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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.
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