Trader’s Narrative

With today’s close the S&P 500 index arrived at a new high for the year. So far, it has risen 22.8% - not bad at all compared to the average historical return. And the year isn’t even over yet. If we look at the performance from the very bottom of the lows in March, it is even more remarkable at 63%.

But even as the stock market continues to power ahead, and longevity of this rally continues to strain all credulity, we can’t ignore that the market breadth is down right horrible. Usually, the measure of advancing vs. declining stocks rises and falls like a tide, keeping a rhythm with the indexes.

Right now however, the 20 day average of Nasdaq’s daily advancing and declining issues is acting the way it would at intermediate lows - even though we’ve well into an uptrend:

This means that fewer and fewer stocks are pushing the averages higher. When we start to see less participation from the wider spectrum of stocks trading on the exchange, we don’t have a healthy rally. My hunch is that most of gains can be laid at the feet of the large caps either because of their international sales exposure or because of the dollar carry trade (sell the dollar and buy anything risky). Check out the Russell 2000 - it has yet to confirm a new year to date high as the S&P 500 index. The same can be said for the equal weight S&P 500 index.

Another cause for concern is just how quickly the index has been able to rise on the back of fewer and fewer rallying stocks. For a bull market to be considered healthy, it has to have staying power. This is an endurance run after all, not a sprint. I measure the speed of a rally by comparing the closing daily price to the long term trend as measured by the 200 day moving average.

While the 200 day moving average has been rising, it hasn’t been able to climb as fast or faster than the price it tracks. So the distance between them as a ratio has increased. With today’s strong close, the S&p 500 index is now 19.3% higher than its long term trend line. That’s slightly more than the last time this same metric made me raise the caution flag: Stocks Have Little Room to the Upside.

That was 11 points lower than we are now. Running the numbers with a 20% and 21% ceiling, we get 1117 points and 1127 points respectively. So imagining that we leapfrog 8 to 18 points from here, we will have hit an invisible wall. Check out the previous link above to see a chart.

So odds are that we either correct here (again) to give the long term moving average a bit of time to catch up. Or prices meander to and fro, not really going anywhere and boring both bears and bulls. There is very little probability, from a historical study of the market, that we will see a rush higher.

Back at the beginning of August, we looked a study of momentum thrusts which showed that historically, when the 10 day ratio of NYSE advance decline was pushed to an extreme the market tended to enter a protracted rally.

There were only 10 instances in the past 4 decades, with 2 of them occurring this year. Since some time has passed, I wanted to update the table and look at where breadth stands now:

From March 23 2009, the market rallied about 12% in 3 months and almost 30% in 6 months. And forward 3 months from July 23rd, the market rose 18.6%. That’s in line with the previous returns historically (or slightly better).

When Wayne shared this historical study with me, my initial concern was that this is relying on NYSE breadth data. As I’ve stressed several times before, NYSE market internals are now skewed by the increasing number of non-operating company securities trading on the big board. While the NYSE is the most well known stock exchange around the world, increasingly ETFs, municipal bond funds and other CEFs and even bonds have started to take a larger and larger share of trading.

But, if you look closely at the Nasdaq data, it corroborates the last two momentum thrusts that are shown above. In late March and late July you can see two distinctive spikes:

So far, so good. Or more accurately, in line with historical norms. Lately though, the breadth has been horrible. We haven’t seen market internals this bad since the beginning of the year - just before the spring rally was launched.

While I think the S&P 500 has more room to the downside, the bounce today wasn’t unexpected. If you listen to the mainstream media, the explanation is the the positive GDP numbers, which at 3.4% blew away expectations.

While it will take a few days for the whole report to be dissected, it is more likely that it was an excused used to run up prices, rather than the actual rationale. Especially since many have pointed out reasons at the beginning of the third quarter why the recession may be over. I attribute the bounce today to the extremely oversold breadth - in the very short term.

One of the best measures for this is the percent of S&P 500 stocks above their short term (10 day) moving average. This metric sharply fell to just 6% yesterday. At the start of the week it was 20.4% and on Tuesday it was 14.4% and then it fell below the important 10% level which marks extreme short term oversold levels. This is the level that was mentioned in the recent Lowry report: Turbulence Ahead.

The oversold level was clearly visible across many important sectors. Many of which had equal or worse breadth than the general market proxy. The transports were especially hard hit for example. As were the gold stocks, which as I’ve repeatedly mentioned, tend to follow the general market.

Another measure of short term breadth is the ratio of daily new highs to new lows on the Nasdaq:

As the chart shows, the last time new lows increased this much and new highs dissipated this much was back in early July, which launched the second leg of the spring rally. As Lowry’s report mentioned it is quite possible to experience a short term set back within a primary uptrend. Things to watch for are how the market responds to this oversold condition. If the market weakens significantly in spite of poor breadth, then it will need to trade lower to find a strong bid. If on the other hand, the S&P 500 can rally immediately off such a short term extreme, then we know that the uptrend is intact.

