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Obviously we are extremely oversold in the short term. How else would you describe a day when 98% of the volume flowed to declining issues on the NYSE? On the Nasdaq, market breadth was slightly better with 94% of share volume declining. The support that has held at 1040 on the S&P 500 is getting seriously challenged as the bears jump on it for the fourth time (February 5th, May 20th, June 8th and June 29th). The difference, of course, is that while the level was previously tested intra-day, it closed there today.
Below are a handful of technical signs that the market is deteriorating not just in the short term but in the long term as well:
S&P 500 Cumulative Advance Decline Line Falls Off The Ledge
The cumulative advance decline line for the S&P 500 was on the ledge last week. Today it jumped off.
The leap off the ledge by the cumulative AD line means that the red we saw across our screens today has wide participation. It isn’t just a few large cap stocks dragging down the index but a plebian sell-off. Technically speaking, the cumulative AD line is still above its February lows so the positive divergence is still in effect. But further deterioration will see that next level taken out as well.
Percent Above Moving Averages
The oversold condition is clear in the short term, however, there are continuing signs of a change in market tone that should concern the bulls. For example, the percentage of S&P 500 stocks trading above their 50 day moving average has been loitering within historic lows for some time now.
Since May it has been below 50% (with the small exception of a few days). At today’s close, only 8% of S&P 500 index components are above their intermediate average. And as I’ve written before, the longer this indicator remains so low, the more it is telling us of a market that is too tired to rally.
The long term prospects are weakening since the percentage of S&P 500 components above their 150 day moving average are at 25%, the lowest they’ve been since late March 2009 - just as the equity market embarked on a powerful cyclical bull rally. By mid-May, the subtle shift in the balance of power was noticeable. I’ve used this chart several times previously to point out a “box of bullishness” - a persistent state of high momentum that propels the market higher.
The reverse is also true - a persistently weak breadth means that the bears have the upper hand and control the market (see red boxes in above chart). We aren’t there yet, but the important point here is that we’ve seen a shift in the underlying market current market.
The CBOE’s Volatility Index is elevated at 34 but the last time the S&P 500 index was retesting these levels, the “fear index” was significantly higher. This can be interpreted two ways. The argument that you feel more comfortable says more about your inherent bias than provide any definitive edge.
The last time we looked at (an even more pronounced) volatility divergence was in February 2009 just as the market was about to find its footing. Thanks to 20/20 hindsight we now know that the relatively low volatility didn’t keep the bulls from taking control over from the bears.
Head & Shoulders
I’m sure you can see the completed head and shoulder on the S&P 500 - it is so clear that I didn’t bother drawing it on my chart above and distracting you from the pure price action. A measured move from the neckline gives us a target of 900 for the S&P 500 index. If we do get there, with the deteriorating breadth and technicals that I outlined above it is difficult for me to imagine the index not falling lower.
More than a few readers have written to me or commented on the blog that I’m a bit too optimistic, being too ready to “buy the dips”. It may certainly be true that I have a bullish bias - after all, I am all too human. I do make a conscious effort to be as agnostic as I can be. And looking back quickly through my previous comments, for example, there is this from late March when I wrote, When the Market Goes Streaking:
Based on this and other indicators (like the options trading activity and the amount of froth from speculative trading), I do think we are at or very close to a top here. The market may move ahead a bit more but like other times, it will quickly give that all back and more. As well, a simple resistance/support analysis of the S&P 500 finds the market very close to major resistance in the area of 1200. A similar resistance level is coming up for the Wilshire 5000 index in the 12,500 range.
If I seem too ready to pounce on a decline, as I did back in February, it is because I try to follow the same methods and indicators that have proven themselves. Of course, indicators react differently under different market conditions but I find that it is not useful to jump at every shadow, fearing that every single wiggle is a shift in the major context of the market.
The result is that, ultimately, I’ll be wrong, but along the way, I’ll be right several times over. As long as one has discipline in money management and risk control this method isn’t all that bad.
How do you approach the market? I’d love to hear back from readers about their over-arching philosophy or approach. Or be as specific as you like.
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