For stock market, fall can bring bear trends

Our favorite time of the year is rapidly approaching – fall. In short order we’ll be able to take those long strolls with crunching leaves under foot as the steam from our breath tells us summer is finally over. Fireplace fires will be lit and get-togethers with friends will be planned. Those hazy, humid days of August with shorts and t-shirts morph into a chill with sweaters and mittens. Ah, fall….

But the Autumnal Equinox can also be accompanied by less auspicious events. In fact, some of the worst bear trends in stock market history have developed toward the end of the third quarter of the year. The granddaddy of them all occurred in 1929 when the Dow Jones Industrial Average peaked on September 23 and then proceeded to lose nearly 50% of its value over the next few months as the Great Depression began. Ultimately the Dow gave up nearly 90% of its value in that major cycle decline that lasted until July 1932. In 1987 the market peaked on August 26. During the crash that lasted until late October, the Dow 30 lost nearly 41% of its value even though bulls were ultimately given a reprieve since the decline proved to be nothing but an intermediate-term blip in a major advance. The Dow rose more than 700% over the next 13 years into the 2000 highs. Most recently, the market peak in October 2007 was followed by a 54% loss in the Dow which hit a significant low in March 2009.

So are we offering some not so subtle bearish hints heading into the fall of 2010? Perhaps a few, but with caveats.

Aside from the fact that the September 22 will mark high bloom for the Autumnal Equinox, that period of the year when nine of the most violent storms in U.S. history occurred, “storms” which have occasionally proven to be a metaphor for equity prices, it is nonetheless true that the stock market has demonstrated little conviction for the better part of the past year. In fact, a buy and hold investor is really no better off now than back in early November 2009. Even nimble short-term traders have been challenged to take profits out of the market. Except for the nicely trending rally from early February through late April, moving in and out of the market has been treacherous. So, is the market encountering a lull before the, well…, storm?

And on the internal front, for months we have been noting that our Most Actives Advance/Decline Line (MAAD) has been in synch with the market on the upside, but that the recovery of the indicator relative to the March 2009 price lows has been anemic. MAAD has only retraced about 20% of is decline while the market is recovered more than 60%. While the upward bias of the indicator is positive, it is the lack of overall Smart Money participation that has acted as a damper on the performance of MAAD. That added to the fact that it wouldn’t take much selling to push the indicator downward and below those March 2009 lows. Put another way, if MAAD makes new lows, such action would not bode well for the broad market.

There is another problem hampering our market optimism – Cumulative Volume. CV, which is a measurement of net upside and downside activity relative to price, has been weak for nearly a year and has been deteriorating, net, since the beginning of the formation back in January of what could prove to be a Head and Shoulders distribution top. CV also took a big hit after the April 2010 price highs in that it moved dramatically below the February lows as the May mini-crash developed. CV has also shown little enthusiasm since the July lows and was last plotted at levels in the S&P 500 and Dow 30 at points not seen since May 2009. Clearly CV and MAAD, which are created from two entirely different streams of data, remain unenthusiastic about market prospects.

Last week the market sold sharply lower on Wednesday (nearly 265 points). That selling and deteriorating momentum probably terminated the short-term uptrend initiated in early July. At the same time, the potential Right Shoulder of a possible Head and Shoulders top may be nearing completion. If this market is going to resolve itself on the downside within the context of an Intermediate Cycle which remains negative, we would need to see concerted selling below those early July lows at 1010.91—S&P 500 and 9614.32—Dow 30. On the flip side, nothing but buying above the late April price highs at 1219.80—S&P 500 Index and 11258.01—Dow 30 would reassert the uptrend begun in March 2009.

McCurtain Most Actives Advance/Decline Line (MAAD)

Our Most Actives Advance/Decline line peaked on July 27 and nearly two weeks before index pricing. Currently the indicator remains in a short-term downtrend with the Daily MAAD Ratio slipping back into short-term “oversold” territory. As we’ve mentioned before, however, “oversold” is not always what it seems to be.

Simply put, what the indicator is telling us at this juncture is that Smart Money preceded the market on the sell side and remains negative on the minor cycle with little demonstrable cheer leading on the longer term. Given our preliminary comments in this week’s Market Summary about the anemic performance of MAAD since the March 2009 lows, we continue to suspect that it would behoove investors with a net long bias to take a very hard look at downside stop points since the underpinnings of this market continue to look iffy.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL was net negative last week, but not by much. The indicator continues to remain locked between its February lows and April highs. A dramatic market move in one direction or another would probably cause CPFL to either make a new high above that April peak, or to break below support at that February low. A failure to confirm market action would leave index prices in a quandary.

What the indicator is currently suggesting from the cumulative action of options buyers is that call/put buyers are in a wait and see mode. It is a sure thing, however, that whatever market movement develops in the weeks just ahead, sustenance of that move will require CPFL confirmation. As we’ve noted before, we have never seen an instance where market movement was not confirmed by CPFL.

Click charts to enlarge

Conclusion

The short-term uptrend that began back at the early July lows was probably ended last week. Sharp downward movement in prices last Wednesday with virtually no upside follow through Thursday or Friday suggests more selling could follow. When coupled with the weak internal dynamics of this market, we continue to wonder as we move into a historically volatile time of the year if the market could be setting itself up for a decline of some importance. If our suggestion that a Head and Shoulders distribution top that has been developing since last January unfolds, resolution of the pattern would come in only one way -- a significant decline with movement below the July lows.

If our prognosis is overly pessimistic, we can only continue to suggest that nothing but new highs and movement above the April 2010 intermediate-term highs will resolve the longer-term issue in favor of the bulls. Considering current market internals, the bullish camp has a very large point to prove. In other words, if the bulls do not prove their case and relatively soon, it could be about time to pull those long chestnuts out of the fall fires.

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.