Bear market retracement implied by market breadth

Netflix, Value Line or cows: Choices since March 2009

The stock market rally squad was out again last week to the extent the S&P 500, Dow Jones Industrial Average, Nasdaq Composite, and the Value Line Index all hit their best levels since March 2009. But given the ongoing failure of Cumulative Volume to confirm any of the strength in any of the major indexes, we wonder if buying at some point could turn out to be a Pyrrhic victory.

In addition, while options buyers continue willing to bid up call prices at the expense of put premiums as reflected in our Call/Put Dollar Value Flow Line (CPFL), and even though NYSE Up/Down Volume made new highs relative to the July lows, that latter series has yet to exceed its late April 2010 highs. At the same time, the NYSE Advance/Decline Line has faltered below the early November plot highs while our proprietary Volatility Ratio is now as overheated on the Intermediate-term Cycle as at any time over the past 20 years.

It is also important to remember that strength since March 2009 has not developed within a bubble. Gains since that spring 2009 bottom have occurred in the wake of a severe decline that followed the October 2007 highs. Put another way, lacking strength above those 2007 highs (1576.09—S&P 500 index, 14198.10—Dow 30, and Nasdaq Composite 2861.51), buying since March 2009 could prove to be nothing more than a bear market retracement.

While some may suggest that investing in the Value Line Index is the way investors should have gone since that index has bettered its October 2007 highs by over 13%, it’s also true that same index lost nearly 60% of its market value from October 2007 through early March 2009. It could even be pointed out that the Nasdaq Composite at 2642.97 last Friday only has to rally a bit more than 8% to make new highs along with Value Line.

To such revelations we might suggest that instead of the Value Line or the Nasdaq, the prescient investor should have purchased Gold futures which have more than doubled since March 2009. Or how about Apple computer (AAPL) which has rallied over 300% in the same time frame. And then there’s the big Kahuna rally in Netflix (NFLX) which appreciated from nearly $18 in October 2008 to nearly $210 per share recently for a gain of over 1,000%.

Coulda, shoulda, woulda are not investment strategies. At some point an investor must make strategic choices otherwise market "participation" will remain amorphous. Retrospect may cause wisdom, but it may not create future wealth. In fact, the only way an investor can participate in the investment world is to buy something, sometime. And the profitability of that purchase will be determined by whether or not the investor buys during an up cycle or a down cycle. Same for selling. For someone who bought the Dow in October 2007 and who is now still long crying towels remain in order because of a lingering net loss of nearly 20%. If the same investor had bought the Value Line Index in October 2007, he would be up 13% or just under 4.5%. That gain is hardly reason to get out the hats and horns.

Index

Daily Stops

Weekly Stop Monthly Stop
12/20 12/21 12/22 12/23 12/24 12/23 12/31
S&P 1224.11 1228.36 1230.70 1231.96 Holiday 1165.81 1061.14
Dow 30 11328.97 11358.75 11382.74 11394.33 Holiday 10954.70 9978.80
NASDAQ 2595.92 2604.04 2608.31 2611.26 Holiday 2437.31 2154.04
Val. Line 2775.10 2787.58 2795.15 2800.11 Holiday 2560.05 2228.83

Note: Stop Loss levels based on the trailing moving average of the lows presumes a continuation of recent market momentum and volatility.

Of course, our discussion here is meant to peripherally underscore our belief that long-term investing is no panacea unless the investor remains on the right side of the trend. And while we do not mean to suggest that "what" the investor buys is not important, "when" the investor buys and the "price" he pays will ultimately prove to be a far greater measure of investment success EVEN IF he does not hold all the ‘high fliers" that can be seen retrospectively as having been the best choices. Such investing is not only impossible, it is nonsense. First identify the direction of the dominant trend and then make the best choices possible.

Rest assured that the uptrend that began in the spring of 2009 will come to an end. That assumption is as certain as Death and Taxes. What we are suggesting in the current environment and in spite of strength to levels above the April 2010 index highs, and even by some major indexes to new all-time highs, is that the same tools which presaged the market top in 2007 and the subsequent and devastating decline may again come into play. In fact, some market tools have been warning for months that investors should continue to be very wary of this market. That is a truth which may be found in a Netflix documentary.

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD continued to dawdle along last week on both the Daily and Weekly Cycles. Daily MAAD has yet to surpass its October 12 short-term plot highs, let alone April 14 peak. At the same time, Weekly MAAD data continues to hover marginally below highs made the week ending November 5.

The combination of the two cycle failures continues to suggest that "Smart Money" has yet to participate on the upside to the same extent they bought equities prior to the October 2007 market highs. Some would suggest, "So what? There have been huge gains in some of the major indexes and individual issues over the past 21 months?" That’s true, but it’s important to remember that MAAD is a "sentiment" indicator, a measure of the market’s "pulse" and "health." Put another way, the market, the patient, can continue to breathe even if propped in a hospital bed with pillows.

