McCurtain's Equity Index Weekly Summary

“The smart trader looks at the ‘event,’ not the cause.”

In a little over three weeks from the April 26 intraday index price highs reached on April 26 through last Friday’s closing levels, the S&P 500 Index lost 132.25 points, or 10.8%, while the Dow Jones Industrial Average sank 1064.62 points, or 9.4%.

And in the wake of those historic declines which saw the S&P sink to a new short-term low (1055.90) on Friday (the Dow by less than 50 points), market pundits and many analysts have continued to focus on the “why?” part of the decline. But from an investor’s point of view, at this stage of the game the causes of the decline are far less important than the “event” itself. In other words, will the investor who is still long the market feel any better knowing that a big-fingered trader or European debt were the catalysts that caused prices to sink? From our perspective such information is all but worthless in retrospect. Knowing that the horses have run outside of the barn may make for interesting conversation, but what’s being done about the damage is the issue.

That is why we warned BEFORE the mini-crash that the short-term cycle looked overheated and vulnerable. That’s why we stipulated points at which a near-term reversal would be initiated. And these warnings have continued to occur within the context of an uptrend that we have repeatedly pointed out over the past several months has been suspicious. Not only have volume configurations as measured by some of our Cumulative Volume statistics looked weak over the past few months, just as they looked weak into the top in 2007, but one of our key indicators, the Most Actives Advance/Decline Line (MAAD) has consistently failed to provide anything but anemic underpinnings for the rally that has lasted for over a year—at least up until April 26. To use a metaphor, the Ferrari has had a full tank of gasoline, but the fuel was of inferior octane quality.

So what now?

As we mentioned in our May 7 weekly Market Summary, “…those indexes and the other major bellwethers must now recover all of those losses and a bit more to reassert the uptrend that began in March 2009.” Obviously, such action has yet to develop. Even though the major indexes bounced a bit late last week and even though the short-term cycle is decidedly “oversold,” some of those same indicators were already “oversold” prior to the sell off. And although downside statistical extremes on the minor cycle have somewhat more upside potential now than they did a couple of weeks ago, what is now the issue is potential price weakness on the intermediate cycle that demonstrated selling below defined price channels and downside “failsafe” levels during that price cataclysm on May 6. In addition, intermediate-term oscillators like Momentum, Slow Stochastics, and our proprietary Timing Oscillator are now threatening negative reversals on that larger cycle. Next, the major cycle at 978—S&P 500 and 9156—Dow 30 would become an issue. Adding to that ominous tone, this is the first time since a brief “tease” on the downside during the June/July 2009 pullback that index prices have declined below trailing 200-day moving averages and key reference points.

Near-term, we would need to see the S&P 500 index rally back above 1162 (to 1132 as the week progresses) with the Dow 30 above 10815 (to 10583) with confirmation from short-term Momentum, Slow Stochastics, and our Minor Cycle Trading Oscillator. Lacking such action, not only would the minor cycle remain negative, but there would a possibility that more selling would further weaken the intermediate trend while contributing to a full blown intermediate-term negative that would stand the chance of reversing the major cycle positive to negative. In the background, negativity would continue to weaken an already tentative weekly MAAD that could make new lows with relative ease.

So, as we suggested when this decline came into full bloom just over two weeks ago, the burden of proof now rests squarely on the shoulders of the bullish camp. There will be no rationalizing this sell off as simply a new “buying opportunity” if weakness continues. At the same time, if a short-term rally does develop and new highs do not follow, in a similar vein the bulls would be left in an awkward position because, in fact, nothing but new highs can underscore the bull trend. In sum, as we noted at the outset of this commentary, knowing the causes of the event are completely irrelevant except for historians. Taking action is. And at this juncture while we suspect that last week’s selling could prove to be merely a “test” of the May 6 lows, the bulls must now prove the point by not only reversing the minor cycle trend, they must run prices up to new long-term highs.

McCurtain Most Actives Advance/Decline Line (MAAD)
MAAD peaked on the minor cycle back on April 14 and 12 days before the broad market put in place a marginally higher short-term high. Following the May 6 lows and despite a sharp short-covering rally that lasted the better part of a week, MAAD continued to look anemic. When the market began to drift lower following that interim rebound, MAAD sank to yet another short-term low on May 17 and three days before the S&P 500 Index followed suit.

Currently MAAD remains above a defined short-to-intermediate uptrend that stretches back to the March 2009 indicator lows. It is also decidedly “oversold” on the short-term cycle, but was last holding near neutral on the intermediate cycle after having declined steadily on that larger trend over the past two weeks.

In short, MAAD looks somewhat better than prices, but doesn’t have much downside margin left before key trendlines and supports would be terminated to suggest that recent weakness is more than just a minor cycle pullback in a larger uptrend. Bottom line? If the market rallies, MAAD needs to improve with it. If the market also creates new highs, MAAD needs to confirm those new highs.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)
Despite dramatic price weakness following the April 26 index price highs, CPFL has continued to hold relatively close to its short-term peak reached on May 5. Admittedly, that new minor cycle high made by a few fractions was not confirmed on the intermediate, or weekly, cycle, by subsequent events. Aside from the indicator peak, however, CPFL is, like its MAAD counterpart, deeply “oversold” on the minor cycle but holding near neutral via the Weekly Ratio. The indicator has also held well above the early February indicator lows, even though index prices have not.

So, while the market as measured by the bellwether indexes has taken a good hammering over the past few weeks, CPFL continues to suggest that options players remain somewhat optimistic. But as with MAAD, CPFL must rally with the market when the inevitable short-term rally develops and it must hold above key uptrends that stretch back to those March 2009 lows. Which is a bit of a problem on the weekly cycle because via last week’s action CPFL slightly fractured its defined uptrend line on the downside. But we’ve decided to give the indicator a small pass on that one since the more sensitive daily trend remains intact.

Nonetheless, as with most market indicators, CPFL is in a developing “do or die” situation: a failure to rally on market strength, or more indicator weakness on market selling would substantially damage an already tentative market and indicator environment.

Click charts to enlarge

Conclusion
After another week of trading following the May 6 sell off, we are left in much the same position as we found ourselves at the end of the previous week’s price action even though prices were modestly higher then: our key indicators remain “oversold” and the market has suffered substantial damage. At the same time, the remedy remains the same: prices must not give much more ground on the downside AND the key indexes must soon rally to reassert the bull move that began in March 2009. The failure to do so would not only advance the bearish cause but could set prices up for a “test” of those March 2009 lows even though such action might seem out of the question at this point. In sum, either this market begins to rally relatively soon or there could be a world of hurt developing in the not too distant future for those investors foolish enough to remain long in such an environment.

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

*Note: Unchanged issues are not counted.

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.

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, read a Futures article on the concept. This will take you to the MAAD article. Robert can be reached at traderbob@nyc.rr.com.