Equity market is still in peril; don't become complacent

Sometimes, like in war, the market is a 'Bridge too Far'

Sixty-eight years ago this fall one of the greatest battles in the history of warfare, and of World War II, was being waged on the shores of the Volga in the former Soviet Union at a town called Stalingrad. The victorious Sixth army of the German Wermacht, the same troops that had marched triumphantly into Paris just two years before in June 1940, was pitted against a seemingly desperate and demoralized Russian military.

After Germany attacked Russia on July 17, 1942, the Sixth army under the command of General Friedrich Paulus fought its way nearly 1000 miles to the door of Stalingrad. The Wermacht troops believed victory was theirs for the taking, that the defeat of the Russian army was a forgone conclusion and only a little more "mopping up" would achieve that goal. They thought they would be home for Christmas.

But history proved otherwise….

After eight brutal months more than two million souls on both sides of the conflict had perished in a campaign that marked the turning point in the war for the western allies and led to the final defeat of Nazi Germany.

When major historical events are unfolding, erroneous presumptions as to the final outcome of the event can prove to be disastrous. That was the case for the Germans at Stalingrad. So it can be with the stock market that has been locked in a stalemate for the better part of the past year. The battle lines between the bulls and the bears have been drawn. The thrust and parry waltz has been progressing with little net improvement since last November. Since the April highs the S&P 500 Index and the Dow Jones Industrial average have staged three short-term declines and two short-term advances with a third rally now underway. And still the Intermediate-term Cycle remains negative and undecided.

In last week’s Market Summary we suggested that, statistically, the market is in as good a position as at any time since the intermediate decline began back in April. It is certainly not "overbought" on the intermediate trend. MAAD and CPFL could still allow for price improvement. In addition, with prices now back at downtrend lines that stretch back to the April highs with connecting points at the early August peaks (1219-80 and 1129.24—S&P; 1039.70 and 1010.91—Dow 30), concerted strength could push prices upward through those trend lines while more buying would almost certainly cause our intermediate-term oscillators to move back into positive territory to confirm the larger cycle rally.

We nonetheless remain troubled by this market. Since the market bottom of March 2009, many on Wall Street, in the financial media, and investors in general have continued to suggest, assume, that price action over the past several months will prove to be nothing but a corrective phase in an otherwise longer-term bull trend. "There’s really no need to worry," they say, "higher earnings and rising corporate profits will cause stock market prices to rise."

Maybe…. if you believe earnings and corporate profits lead the market.

As we have noted before, "oversold" conditions have on occasion stayed "oversold" while prices declined further despite investor suppositions that the market was in a zone of opportunity. A case in point was when the Dow Jones Industrial average sold lower by nearly 6000 points from May 2008 until early March 2009. Readings early in the decline dipped into "oversold" territory and stayed there for nearly 10 months.

In no order of importance we suggest the following three scenarios as stock market prices continue to thrash about:

  1. The major indexes continue higher, break above defined downtrend lines that stretch back to the late April highs, and then move above the early August peaks. The Intermediate-term Cycle turns positive as the rally continues and the April highs are breached to re-assert the longer-term uptrend begun back in March 2009. The long-term bull is re-affirmed.
  2. The short-term trend betters those August highs, but then stalls out before prices can reach the April 2010 highs. Potential upside targets on a failed rally could put the S&P toward 1160 with the Dow 30 near 11050. Realization of those targets would suggest that price action since the July lows could prove to be an a-b-c rally with the failed rally highs completing the "c" leg of the move.
  3. Market prices begin fading at any time, given "overbought" conditions in some key indicators on the minor cycle. The August and then the July lows are quickly terminated on renewed selling. The final "C" leg of a larger A-B-C decline measured from the late April highs is initiated and the S&P heads toward 875 and the Dow toward 8740 to complete the selling on the larger Intermediate Cycle.

In sum, the battle lines are drawn and it remains to be seen which side of the chess board ultimately exerts enough pressure to prevail, whether the bullish case proves to be a "Bridge Too Far," or if the setup for a rally bears fruit, attracts new buyers, and drives prices back above the April 2010 highs. Whatever the outcome, history may prove yet again that premature presumptions can be, well…, premature.

McCurtain Most Actives Advance/Decline Line (MAAD)
MAAD eked out an upside break of its downtrend line stretching back to the April highs via Daily data last week with the same action not yet evident using Weekly inputs. At the same time, the Daily Ratio in MAAD is as "overbought" as at any time over the past three years. The Weekly Ratio is modestly "overbought."

