Trader’s Narrative

According to the talking heads the US stock market declined because of worries related to the “stress test” and due to the bad news from Bank of America (BAC). While these are valid events, they aren’t the main cause of the market’s weakness because they aren’t really news. Had it not been for these ‘news’ the market would have fallen on some other event or in spite of any significant news at all.

At the start of the month I started pointing out that the market had com too far too fast and we were about to see another cycle high: Stock Market Rally Hitting the Wall. Since then the confirming news from sentiment, technical analysis and market internals have piled on.

Consider that we are now seeing an astronomically high level of market breadth as almost every single security out there has suddenly come to life:

I use the Nasdaq advance decline numbers because the NYSE data is notoriously polluted with non-common stock securities such as ETFs, CEFs, LPs, bonds, etc. The only time in recent history we saw so many stocks participate in a short term rally was in early January 2009. To be fair, there have been times when the stock market continues to go up in spite of breadth becoming over-extended. But these are rare and usually occur at the early stages of a powerful new bull market.

Another measure of breadth, the percentage of the number of securities within the S&P 500 Index that are trading above their 50 day moving average has reached an extreme:

On Friday, it just about reached 90% and with today’s market weakness, backed down. Anything time 80% or more are above their 50 day moving average, stock prices in general either slow down their pace or simply top and fall.

We’ve also seen an very rare occurrence in the same indicator’s short term perspective. The percentage of S&P 500 (SPX) constituents that have closed above their 10 day moving average has clustered above 80% for most of March and April 2009.

Finally, another measure of the market’s internal health, the Nasdaq McClellan Summation Index hit 241 today. This level corresponds to difficult going for any rally in the past. The only exception was during the 2003 (new) bull market when we saw breadth overextend beyond this with no ill effects to stock prices.

Sentiment
As long time readers will know from the weekly sentiment overview, option traders which had been behaving in a rather uncharacteristic way throughout the bear market have now shown their hands quite clearly. They are unmistakeably bullish with a penchant for call options vs. put options (and I’m referring specifically to trades which result in a new long position in either calls or puts).

Limited Time Free Access to Elliott Wave
By the way, don’t miss the chance to download the FREE 120 page report from Elliott Wave covering the US, European and Asian markets as well as interest rates, commodities, currencies and much more. This is the most recent edition of their comprehensive Global Market Perspective and is exactly what their regular paying clients receive. But it is only available free for just a few days. There’s no obligation to purchase anything and you only need your email. I’ll go over it shortly on the blog but get your copy while you still can.

Although the release of a report by Mike Mayo of Calyon Securities (formerly with Deustche Bank) on the health of US banks is being blamed for the weakness of the market today, the truth is that this rally has just about exhausted itself. You can see this by looking under the superficial cover of the index prices. For example, take a look at the short term average of the Nasdaq TICK:

I prefer to use the Nasdaq TICK data because the NYSE’s is influenced by too much noise as a result of the non-operating company listings. Clearly, we are in thin air territory here. A simple moving average of TICK serves as a crude approximation of the cumulative TICK measure made famous by market wizard, Mark D. Cook.

Another way to look at the market internals is the percentage that are trading above their 50 day moving average:

As a reader pointed out when I asked, How Far Will This Rally Take Us?, the 80% line has been a “line in the sand” where prices have either paused or reversed in the past (red arrows):
Continue reading ‘Recent Stock Market Rally Hitting The Wall’

Yesterday, the market flirted with the lows that we saw back in November 2008. So that’s the question on everyone’s mind. Will support hold, or will we see another waterfall decline?

If you were watching the action, you would already know that it was horrendous. Breadth was extreme: out of all the securities on the NYSE, less than 10% were able to close higher than the previous trading day.

We’ve already touched on many sentiment gauges which show an alarming amount of complacency. But what is truly astounding is that in the face of such horrific performance, small option traders plowed their money into call buying. The ISE sentiment index (equities only) moved up slightly to close at 135, meaning that after everything was said and done, 135 calls were purchased for every 100 puts. That, needless to say, is not despondency that carves out lasting floors in market prices.