MAAD, a measurement of the market as "patient" is still suggesting that net strength in the broad market since March 2009 could prove to be nothing but a countertrend rally in an otherwise negative longer-term trend. In fact, a brief observation of MAAD data underscores the lack of strength since March 2009 with MAAD having recovered not even a quarter of its losses since those March 2009 lows. With that notable divergence still in place, one of two things can happen: either MAAD plays a game of catch-up or, when selling develops, MAAD sinks to new lows and levels below the March 2009 plot bottom. Such action would not bode well for stock market prices on the longer term cycle.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Options players remain upbeat. Since the end of June the Call/put Dollar Value Flow Line has continued to move steadily higher. Last week CPFL data on both the Daily and Weekly cycles rallied to new highs. Ironically, however, CPFL has only recovered about one-half of its decline since the 2007 highs to simply mimic the underlying S&P 100 Index upon which it is based.

At the same time, the Weekly CPFL Ratio is now as overheated as at any time since early 1983 when the OEX index options began trading. Unfortunately, such "overbought" readings have had a tendency to self-correct in major advances while also tending to coincide with important intermediate tops. Which kind of overheating will develop this time around remains to be seen.

Plotted against some of the skepticism in other indicator quarters, we suspect that while options optimism at this point may be a lingering note of optimism, price negativity, the ultimate arbiter of market tone, could easily pop the options party balloon.

Click chart to enlarge

Conclusion

For months this market has reminded us of the farmer who was queried about how good his business had been over the past couple of years.

"Well," he said, "Cattle’s been doing well…."

"Yes, I’ve heard that," the questioner points out. "And how many cows have you produced?"

"None," the farmer asks. "Don’t like steak."

The point? While, as always, "what is bought and when" remain of paramount importance in the stock market, the "will" to buy seems to have been another big issue for the better part of the past two years. True, there have been historic gains in some sectors even if most of the strength was a retracement of the losses from the 2007 highs. Ultimately, when the music stops, we wonder if selling could take on a renewed significance, a stance which may have been forgotten a bit too soon.

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

Date

NYSE Adv

NYSE Dec

Date

OEX Call $Volume

OEX Put $Volume

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

9-17-10

15

5

9-17-10

289703

112410

9-24-10

12

8

9-24-10

209124

100570

10-1-10

9

11

10-1-10

145020

121894

10-8-10

14

6

10-8-10

394156

98483

10-15-10

10

10

10-15-10

476975

115923

10-22-10

11

9

10-22-10

2575024

116468

10-29-10

10

10

10-29-10

376133

120924

11-5-10

13

7

11-5-10

547056

71345

11-12-10

5

15

11-12-10

203906

305387

11-19-10

7

13

11-19-10

241420

143672

11-26-10

5

15

11-26-10

116916

149196

12-3-10

16

4

12-3-10

701973

55878

12-10-10

15

5

12-10-10

395991

42814

12-17-10

9

11

12-17-10

441634

61008



*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

11-5-10

10

10

11-5-10

170900

27121

11-8-10

12

8

11-8-10

68863

17326

11-9-10

5

15

11-9-10

169694

45289

11-10-10

11

9

11-10-10

42694

33514

11-11-10

8

12

11-11-10

37089

30380

11-12-10

4

15

11-12-10

30639

94150

11-15-10

11

9

11-15-10

84443

47402

11-16-10

3

17

11-16-10

43071

180668

11-17-10

6

14

11-17-10

20420

78711

11-18-10

16

4

11-18-10

52596

35984

11-19-10

8

11

11-19-10

77047

28454

11-22-10

6

14

11-22-10

40764

46671

11-23-10

4

16

11-23-10

36998

63173

11-24-10

15

5

11-24-10

59261

23407

11-25-10

Holiday

11-25-10

Holiday

11-26-10

6

14

11-26-10

7371

22639

11-29-10

11

8

11-29-10

134852

34060

11-30-10

7

13

11-30-10

33479

24500

12-1-10

16

4

12-1-10

85253

28247

12-2-10

15

5

12-2-10

182715

28232

12-3-10

17

3

12-3-10

115848

24527

12-6-10

8

11

12-6-10

40933

17375

12-7-10

8

12

12-7-10

80650

30593

12-8-10

13

7

12-8-10

50397

15116

12-9-10

15

5

12-9-10

108582

14892

12-10-10

13

7

12-10-10

72621

16651

12-13-10

9

11

12-13-10

283329

35410

12-14-10

6

14

12-14-10

40676

17570

12-15-10

8

12

12-15-10

96633

33646

12-16-10

11

9

12-16-10

40412

30436

12-17-10

10

9

12-17-10

91895

20598

**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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