Last month, just a day before the now infamous “Flash Crash”, we looked at the sentiment data from Investors Intelligence as well as the technical data (buying climaxes). Both of them were pointing rather clearly to an upcoming correction for equity markets.
While the analysis was accurate, to be fair, ChartCraft was not expecting such an immediate correction. Their estimate was for a top to form in mid-May. In any case, we fast forward to today and find the S&P 500 has retraced about 13% from its recent highs.
The sharp drop in stock prices has caused buying climaxes to lurch from one extreme to another. A buying climax, by the way, is when a stock makes a new 52 week high and then closes the week lower. Last month they spiked to a new record weekly high, going back more than 20 years.
The last week in May took this indicator to the other extreme as selling climaxes spiked up to levels not seen since the March 2009 low. This suggests that a lot of weak hands have been thrown out of the market and implies that these recent lows should hold.
We can see the same technical breakdown in both the Short Term Composite and the Long Term Composite indexes from Investors Intelligence. These are are generated from the scores awarded to over forty indicators including breadth, sentiment, money flow, etc.
The only situation I can imagine under which stock prices would continue to deteriorate while within such an overwhelmingly oversold technical context is a crash or severe bear market. Bar that, under, so called, normal conditions, the market has reacted with higher prices in the past and I can’t find a good reason to expect otherwise today.
Yesterday we looked at the Lowry Buying Power and Selling Pressure indexes which measure the underlying demand and supply for stocks. They are telling us that amid the weak numbers and the red filling up screens, the underlying uptrend for the market is still healthy.
Tarquin Coe, market analyst at the Coe Report, points out that the S&P 500 is creating a base which corresponds to the February support level and is right under the 500 day moving average (exponential). This average has been a major guide for both bull and bear markets:
As well, breadth, as measured by the bullish percent index for the S&P 500 is the lowest it has been since March 2009. The Fibonacci 23.6% level is also offering an area of support (calculated from the March 2009 low to the April 2010 high).
According to my calculations, this Fibonacci level corresponds to 1089 - a level which the market has been trading under for 4 days. Also, when it comes to the 500 day exponential moving average, while its slope is trending upwards, during the past cyclical bull market (2003-2007) prices never fell below it but always bounced higher after approaching it from above. So I’m not persuaded by this technical analysis as much as the ones we covered above.
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