And yet, even after yesterday’s carnage, we aren’t really close to a complete washout, from a technical point of view. Take the percentage of stocks trading above their moving average, an indicator which shows where we are in terms of breadth. Yesterday, 21.6% of the S&P 500 index component stocks closed above their 50 day moving average:

That might seem low to you but consider that although 20% is the ‘magical’ demarcation in normal, healthy markets, it isn’t so for bear markets. In fact, just as we saw a few months ago, this indicator can go much lower. That is almost exactly where it fell in late 2002

Looking at the bullish percent index, we find the same thing. For the S&P 500 index, yesterday’s reading was 39.60% but the last time market prices where at these levels - in November 2008 - the bullish percent was just 8.6%.

Everything is possible… who knows, the fabled Plunge Protection Team may decide to show up and rescue the day (remember them?) or we may just get a reprieve by a good old snap back rally. But even so, the market internals and the sentiment do not paint a pretty picture.

What an inauspicious anniversary. It is a year since the Dow closed at its all time high - it is now trading down about 35% from that level. While I don’t think we are going to go straight up if things do stabilize, there is enough shrill panic out there to make me think that we should be close to a floor. If we aren’t, then all bets are off and I suggest we all flee to the hills. This isn’t based on mere “gut feeling” but on metrics and indicators that have been faithful guides historically.

So here are some observations:

Global Meltdown
There is enough pain for every single market out there. Forget banning short selling, Iceland outright suspended trading altogether. Indonesia halted trading after a 10% plunge. Russia has seen an utter collapse of their market. Same thing with China’s equity bubble. England has taken equity stakes in financial institutions while other European countries struggle to find a solution. There is a blanket of fear and panic covering the world to a degree that we haven’t seen in a very long time.

Credit Squeeze Easing
The first hints that we could finally be seeing a loosening up of the tight credit markets are here. The spread between the rate for the 2 year interest rate swaps and Treasury yields seems to have formed a double top at 167 on September 29th and October 2nd 2008. At its top, the spread was the widest since data has been collected (going back to 1988). This is a signal of easing for the LIBOR rate but the bad news is that LIBOR and TED spread haven’t responded by falling yet. But this may be the first inkling that they are about to.

Sheer Disgust & Panic
Finally, we can say that there is extremely negative sentiment out there. Both from everyday investors and traders, to newsletter editors. The option metrics are still not “cooperating” by showing extreme put buying. Which is something that I’ve mentioned before. It is still very puzzling to me. But the other traditional measures of sentiment show that the vast majority have thrown in the towel and believe that we will see further declines. From a contrarian point of view, this is a good thing. I’ll go into more detail in tomorrow’s sentiment overview.

How Bad Is It?
Things are so bad that, of the 500 stocks in the S&P 500 Index, only 6 closed trading yesterday above their 50 day moving average. And only 4.2% are trading above their long term, 200 day moving average. For the Dow, all 30 stocks are trading below both of the moving averages.
Continue reading ‘If We Aren’t Near A Bottom, Find A Cave & Buy Guns’

About 4 months ago I wrote about the Canadian stock markets with a dual message: the Canadian retail investor was panicking and cashing in their mutual fund. According to contrarian analysis, this is a good thing because the less knowledgeable and weaker market participants are usually wrong - especially when they react like a herd.

But I also wrote “Caution, Caution, Caution”, saying that even so, I was worried that the market looked heavy. My reasoning was based on the percentage of stocks above their moving average.

My thinking was that although the sentiment would probably put a floor on the market, things could get a bit dicey. Did they ever!

In this case, it pays to be lucky! I was right in being cautious but wrong in thinking that the market would soon rebound from any weakness. After falling, the index has been wrapped up in a tight trading range for the past two months. To be honest, it shocked me to see it so weak in the aftermath of the July sell off.

I wanted to layout my thinking to illustrate that relying on any one indicator, however sound or logical it may be, is dangerous. Timing the stock market is an extremely difficult thing to do and if you’re going to get lucky, it pays to have many tools in your toolbox.