I just pointed out three prime examples of a sub market within the larger market helping forecast the next move in the market's prices. Now, I will try to use what the chart is saying to project where this next rally could potentially end.

1) After bottoming in March, the Utilities have bounced in a countertrend rally up over 20%. That is significantly lower than the markets in general which are up over 40%. So, right there we have underperformance of the Utilities which means they may not be a very good sector to put money in to catch this bounce. However, they also did not fall as much during the bear, so they could be considered a safer, less volatile sector.

2) I have counted 3 complete moves in Pink from the March bottom to A. at $358. Typically countrend rallies will retrace to the fibonacci zone of 38-62% which right now is still 15% higher in the $390 zone. From an Elliott Wave perspective the 3 part move up to A. is satisfactory for the countertrend move. We will have to wait to see how prices pan out before we can tell if that A. is part of a larger A., B., C. (which the fibonacci retrace zone tells us should be true). If the utilities trade above $358 then that would be strong support for a move to $390.

3) Typically countrend rallies following a move with a triangle in the previous 4th wave will retrace back to that triangle. So this move should theoretically retrace back to the triangle (in black) region. At $358 it has sufficiently done that. However, the triangle also has territory in the $390 price area, so there is more room to go, if needs be.

Overall, this chart was a big help during the crash of 2008. It forecasted the initial fall with the head and shoulders top and breakdown, it showed no divergence at the October lows forecasting another move lower (which occured in Feb/Mar), and it now shows the potential for a move up to $380-$390. A move below $325 may mean this rally is complete, but right now all signs point to another move higher.