McCurtain's Equity Index Weekly Summary

"Either learn from history or be surprised by new history"

The lead story in the Saturday, May 29, edition of The Wall Street Journal read “Dow’s Worst May Since ’40.”

And what a year 1940 was. It was a cusp year, the beginning of a new decade, and the confluence point for major socio-economic changes. May 1940 followed the fall of Poland just eight months earlier in September 1939. It coincided with the Fall of France and preceded the Battle of Britain that lasted until the fall of 1940. The Great Depression was in an endgame. Franklin Roosevelt, the New Deal president, would be elected to his third term of office in November 1940. A year later the United States would be attacked by Japan at Pearl Harbor and the Second World War would officially begin. In June 1942 the Battle of Midway spelled the beginning of the end of the Japanese power in the Pacific. A month earlier a four-year bull market began. In Europe 20 million souls would have to perish before the nightmare ended.

While this digression into history may seem unrelated to current events, we are nonetheless reminded of the George Santayana quote that can be paraphrased: “Those who do not learn from history are bound to repeat it.” While no doubt true, we wonder if a modification of that thought might be apropos now: “Those who do not learn from history are also surprised by new history.” In that vein read in the stock market tops in 2000 and 2007, the peak of the housing market in 2005, and the run up in the precious metals market over the past several years that has seen gold quadruple to more than $1200 an ounce. Point is, almost without exception conventional wisdom missed every one of those major turning points. No lessons had been learned and we now wonder if that wisdom is about to bat a thousand once again?

We can absolutely understand why major inflection points are missed because it’s human nature to look on the bright side, collectively, and despite the direst circumstances. “You've gotta have hope! Musn't sit around and mope,” or so go the song lyrics. But the truth is there are times when all the positive thinking in the world is not going to change the unfolding of a major event.

Click chart to enlarge

So what does all this have to do with current stock market events? Notice the accompanying chart of the Dow Jones Industrial Average that shows the performance of the bellwether from November 1931 through January 1943 including the May 1940 market collapse. On the bottom left is the nadir of the 1929-1932 bear market. Then comes the initial recovery phase that lasted until March 1937. What follows is a classic A-B-C retracement of the 1929-32 bear that culminates in the May 1942 market lows. In fact, the May 1940 mini-crash was simply the start of the “C” leg of the pattern. And taken in an historical context, the March 1937 through May 1942 bear market was merely a “test” of those 1932 lows. In an historical political context there was no reason for investors to be buying equities just when the war effort was looking the bleakest for the allied powers in early 1942. But that point was the beginning of a four year bull market than ended in mid-1946.

In the late 19th century Baron Rothschild once famously said that investors should “Buy when there’s blood in the streets.” That was certainly the case in May 1942. But there could be an antithetical corollary to that famous dictum: “Sell when Pollyanna promises that all equities are undervalued pearls from heaven.” Of course we’ve taken some poetic license with that latter quote, but the point is the same: when there’s a lot of handwriting on the wall in terms of broad socio-economic strokes and a stock market that “just doesn’t feel right” (read in 2000 and 2007 for equities), the strategy should be one of caveat emptor, or buyer beware. Net, investors should always, always, always err on the side of the market that inevitably leads.

Over the past three weeks and since the 1000 point mini-crash, we have heard any number of pundits putting forth opinions as to what “caused” the sell off. Now, apparently no one, not even the Masters of the Universe, may ever know. That’s why we suggested a few weeks ago that despite theories about a “big finger” trader that entered in a wrong sell order, or problems in Greece, or concerns about U.S. federal debt and so on and so on, ad nauseum, the facts are simple: the market sold sharply lower. The larger Intermediate Cycle is now negative and the Major Cycle trend has been seriously challenged. And aside from our inbred Piscean instincts, underscoring our prescient feeling that “something is just not right about this market,” one of our key indicators, the Most Actives Advance/Decline Line (MAAD), a measurement of the so-called “Smart Money,” has remained anemic for the better part of the past fourteen months, and noticeably so, for only the second time in its 30 year history. The other instance was into the 2000 market highs.