An important part of this is the medium term outlook. The percent of S&P 500 stocks above their 50 day moving average has managed to put in higher lows each time as the chart below shows:

Since October 2008, medium term breadth for the S&P 500 index has been stair stepping higher. It needs to remain above 30% to maintain the uptrend, which it seems to have done already.

And the very long term breadth measure - the percentage of S&P 500 components above their 200 day moving average - remains at peak levels. With today’s strong showing, it moved once again above 90% where it has been since August 2009. This is reminiscent of the rally we saw in late 2003. I’ve detailed this here: Comparing Market Breadth To 2003’s Bull Market.

Let’s check in with the latest Lowry Research proprietary indicators. As persevering readers will recall, Lowry arrived late to the (bullish) party with their intermediate buy signal in August. Since then, they’ve continued to monitor their indicators and diagnose the uptrend as healthy: Rally Continues Strong. No indicator, whether proprietary or otherwise is perfect and no one has a crystal ball.

HAving said that, personally, I respect the oldest technical analysis firm on Wall Street not just for their heritage but also because they refuse to be swayed by emotion and always root their approach in a methodical study of the market.

Here are some notes from the latest interview with Tracy Knudson of Lowry Research (you can listen to the whole podcast at the bottom):

• S&P 500 bouncing off its 50 day moving average
• near term, we could get a move down to that MA
• around 1045-1050 which is a converging support area
• the trendline from March and July lows also meets in that area
• this area will act like magnet to draw market lower
• volume is sending a clear message: weakness on upside and more strength on downside
• S&P 500 tried several times to clear the 1100 level
• it has approached that level on contracting volume
• but volume expands on downside days
• this telling us demand weakening and selling more intense
• so the market is gearing up for a correction
• last short term pullback occurred in late Sept to early October
• that began with a downside reversal day
• this is when the market made new high then wasn’t able to sustain it and made a new low

Continue reading ‘Lowry Research: Turbulence Ahead, Uptrend Intact’

It is only six weeks since Lowry Research gave an intermediate trend buy signal. Since then the market has gained appx. 6%. Here is update on where the oldest technical analysis firm on Wall Street stands. You can listen to the Bloomberg podcast at the end of this post.

If you’re new to Lowry’s, many of the terms below may be confusing. For example, Pim refers to “Lowry stocks” which is a misnomer. What he means is OCO (operating company only) breadth, which is Lowry’s response to the pollution on the NYSE. This measure strips out ADRs, CEFs, REITs, bonds, ETFs, etc. and only shows market breadth for operating companies. For more background like that, as well as an explanation of Lowry’s proprietary indicators, take a look at my post late last year outlining Lowry Research’s position on the then market conditions.

Here are some notes from the recent Bloomberg interview with Tracy Knudson of Lowry Research:

• from Lowry’s market newsletter: “strong rallies but there are flaws”
• potential growing selectivity within the rally
• breadth momentum % above 10 day moving average declined last week as
• this indicator was at 88% (time of interview) - extremely overbought
• now it is lower at 82.6% (see chart above)
• also there are overbought price momentum indicators
• demand volume weak: NYSE up volume 52% (Sept 15th) of total up+down volume
• this is another blemish on the aging rally
• S&P 500 trading envelope: overlay 21 day moving average then +/-3% range
• this provides and indication of overbought/oversold condition
• right now the S&P 500 index is hugging its upper trading envelope
• we’ve seen this happen before during the rally - this is the 3rd time since early June
• each time as the S&P hugged this upper envelope, we also had deterioration in the momentum indicator (% above 10 day MA)
• the confluence of waning breadth momentum and the overbought condition lead to corrections
• the first correction was 7%, the second less
• not a signal of an important market top but evidence mounting for a correction
• LT indicators are telling us the correction will be short term & shallow correction
• new highs in advance/decline line, and Lowry’s proprietary indicator: Buying Power index continues in an uptrend
• as well Lowry’s Avg. Power Rating index which measures demand across stock market has tripled since March low
• strong indications of demand so correction will probably be shallower than 5-10%
• price momentum is also very overbought (short term condition pointing to correction)
• traders have been expecting a correction since the market can’t move up in a straight line
• but the market has been very resilient
• even so, we haven’t seen panic buying which precedes important corrective points
• if we see complacency and sharp move higher = panic buying and look out below
• have not seen true panic buying from the March lows
• OCO advance/decline line is confirming new highs in major market averages
• no divergence - that would be seen at an important market top
• any selling is met with a renewed wave of buying which overwhelms it
• watch to see if “buy the dip mentality” fades - watch for waning intra-day resilience
• Nasdaq advance/decline line was lagging but is now at a new high as index leads
• this rally has not run its course
• during a pullback, if market internals deteriorate proportionally more than the market, we’d reevaluate our stance

Tracy Knudson of Lowry Research (Bloomberg):
Pim’s interview with Tracy is at the beginning of the podcast so just press play and listen: