Oversold market on short-term cycle comes with caveats

"Not much."

That would be the answer to the question, "What happened in the stock market last week?"

That’s unless you bought Parkvale Financial (PVSA), +83.08% to 20.56, M&F Worldwide (MFW), +51.24% to 25.65, or Timberland (TBL), +43.48% to 43.03. Such is the market…. But performance in the major indexes was pretty much the norm, however, with the S&P 500 ahead a scant .04%, the Dow 30 up .43%, the NADSAQ Composite down 1.03%, and the Value Line Index up .32%. Once again, the writers of call options may have gained the most.

From a trading point-of-view while the Intermediate-term Cycle has turned marginally negative as measured by Momentum and our Proprietary Trading Oscillators, Short-term statistics are currently as "oversold" as at any time over the past year. In fact, Minor Cycle Momentum and the same Trading Oscillators on the smaller cycle are now equal to Minor Cycle lows put in place last July, via the pullback and "test" in August, December, and then again in March of this year. Each of those previous lows was followed by a healthy market rally.

But the big difference between those lows and the current environment is that each of those previous Minor Cycle market bottoms was coincident with an Intermediate-term Cycle that was "encouraging." That is not the case currently even though the "The Market" as measured by the major indexes appears to have also found support at 200-Day Moving Averages and a longer-term support.

And while we could see some near-term rebounding just ahead as we suggested last week, to presume that the market will power higher from current levels and make new highs could be a stretch. There is also the ongoing failure of Cumulative Volume to contend with. As we have noted for some time, CV has not only failed to better its April 2010 plot highs even though index prices overcame similar levels, but a second smaller failure developed into the May highs after CV failed to surpass its February plot highs. That lack of confirmation was seconded by our Most Actives Advance/Decline Line (MAAD) and the Call/Put Dollar Value Flow Line (CPFL) which made highs back in late February and early March and then refused to move to new highs with the indexes in May.

These ongoing negative divergences as reflected in CV, MAAD, CPFL, and Momentum, all computed from different market statistics simply continue to underscore the lingering lack of internal market strength.

Click chart to enlarge

S&P 500 Index with Cumulative Volume

So we are left with a few possible market scenarios which could play out over the next several sessions to a few weeks on the Short-term Cycle:

• The broad market simply continues to decline on the Short- to Intermediate-term Cycle until an Intermediate-term low is put in place. We’d give that scenario about a 25% chance of playing out.
• The market stabilizes on the Minor Cycle and then begins to rally back toward what is now Intermediate-term statistical resistance at 10-Week price channels near 1325-1350—S&P 500, 12475-12625—Dow 30, and 2805-2840—NASDAQ Composite. New highs would not follow. We give that possibility about a 50% chance.
• A Short-term low is put in place, prices rally strongly, and new highs develop even though most of our indicators fail to confirm the rally. The chances for that possibility we’d put at about 25%.

After creating a plot high back on February 25, Daily CPFL data has moved steadily lower. The indicator confirmed none of the market’s strength into the May highs. On the positive side of the ledger, however, the downward bias of the indicator has not been dramatic. Unlike MAAD which fractured its uptrend line stretching back to the July 2010 price lows, CPFL continues to remain above a similar trendline.

But like MAAD, CPFL must rally to a new high and back above its late February levels to suggest a resumption of the bull trend it has been diverging from for the better part of the past four months. The last time such a significant disparity developed was prior to the October 2007 market highs.

Click charts to enlarge

Conclusion

Short-term "Oversold" conditions have developed in the major indexes within the context of what is currently an Intermediate Cycle negative. Indicator conditions reflect readings recorded into important Short-term lows over the past year. What is now different is that the Intermediate Cycle is more negative than positive.

While we cannot preclude the possibility that prices will rally sharply as they correct those Short-term "Oversold" levels, we find it difficult to believe that strength will be good enough to not only make new highs in the market, but to also erase negative indicator disparities. At this juncture, we suspect a rally could develop, but that it will prove to be a retracement move within the context of an Intermediate-term Cycle that has not yet run its downward course.

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

*Note: All data is for calendar 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. He is a member of the Market Technicians Association and can be reached at traderbob@nyc.rr.com. 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.