In sum, what we have been attempting to do in this week’s discussion is to point out that while many will attempt to lump socio-economic and stock market activity into one pot in terms of cause and effect, they are really two quite separate items and are only coincident occasionally, such as May 1940 in the midst of a five-year bear market. But they are coincident almost never at major turning points, such as in May 1942 when war prospects looked very bleak for the Allies. Because the market always “anticipates,” it will be turning lower when the “hope” mantra seems brightest and will be moving upward when gloom and pessimism are the thickest. We could be near one of those key turning points now when many have begun to suggest recent weakness has been merely a pullback in a major uptrend and that a recovery is still underway. Maybe...

Just as equities rallied for nearly five years off of the 1932 market lows until the 1937 highs and then declined for five years until those 1942 lows, prices have staged a sharp rebound following the 2009 lows and could be setting up for a “test” of the 2009 bottom just as was the case after the 1932 lows. While the time frame is somewhat truncated in the current environment relative to 1929-1942, notice that what could be a super cycle market top begun with the first major highs in 2000 has now been under way for over 10 years. In sum, while human nature would like for the current economic environment to give way to a “robust” recovery, the stock market, which has always preceded such economic action, continues to exhibit some major “doubts.” And May 6 and its aftermath have left a giant onus on the shoulders of the bullish camp—whatever the cause of recent selling.

McCurtain Most Actives Advance/Decline Line (MAAD)
After peaking back on April 14 on the minor cycle, MAAD has remained in a defined short-term downtrend. As the indicator has found “support” near the September 2009 plot highs, the MAAD Ratio on the minor cycle remains in deeply “oversold” territory. Also of note is the fact that while the broad market averages have declined below the early February 2010 lows, MAAD has not. That this bellwether of “Smart Money” activity has only pulled back about 50% from its highest levels for the move that began in March 2009 could be a positive sign. On the flip side of that optimistic coin, however, we must continue to note that MAAD on the larger Intermediate Cycle using weekly data has remained noticeably anemic during that same rally for the past 14 months to the extent that it has only retraced a small fraction of its decline since the mid-2007 bull market highs. In fact, it wouldn’t take much concerted selling to force MAAD to new major cycle lows. In that is the worry.

So we are left with a conundrum: MAAD looks good near-term, but unless it rallies to new highs, the overall bearish bias of the indicator will persist. And given historical precedent, we have never seen an instance where a continuing negative tone in MAAD didn’t ultimately work against market prices.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)
Like MAAD, CPFL is deeply oversold on the minor cycle. And similarly, like MAAD, CPFL has not demonstrated as much weakness on the downside over the past several weeks as have major market index prices. So we could conclude that if short-term “oversold” conditions take hold as reflected by the apparent and lingering “optimism” of options players, there could be a decent rally in the stock market.

But what is critical at this juncture is that CPFL rallies to new highs with, or before, general market prices. If “with” such action would be confirmatory. If “before” such action could be prescient. However, if the broad market begins to bounce and options players begin to use strength to liquidate, the indicator would fail on the upside EVEN THOUGH we could see the Daily Ratio move higher from deeply “oversold” conditions simply because extremely low numbers are being replaced by relatively neutral inputs. The indicator could then become neutral to modestly “overbought” without making new Advance/Decline highs. If such action occurred coincident with an upside market failure, then the currently bearish tone would be reasserted. If such action developed in the face of new market highs (above the late April highs) the same would apply. Net, the burden of proof remains on the bulls.

Click charts to enlarge

History does repeat itself—only differently. And those folks who tend to ignore the lessons of the past will probably not only repeat mistakes, but they will also be surprised—yet again. How could someone not see the housing crisis coming in 2005 when each time over the past 70 years that Housing Starts have exceeded one million there has been a major contraction in real estate? How could so many investors, professional and amateurs alike, be lulled into believing that because “things couldn’t be better,” that equities were still positive in early 2000 and again in late 2007? Why? Because they had no historical context to follow.