As with the broad market, MAAD remains stuck between the proverbial "rock and a hard place." While the indicator did not sink to new lows with the major indexes to break key supports into the May decline with subsequent lows in early July, nothing but new highs above the indicator’s statistical peak in April will re-assert the major uptrend in the indicator.

Adding a bit more worry to the mix, MAAD on the larger and more important Intermediate-term Cycle has yet to demonstrate the upside enthusiasm on a net basis since March 2009 as have index prices. We have noted this problem before. That disparity continues to suggest Big Money, while participating since March 2009, has been unable to garner the enthusiasm for the market as in previous bull phases. It also suggests, given the proximity of current plots to those March 2009 lows, that it wouldn’t take much selling to drive the indicator to new lows.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)
CPFL rallied a bit last week, but as measured by cumulative Call/Put $Value data, the indicator, like MAAD, remains locked between its April highs and the early July lows. CPFL is toward neutral as measured by both the Daily and the Weekly C/P $Value Ratios while continuing to offer upside potential. Unfortunately, as we’ve noted previously, such readings can persist in a downtrend.

Net, if the market rallies in this frustrating and uncertain environment, CPFL must confirm if the market reaches new highs. A lingering failure of CPFL to underscore market action on the upside would not bode well for the major indexes.

Click charts to enlarge

Conclusion
It has become increasingly difficult to offer plausible opinions about this range bound stock market. Nonetheless, we will continue to suggest options given the fact that history has proven repeatedly that presumptions and foregone conclusions can end in disaster. Such was the case at Stalingrad nearly seven decades ago. Similarly, current history suggests that letting the stock market dictate its own course is the best strategy to follow, regardless of suppositions about where it "ought" to be headed.

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

Date NYSE Adv NYSE Dec Date OEX Call $Volume OEX Put $Volume
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
6-4-10 5 15 6-4-10 265339 515370
6-11-10 12 8 6-11-10 263791 544655
6-18-10 11 9 6-18-10 357965 119532
6-25-10 5 15 6-25-10 91068 599114
7-2-10 4 16 7-2-10 1034509 771231
7-9-10 18 2 7-9-10 635690 110808
7-16-10 9 11 7-16-10 171633 445073
7-23-10 16 4 7-23-10 322870 174663
7-30-10 15 5 7-30-10 199970 217368
8-6-10 15 5 8-6-10 271701 115037
8-13-10 3 16 8-13-10 132060 409972
8-20-10 8 12 8-20-10 176830 488032
8-27-10 6 14 8-27-10 207995 222943
9-3-10 17 3 9-3-10 488323 102016
9-10-10 12 7 9-10-10 287697 82863

*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
7-30-10 7 12 7-30-10 41025 42071
8-2-10 15 4 8-2-10 141725 31355
8-3-10 5 14 8-3-10 47386 35459
8-4-10 10 10 8-4-10 52252 20624
8-5-10 6 14 8-5-10 31608 23941
8-6-10 8 12 8-6-10 76376 35429
8-9-10 11 9 8-9-10 45247 19760
8-10-10 5 15 8-10-10 54235 52153
8-11-10 3 17 8-11-10 69487. 107497
8-12-10 11 9 8-12-10 52311 72308
8-13-10 10 9 8-13-10 31747 51598
8-16-10 10 9 8-16-10 21782 67573
8-17-10 15 5 8-17-10 99035 95632
8-18-10 14 6 8-18-10 52063 68877
8-19-10 5 15 8-19-10 146897 226482
8-20-10 6 14 8-20-10 77321 72273
8-23-10 4 14 8-23-10 29601 63019
8-24-10 1 19 8-24-10 86432 149165
8-25-10 12 6 8-25-10 63569 70929
8-26-10 1 18 8-26-10 62080 78690
8-27-10 18 2 8-27-10 40020 40885
8-30-10 6 14 8-30-10 19791 51145
8-31-10 11 9 8-31-10 25663 67903
9-1-10 15 5 9-1-10 119254 49407
9-2-10 17 3 9-2-10 65874 27545
9-3-10 15 4 9-3-10 110203 49266
9-7-10 6 14 9-7-10 117904 30367
9-8-10 16 3 9-8-10 28574 24874
9-9-10 16 3 9-9-10 75428 56235
9-10-10 12 7 9-10-10 50482 44100

**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.

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