November 2: Major or Minor Correction Underway?

Given today's huge down move in stocks, there's panic everywhere.  The fear that this is the start of another down leg is everywhere.  The deflationists are giddy with glee that the dollar is finally strengthening!

We believe that they're in for a rude awakening.  Of course, anything can happen at any time, but not only was this correction expected, but it's just what we've been waiting for...

 At this stage, we believe that this is simply another short term pullback, and that after this week--give or take a few days--the dollar decline will continue and asset prices will rise again.  As of end of day Friday, the dollar appears to have fallen out of another flag, which implies that the downside may have already begun again.  Fast moving traders could buy positions now in key assets, notably gold, and add to them when the dollar breaks 75.83.  The more prudent trader may want to wait for a confirmed break below that level, and longer term investors should be accumulating now.  Be prepared to exit positions if the dollar breaks above the 50 dma.

So, why all of the sudden concern in the financial media about this being the beginning of another major leg down?  On October 22 we showed a long term S&P chart with Fibonacci retracements:

Note that we listed the following key resistance levels:

- 1100 (round number, not marked on the chart)
- 1124 50% retracement from the lows.  This is a key level of possible failure in the rally.
- 1230 61.8% retracement from the lows.  This is, in our belief, the most likely failure point before 1350.
- 1350 (red horizontal line) Target of the inverse head and shoulders pattern

Note that the decline in equities started the general asset decline as the EURUSD cross failed to hold 1.50.  At the same time, the S&P was just over 1100, which is round number resistance that is relatively close to the 50% retracement level of 1124.  In essence, the S&P has hit a strong "zone of resistance" while being very overbought and the dollar being very oversold.  This appears to be a short correction, though we'll watch the 1124 level on the S&P closely.  Since that level is on a weekly chart and is a major Fibonacci retracement level, it appears market traders have opted to sell out here.  We do not believe that this will be an intermediate top--only a short term correction that may already be reversing.

Take a look at the VIX vs. the S&P for the last three years:

 Note that almost every spike on the VIX leads to a short term bottom in the S&P.  On Friday, October 30, the VIX spiked to 30.69.  We believe that will be the bottom, or very close to it (we may retest it this week), in the short term.

On a short term basis, all major asset classes are oversold.  On an intermediate term basis, they still have upside room, and early bullish patterns (like the inverse head and shoulders in the S&P chart above) still have upside potential.

By all indications, this is a buying opportunity with a bit more room to run before a major consolidation that will occur at the 70-72 USDX level.