McCurtain's equity index weekly summary

In the 1987 film classic, “Wall Street,” just before the protagonist, Bud Fox (Charlie Sheen), is arrested by the fed’s for securities fraud he’s stopped outside of his office for a moment by Lou Mannheim (Hal Holbrook), a veteran stock broker. Lou tells Bud:

“Bud…just remember something. Man looks in the abyss. There’s nothin’ starring back at him. At that moment man finds his character and that is what keeps him out of the abyss.”

Of note is the fact that the movie was released on December 11, 1987 less than two months after the October 1987 Crash. Obviously the film had been in production for months and the producers had no way of knowing that their film would not only mirror the frantic 80s, but that Mannheim’s character would inadvertently reflect a moment in the fall of that year when all investors were able to look into the abyss. Fortunately, the great bull market keep most from ruin, by default, when it resumed its upward trek in early 1988.

But it’s 23 years later and we do not have the luxury of retrospect just yet. Not only is the stock market still attempting to resolve its longer term trend in the wake of a devastating decline in 2008, but the current environment has left many wondering if the sharp rally that began in the spring of 2009 has begun to look a bit frayed. The decline since the April highs has underscored that worry.

Last week we posted a short-term chart (see below) with an update this week. It shows a potential Head and Shoulders distribution top that could be tracing out the end of the 15-month-old uptrend. Given the fact that the Intermediate-term Cycle currently remains negative following that month-long decline that began in late April and despite a brief rebound, last week’s 40.75 point (-3.65%) loss in the S&P 500 to 1076.76 with a coincident drop in the Dow Jones Industrial Average to 10143.81 for a loss of 306.41 (-2.94%) moved both bellwethers within range of defined H&S Necklines that if breached on increasing volume would not bode well for bulls.

Click chart to enlarge. Courtesy Tradestation Securities

There are other troubling signs. Our proprietary weekly NYSE Up/Down Volume indicator (see chart below) peaked the week ending September 9, 2009 and has been dropping, net, ever since. In fact, it is just marginally above the March 2009 lows. Since Up/Down Volume tends to precede market action to the extent that volume is necessary to sustain price moves, the fact that market strength after September and into the recent April highs was accompanied by deteriorating Up/Down Volume suggests that some players have been selling into strength.

Click chart to enlarge. Courtesy Tradestation Securities

In addition, as we’ve noted frequently over the past several months, our Most Actives Advance/Decline Line has also underscored the negative, internal market tone. While MAAD has participated on the upside since the March 2009 lows, it has been anemic and has only retraced about one fifth of the losses it generated in the 2008 bear market. That divergence is a sign that the so-called Smart Money crowd has remained skeptical of the rally for many months.

There are other problems. Not only is a potential Head and Shoulders top developing on the Minor Cycle, but the very long-term Super Cycle stretching back to the 1932 lows suggests the Dow Jones Industrial Average could be working out the Right Shoulder of an H&S top that is now into its 10th year (see chart below).

Click chart to enlarge. Courtesy Tradestation Securities

While more time could be required for the formation to be completed with chart “symmetry,” the downside implications are nonetheless troubling: A break of the March 2009 lows of the S&P 500 at 666.79 and the neckline of the S&P and a break below 6469.95 in the Dow 30 and its neckline on increasing volume would suggest an end to the nearly 80-year-old bull market that began after the 1929 to1932 bear market.

In another market sector, interest rates, we continue to note yet another potential Head and Shoulders distribution top (see chart below and July issue of Futures -- “Tech Talk: Are Bonds Ready to Collapse?”). That pattern which is now well into its third year is also working out what could be the Right Shoulder of an H&S top.

Click chart to enlarge. Courtesy Tradestation Securities

While many pundits continue to believe that cheap money will persist, we wonder why, if the economy is improving, rates have not moved up? Where is the demand for capital to make those rates rise? Of course, there could be another reason rates will rise: credit defaults by municipalities, states, or sovereign governments could cause investors to demand higher interest on their investments just for taking on additional risk. That would definitely not bode well for the larger world economy.

And for those convinced the precious metals are an anachronism, the fact that Gold continues to hold near all-time highs should be somewhat disconcerting since movement to the precious metals is often, historically, a sign of a lack of faith in fiat currencies and, by proxy, government debt. This cycle could prove to be no exception to that rule.

So we have a market, or markets, if you include interest rates and the precious metals that offer potential. Unfortunately that potential would have a negative onus for normally bullish long-term equity investors. Underscoring those prospects we continue to observe internal weakness such as ongoing deterioration of longer-term Up/Down Volume, the lack of enthusiasm in MAAD and CPFL, and the relative surprise of market participants when a session like May 6 hits the ticker and the Dow loses nearly 1000 points in 10 minutes. Perhaps if the underpinnings of this market were viewed a bit closer, participants might not be so surprised.

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD sold down to a new short-term low last week and its worst level since reaching a peak for the move on April 14. That weakness has moved MAAD within striking range of an uptrend stretching back to the March 2009 lows. Both Daily and Weekly MAAD Ratios are “oversold,” but market history is replete with examples where “oversold” conditions have persisted even as prices have deteriorated further.

The only mitigating factor that could work in favor of MAAD and the market at this juncture is that index pricing is also approaching support points in terms of potential Head and Shoulder necklines in the major indexes. Of course, a bounce in the face of what might turn out to be a valid H&S pattern would be little comfort since the next move of significance would be on the downside. MAAD, given its proximity to its rising uptrends on both the daily and weekly cycles, would likely confirm such negative market movement.

At this point nothing but strength in MAAD to new highs with or without coincident market movement would suggest a reversal of current negative sentiment to a more positive market tone.

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL remains deeply “oversold” on both the Minor and Intermediate-term Cycles. And like MAAD, CPFL has been working lower toward a defined uptrend line. While the CPFL trendline only stretches back to last November due to a reconfiguration at that point, its definition is nonetheless solid enough that a downside break would carry with it negative market implications.

On the bright side, however, the fact that CPFL has remained more positive than index pricing to the extent it has not declined below its February/March 2010 support lows is an indication that options players have remained somewhat more optimistic that index pricing.

We suspect, however, that from this point on CPFL will either rally to a new high to underscore a resumption of the uptrend in index pricing, or it will fail to make new highs if prices move upward again. If CPFL and prices hit new highs coincidentally, or almost so, then our worries will be in vain. But given recent performance, we continue to wave the yellow flag of caution.

Conclusion

We could drive our readers to distraction at this point by attempting to outline any number of possible market scenarios. One might call for a short-term rally from currently oversold conditions that morph into an Intermediate-term rally that would eclipse recent negativity and result in new highs for the move since March 2009. Another might call for a rally and then an upside failure. Yet another would suggest more weakness now, new short-term lows, the breaking of the potential Head and Shoulders distribution top necklines in the intermediate time frame and a significant retracement of the advance made over the past 15 months.

But since history suggests that it’s best to wait for prices and indicators to dictate action, predictions aside, we must wait while admitting of a number of possible scenarios. With tips of a number of market “icebergs” now exhibiting potential negativity, however, we wonder if they are prescient enough to be looking toward a new market abyss.

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