Trader’s Narrative

Guest post by Robert Folsom, senior writer for Elliott Wave International

The following text is courtesy of Elliott Wave International. Until Nov. 11, EWI is allowing non-subscribers to download their latest market analysis and forecasts for free, including Robert Prechter’s latest Elliott Wave Theorist and Steve Hochberg’s and Pete Kendall’s latest Elliott Wave Financial Forecast.

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As you read and look at this page, please know that the chart is the star of the show. My description will add only a few details.

The chart published less than two weeks ago in Bob Prechter’s Elliott Wave Theorist. The rectangular box is plain to see: It envelopes the huge S&P 500 rally that began last March — a gain of 61.5% and 430 points, as of Oct. 18.

But there’s a two-part truth to the rally — and that is what the box really shows.

Part one shows the “wall of worry” — basically March through August. That’s when the media and experts were overwhelmingly negative about stocks. They were surprised by the rally. Remember?

Part two shows the more recent time of “euphoria” — basically September and October. The media and experts turned positive. The market was all about “green shoots” and “recovery.”

You see when most of the rally unfolded. Six months of serious worry produces a 373-point climb, whereas “two months of euphoria produces only 57 S&P points.”

Now, the two-part truth about this rally is an easy story to tell. It’s literally a few lines and notations on a price chart. Yet have you seen or read ANYTHING like this in the past two weeks? Has anyone else pointed out that over the past two months, the stock market “rally” has in fact slowed to a crawl?

As you looked at the chart, perhaps you noticed that the decline, which began in 2007, and in turn the recent rally, are both on a similarly large scale. The full version of this chart shows how important that “similarity of scale” really is (Elliott labels were excluded in consideration of Theorist subscribers).

Price action in the stock market this week has only strengthened the analysis in Bob Prechter’s October Theorist issue.

What’s more, you can read the very latest forecasts in the just-published November issue of the Elliott Wave Financial Forecast — both publications (plus the tri-weekly Short Term Update) are yours for free — only during FreeWeek (now through Nov. 11).

Learn more about FreeWeek, and download the November Theorist

Robert Folsom is a financial writer and editor for Elliott Wave International. He has covered politics, popular culture, economics and the financial markets for two decades, via print, radio and the Internet. Robert earned his degree in political science from Columbia University in 1985.

Last week we reviewed the latest position of Lowry Research on the stock market: Turbulence Ahead, Uptrend Intact. One of the major reasons that Lowry’s continues to believe in the health of the market and a continuation of the uptrend is the lack of selling pressure.

Lowry measures this through their proprietary metric called (what else?) Selling Pressure. It remains low and falling, helping to support the thesis of a healthy market rally. According to Paul Desmond: “Every major market top in Lowry’s 76-year history has been preceded by a sustained rise in selling pressure. With selling pressure recording a new 12-month low within the past two weeks, no such rise is now evident.”

This has got to be frustrating for the bears. But it is also unbelievable to the large number of participants in the market who continue to look at the current price levels as a mirage. The US retail investor is not venturing out into equities, even after watching the stock market climb a wall of worry inch by inch.

This has been and continues to be the most hated stock market rally that I’ve ever witnessed. In any case, it is comforting to confirm Lowry’s proprietary measure of selling pressure with a similar measure from InvesTech.

Click chart to see larger version:

Source: InvesTech

Jim Stack, the writer of InvesTech has a handy checklist for new bull market conditions. One of them is this metric. And along with the rest of the list, it has been flashing a bright green buy signal for a few months.

As well, the month of November has been historically one of the best months for the S&P 500 since 1950. I’m not sure that another 20% rally by year end will convince the retail investors to risk their money in the stock market again. But we may just see that.

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’

Well, that didn’t take long. The S&P 500 is only down less than 5% from last month’s peak and already we’re seeing signs that this shallow correction has reached important levels.

Take for example the percentage of stocks closing above their 10 day moving average. This simple breadth measure is surprisingly accurate at finding inflection points, both in the short and intermediate term. According to a study from Lowry Research which I shared with my readers a few years ago, it has an almost perfect track record: Latest Research Report From Lowry Research (2007).

The key level to watch is 10% - which we breached on Friday. Here is a chart of this breadth measure for the components of the S&P 500 index:

This wasn’t limited to just the most popular stock market index. Other indexes provided a similar outlook. Take for example the Nasdaq 100 index where 9% of the stocks closed above their 10 day moving average. Lowry’s operating company only version of this breadth measure was 8.13%, which is the lowest since March 2009.

We can add to this the McClellan Oscillator which is another measure of market breadth. If we strip out the ETFs, CEFs, and other ‘junk’ from the NYSE and just consider real corporations, this operating company only index’s (Ratio Adjusted) McClellan Oscillator is as oversold as it was in March 2009.

But other metrics like the short term average of the daily Nasdaq advance decline numbers are still quite high. So is the percentage of S&P 500 components which closed above their 50 day moving average. In an important bottom, this number can fall to 20% (and lower) but so far the lowest it has reached is a lofty 53.6%.

A note of caution before you jump to conclusions. Interpreting this type of data can be rather tricky. That’s because these measures of internal market breadth act differently during different market conditions. In strong bull markets they can levitate for prolonged periods of time at atypically high levels. While in bear markets they oscillate with much more volatility.

The best way to look at this market juncture is to see it as a litmus test of the spring rally. Just as we went over when we updated Lowry Research’s latest views on their intermediate buy signal, this correction was expected. The best way to take advantage of it is to see how the market reacts to it and specifically how the market internals deteriorate in the face of a decline in stock index prices.

A shallow correction followed by a sharp rebound with very limited damage to the underlying breadth of the market would be a tell that this is a real cyclical bull market and not just a prolonged bear market rally.

For a while now, we’ve been concerned that volume hasn’t been powering the market higher. In fact, if you think of volume as fuel for any sustainable market rally, then we’ve been running on fumes for a few months. Since I wrote that in early June the market wobbled a bit and traced a shallow correction but before long it was on to new highs for the year. This has been a teflon coated rally.

But there is no mistaking that what we are seeing is a true outlier in terms of historical market performance. Here is a chart from Hussman’s most recent commentary which shows the six-month percent change in the S&P 500 from the bottom of each bear market (going back to the early 1940’s) compared to the percent change in volume over that same period:

Source: Hussman Commentary

As you can see, this rally is the largest one powered by the least volume. If we imagine a “best fit” line for the data, it would be going from the lower left to the upper right, implying that usually, the more volume, the bigger the recovery from a bear market low.

The state of volume (or lack thereof) is even more alarming when you consider that for the past year a baker’s dozen of stocks have grown to account for eyepopping proportions of total volume on the exchanges. Just to give you an example, on August 6th 2009 Citigroup (C) and Bank of America (BAC) accounted for 25% of total NYSE volume. Dr. Brett have brought attention to this last month: The Recent Concentration of Volume.

There are many theories about what exactly is behind this crazy volume: daytraders, HFT, short covering, secret government recapitalization, etc. Whichever reason is the real one, a market structure where total volume is distorted by such gigantic proportions from a handful of issues is, simply put, deceptive.