Which brings us up to date. Near-term we continue to see the potential for a stock market rebound after what may have been a “test” of the May 6 lows last week. To turn the minor cycle positive we would need to see the S&P 500 Index back above 1111 to 1099 on a sliding scale as the week progresses through June 4 with the Dow Jones 30 above 10392 to 10263. What makes this task even more difficult for the bulls currently is the fact that with the next larger Intermediate-term cycle now marginally negative, we would need to see prices rally back above defined 10-week price channels on the Intermediate Cycle at 1196—S&P 500 and 1103—Dow 30 to suggest a resumption of the Major Cycle uptrend. Is such action possible? Yes, but it may be increasingly difficult given the blow the market has suffered over the past several weeks.

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

Date NYSE Adv NYSE Dec Date OEX Call $Volume OEX Put $Volume
11-6-09 10 10 11-6-09 284004 210925
11-13-09 13 7 11-13-09 347029 147219
11-20-09 11 9 11-20-09 393221 229286
11-27-09 10 10 11-27-09 113184 195078
12-4-09 13 7 12-4-09 380418 272125
12-11-09 9 11 12-11-09 698727 204986
12-18-09 9 11 12-18-09 1879248 275057
12-25-09 14 6 12-25-09 81225 121215
1-1-10 4 16 1-1-10 58023 105653
1-8-10 17 3 1-8-10 196161 90275
1-15-10 5 15 1-15-10 171920 238731
1-22-10 3 17 1-22-10 166423 728001
1-29-10 8 12 1-29-10 230439 706372
2-5-10 7 13 2-5-10 393336 868741
2-12-10 10 10 2-12-10 252621 233578
2-19-10 15 5 2-19-10 308216 96223
2-26-10 7 13 2-26-10 259727 180469
3-5-10 16 4 3-5-10 447149 104117
3-12-10 17 3 3-12-10 1828237 111309
3-19-10 9 11 3-19-10 656439 147348
3-26-10 15 5 3-26-10 232614 113862
4-2-10 13 7 4-2-10 153692 138948
4-9-10 17 3 4-9-10 310430 99415
4-16-10 11 9 4-16-10 684317 282231
4-23-10 15 5 4-23-10 1049228 141637
4-30-10 2 18 4-30-10 139488 363448
5-7-10 3 17 5-7-10 929902 2329559
5-14-10 14 6 5-14-10 263151 730414
5-21-10 5 15 5-21-10 1172844 1654053
5-28-10 10 10 5-28-10 477797 584893

*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

Date NYSE Adv NYSE Dec Date OEX Call $Volume OEX Put $Volume
4-19-10 10 10 4-19-10 88196 42859
4-20-10 13 7 4-20-10 44729 35845
4-21-10 7 13 4-21-10 24734 48409
4-22-10 7 13 4-22-10 191965 48573
4-23-10 12 8 4-23-10 739177 32764
4-26-10 10 10 4-26-10 62430 39865
4-27-10 3 17 4-27-10 63683 270410
4-28-10 13 7 4-28-10 9375 81124
4-29-10 12 8 4-29-10 32945 31353
4-30-10 2 18 4-30-10 32835 174894
5-3-10 15 5 5-3-10 43077 47782
5-4-10 5 15 5-4-10 102186 192407
5-5-10 9 11 5-5-10 663717 159880
5-6-10 4 16 5-6-10 277786 908812
5-7-10 7 13 5-7-10 203860 595031
5-10-10 15 5 5-10-10 108827 106763
5-11-10 9 10 5-11-10 54680 96146
5-12-10 13 7 5-12-10 121805 48185
5-13-10 9 11 5-13-10 23267 65275
5-14-10 4 16 5-14-10 88891 217422
5-17-10 5 14 5-17-10 132528 141467
5-18-10 5 15 5-18-10 154363 204810
5-19-10 10 10 5-19-10 69021 158617
5-20-10 4 16 5-20-10 134710 485429
5-21-10 15 5 5-21-10 588040 238043
5-24-10 5 15 5-24-10 78521 116561
5-25-10 11 8 5-25-10 140868 317225
5-26-10 11 9 5-26-10 133348 196040
5-27-10 16 4 5-27-10 112601 59778
5-28-10 5 15 5-28-10 48142 61489

*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, read a Futures article on the concept. This will take you to the MAAD article. Robert can be reached at

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