History has proven many times that the stock market is one of the best leading indicators. At a key inflection point when economists are still touting positive numbers as justification for holding stocks, the stock market has rolled over and accelerated to the downside. Several months later the economy begins to weaken as the economic numbers begin to turn bad.
That disconnect between the market and the economy, except for the midway points when they may both be in synch on the upside in a bull phase or holding together on the downside, is a reason why we have always been puzzled when some analysts are looking for “news” to justify current market action. If the market is a forward-looking, discounting mechanism then why would it respond to current events that have apparently already been discounted?
For example, a company holds its annual meeting and the chairman of the board tells the audience, “We’re very optimistic because things couldn’t be better.” A man in the first row stands up, turns, and begins to walk out of the meeting hall. The speaker says, “Hey, where are you going? I just said things couldn’t be better.” The man turns and replies, “Yes, I heard you. That’s the problem. If things couldn’t be better, then why would I want to own your stock?” Point of the story? The investor was selling before the bad news. In fact, he was selling on what is often regarded as good news by the fundamental camp.
While we are not suggesting at this point that equities are headed straight down and that several months down the road negative economic news will justify such a decline, there is still every reason for caution. For the better part of the past several weeks and since the April 26 index price highs, share prices have moved net lower. The S&P 500 Index was last down 12.7% for a net loss of 154.92 points with the Dow Jones Industrial Average off by 11.7%, or 1326.04 points. And while prices are “oversold” on the short-term cycle, they are also markedly below defined 200-day moving averages that can now act as upside resistance.
Adding to the negative mix, our Most Actives Advance/Decline Line (MAAD) continues to exhibit chronic anemia to the extent the indicator has consistently failed to show much improvement over the past 14 months. While it’s true MAAD has confirmed each new short-term high since the March 2009 lows, the indicator has retraced barely one fifth of its losses since the October 2007 highs. That upside failure continues to suggest that while “Smart Money” has participated on the upside during the rally, it has not done so with much enthusiasm. In fact, there appears to have been a subtle undercurrent of selling throughout the rally.
Underscoring our concerns over MAAD, we recently saw an interview given by Richard Russell, the legendary editor of Dow Theory Forecasts. Aside from Russell’s opinion that the U.S. stock market is headed for a crash that will render the United States “unrecognizable by the end of 2010,” he said the following:
“At the end of the 14-month advance (April 2010), I saw something else that I thought was incredible. Lowry's Selling Pressure Index was almost 500 points ABOVE their Buying Power Index, indicating that heavy but disguised selling was taking place during much of the advance.”
After we read that quote our immediate response was to recall the current status of MAAD which also appears to be reflecting interior market demons. Is it possible that the entire move since March 2009 has been nothing but a powerful bear market rally? It seems that MAAD is not the only independent indicator suggesting such a possibility.
So we are currently left with the market that is deeply “oversold” on the minor cycle. Both MAAD and our Call/Put Dollar Value Flow Line (CPFL) are very overextended on the downside near-term. And the larger truth is that the Intermediate-term cycle has also flipped back into negative territory. Only the long-term Major Cycle trend remains positive.
As a consequence, the market is now at a very interesting juncture. If a short-term rally to reverse the downtrend initiated after the April 26 highs develops, nothing but new highs above the late April peak will re-assert the Major Cycle uptrend. At the same time, the Intermediate Cycle would also have to change to positive if the Major Cycle is to remain viable. What’s possible is that prices could rebound on the minor cycle, but not make new highs. Another “test” of the recent lows might have to follow. Then, of course, there would be the danger that new lows could develop and that the long-term trend could be jeopardized. In any case, the bulls have a big point to prove from here on that requires the S&P to recoup nearly 155 points with the Dow finally higher by nearly 1327 points. Or the Major Cycle could be in big trouble.
McCurtain Most Actives Advance/Decline Line (MAAD)
MAAD remains deeply “oversold” on the minor cycle while holding near neutral on the Intermediate Cycle. The indicator topped out April 14 on the shorter trend and has been moving net lower on an advance/decline basis since then and was last holding marginally above an uptrend line that stretches back to the July 2009 plot lows.
And while it is a virtual certainty that MAAD must rally to new highs and above that mid-April peak to reassert the major cycle uptrend, it’s also true the indicator has not performed as poorly as index prices over the past several weeks. While both the S&P 500 Index and the Dow Jones Industrial Average have sold back below supports at the February 2010 lows, MAAD (like CPFL) has held well above similar levels. In fact, MAAD has only retraced about 50% of the uptrend since February.
That positive divergence could mean that the “internals” of the market are stronger than index prices have been suggesting. But there is a larger problem we have alluded to often over the past several months: while MAAD has been participating on the upside and may even be suggesting the market is in a zone of opportunity currently, the indicator has performed very poorly over the past 14 months to suggest that Smart Money has been less than enamored with this market since the March 2009 lows. As a consequence, while some near-term strength could develop, any upside failure once the short-term cycle turns positive would not bode well for the bullish camp.
Click charts to enlarge
McCurtain Call/Put Dollar Value Flow Line (CPFL)
Like MAAD, CPFL remains not only extremely “oversold” on the near-term cycle, but the indicator has not given as much ground on the downside as index prices. Again like MAAD, CPFL has only retraced about 50% of its advance since the February lows where index prices have relinquished all of the gains plus some more.
While that positive divergence could be a sign the market will soon stage a rally of some importance, it remains to be seen if such strength will cause index prices and our indicators to also reach new highs. This side of new highs there are a number of scenarios that could develop, but those would unfold with their variables as time progresses. The bottom line is that to reassert the bull market initiated after the March 2009 lows, CPFL must rally to new highs with index prices. If the indicator is unable to achieve that goal, the prognosis for the major uptrend would not be good.
Click charts to enlarge
While last Friday’s 323.33 point loss in the Dow 30 and the decline of 37.95 points in the S&P 500 index brought both within range of the May 25 index lows at 9774.48—Dow 30 and 1040.78—S&P, it’s possible new lows may not follow and that short-term “oversold” conditions could allow for a positive effect on market prices. But there is a caveat. The Dow must rally above its June 3 intraday high at 10315.21 and the S&P above 1105.67 at levels that also approximate defined 10-day price channels to turn the short-term trend to positive, or any strength would be suspect.
Also, even though near-term strength could develop, the possibility remains that it could prove to be merely a countertrend bounce in what is now an Intermediate-term negative trend. Failure to make new highs would prove the point. That prognosis would not bode well for the larger Major Cycle trend since a mere upward bounce would suggest that the market remains weak internally, that our key indicators would also probably fail on the upside, and that the next short-term reversal that would be on the downside.
To put it mildly, while both MAAD and CPFL are currently offering some signs of short-term hope for the market in that neither has declined as much as index prices and both are deeply “oversold,” the stock market has been seriously injured since the April highs and nothing but new highs for the move will make it whole again.
MAAD data for past 30 Weeks* CPFL data for past 30 Weeks
|Date||NYSE Adv||NYSE Dec||Date||OEX Call $Volume||OEX Put $Volume|
*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|
*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 firstname.lastname@example.org.