McCurtain's Equity Index Weekly Summary

"So, just how schizophrenic was the market last week?"

Well, the stock market was so loopy last week that one Goldman Sachs trader, who was so confused about whether or not he should short the long the company just recommended to a retail client, took a limo up to Times Square to play a game of Three Card Monty to get some clarification. Unfortunately he lost and still didn’t know what to do. Turns out the Monty operator had already shorted the beans and the trader couldn’t have won anyway. Fraud is hell, folks…

In the meantime gold rallied to a new all-time high to underscore bearish psychology even though the major market indexes eked out marginal short-covering gains on the week. The S&P 500 index rallied 239.73 to 1060.18, the Dow Jones Industrials 239.73 to 10620.18, and the NASDAQ 81.21 to 2346.85. Unfortunately for the bulls, all those gains were made early in the week as prices faded sharply on Friday.

So the market is left with a dilemma: a resumption of the longer-term uptrend requires that prices rally and surpass the late April short and intermediate-term highs at1219.80—S& P 500, 11258.01—Dow 30, and 2535.28—NASDAQ or continued price weakness and selling below 1065.79—S&P, 9869.62—Dow 30, and 2185.75—NASDAQ would re-assert short- term negativity and could then reverse the intermediate-term trend that was seriously challenged on May 6. If the latter scenario developed, then the major cycle positive would be in jeopardy.

What could continue to be a problem for the bullish crowd is that not only did index prices slice downward through uptrend lines on May 6 that stretch back to the March 2009 lows, but they did so on big volume that had a very detrimental effect on Cumulative Volume. Not only has CV performed poorly over the past few months relative to prices, but selling on May 6 pushed CV sharply lower, even making new short-term lows below the February 2010 lows.

So we are left with a couple of scenarios:

1. Buyers must gather enough strength in the sessions just ahead to reverse the short-term trend back to positive and then push index prices back above the late April highs to re-assert the bull trend.
2. Buyers fail to push prices higher, more selling develops, and the May 6 lows are threatened and even surpassed on the downside. In the latter instance the intermediate cycle would then be in jeopardy. If that turns negative the S&P would only have until 978, the Dow to 9156, and the NASDAQ to 1932 before the major cycle would be seriously threatened.

Click chart to enlarge

There is also another more ominous scenario that could develop. As we mentioned in last week’s commentary, we have not been too impressed with the “quality” of the rally that has developed over the past year based on a number of our internal market measurements. Yes, it’s true that the rally has been powerful. But as we’ve noted from time to time, the willingness of “Smart Money” as reflected in by our Most Actives Advance/Decline Line (MAAD) to wholeheartedly participate in the market has been absent. In addition, given the current, relative proximity of MAAD to the March 2009 bottom, it wouldn’t take much selling to push MAAD to new lows. That would be a very bearish sign.

So we keep wondering if strength over the past year could turn out to be nothing but a powerful reflex rally within the context of an ongoing bear trend. In fact, is it possible the markets might be tracing out a massive super cycle bull market top? That would be the super cycle trend that began in 1932 and which may have ended with the October 2007 highs. Notice in the accompanying semi-logarithmic chart of the Dow Jones Industrial Average that stretches back to 1923 that the Dow could now be in the final stages of constructing a Right Shoulder in a potential Head and Shoulders pattern that encompasses the high in early 2000, a potential Left Shoulder. The possible Head follows in 2007. While more time may be required to finish the pattern with possibly a sharp down, an up, and then the final resolution down to take out the Neckline of the formation, the point at which this pattern is developing within the context of a shaky economic background makes us wonder—a lot.

In sum, the market will no doubt begin a short-term rebound over the next several days. The inception point from which that rally begins will be the issue, however. While we suspect that new lows below the May 6 “crash” lows will not develop just yet, the startling volatility that has been evident in the market remains a concern. Underscoring that fact, is another fact: it seems the SEC and other market poobahs have yet to discover the cause of the May 6 “crash” and “may never know the cause,” as admitted by SEC Chief Mary Shapiro. Is it possible that the market’s underpinnings are weak and the sell off several days ago was the beginning of longer-term negativity? Stay tuned.

McCurtain Most Actives Advance/Decline Line (MAAD)
While the broad market recovered from its May 6 losses last week, MAAD did not. In fact, by the end of the week the indicator had slipped back to just a notch above its May 6 plot low. While the indicator admittedly remains in deeply “oversold” territory on the minor cycle, the intermediate trend remains moderately overheated. And of course, we continue to point out that MAAD, relative to its March 2009 lows, remains positioned not far above those lows so that any concerted selling that might develop in the broad market could potentially create new lows in MAAD with relative ease, given the fact it has not rallied by much over the past year. Put another way, Smart Money has remained skeptical of market strength for the past 14 months.

Nonetheless, we suspect that MAAD may soon move higher with market prices from oversold conditions. The question remains, however, whether or not the indicator will hit new highs to reaffirm the bull trend. If market prices do hit new highs and MAAD does not, we could make a more bearish case for the markets.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)
CPFL demonstrated little recovery last week in the face of a rebound in the stock market. But the indicator nevertheless remains in deeply “oversold” territory while holding not far below its May 5 plot highs. That somewhat positive bias in the plot point suggests that if concerted buying comes into the market, the indicator could rally to a new high from oversold conditions with relative ease. On the other hand, if the market rallies and CPFL does not, an indication that options buyers were selling into strength, CPFL would then take on a more bearish tone relative to the indexes.

A second scenario developing in conjunction with weaker index prices would call for CPFL to weaken further on the intermediate cycle, despite short-term conditions since the CPFL Weekly Ratio is not yet oversold. Underscoring that negative possibility is the fact that CPFL on the intermediate trend is on the verge of terminating its uptrend line that stretches back to the March 2009 indicator lows.

Click charts to enlarge

Conclusion
The coin slowly flips as the bulls and the bears fight it out in the stock market for domination of the major cycle. In the background two of our key indicators, MAAD and CPFL, both offer the potential for strength of the minor cycle because of deeply “oversold” conditions. On the other hand, neither is oversold on the larger intermediate cycle. That conflict is an indication that could allow for further weakness on the intermediate cycle. Or, a short-term rally could develop from the minor cycle conditions within the context of the larger intermediate trend that could still be in an endgame.

Net, the May 6 “crash” lows will remain as the reference point for the ability of the intermediate-term cycle to remain intact. If those lows hold and the short-term cycle gets enough buying impetus to move higher, the major indexes MUST then make new highs to reaffirm the bull trend. If not, then we have to take another look at the potential for longer-term topping action.

MAAD data for past 30 Weeks* CPFL data for past 30 Weeks

*Note: All data is for week ending on Friday even though ending date may be a holiday.
Unchanged issues in MAAD calculations are not counted.

MAAD data for past 30 days* CPFL data for past 30 Days

*Note: Unchanged issues are not counted.

Robert McCurtain is a technical analyst, market timer and private investor based in New York City. If you would like to read more about how the CPFL is constructed, click here to read a Futures article on the concept. For the MAAD, click here. Robert can be reached at traderbob@nyc.rr.com.