Well, that felt good. Finally some unequivocal stock market action develops. Last week the S&P 500 rallied 5.6%, the Dow Jones Industrial Average was up 5.4%, the NASDAQ Composite gained 6.1%, with the Value Line Index up 5.3%.
Heading into the Fourth of July weekend some folks were inclined to pull out the hats and horns while suggesting that “the gold old bull looks alive and well.” Problem is, one important component that would underscore a resumption of the primary trend went on vacation a bit early – VOLUME. Not only did activity sink to about one half of normal last week, whereas prices in the major indexes have retraced about two-thirds of the losses incurred since the May highs, but Cumulative Volume (CV) has recovered only about one-third of the ground it lost during the same period. Clearly, the underpinnings of the short-term rally that began after the mid-June lows have been spurred by weaker hands.
The poor dynamics of internal market strength have been underscored by our Most Actives Advance/Decline Line (MAAD). While the indicator has recovered with prices since it also put in place a plot low in mid-June, the indicator is nowhere near making a new high. Similar action has developed in our Call/Put Dollar Value Flow Line (CPFL) that moved marginally higher the past several sessions, but also with little enthusiasm.
Given the weak underpinnings of the market as reflected in a variety of indicators calculated with different streams of data, we wonder if recent strength could ultimately prove to be mere “return action” developing within the context of an Intermediate Cycle top. In fact, one could make a case that the deteriorating volume in this short-term rally could prove to be the endgame, or “Right Shoulder,” of a possible Head and Shoulders top since lessening activity as the formation develops is a hallmark of such a topping formation.
Also, we find it interesting that index prices have not only worked back into Short-term ”Overbought” territory very quickly over the past several days, but prices are now almost equal to the February highs at what could be the ”Left Shoulder” of the H&S top if it comes to fruition. The “Head” of the pattern would be the May highs while the “Neckline” of the formation would be drawn at the March/June lows.
S & P 500 Emini Futures contract with Cumulative Volume
There is also another point to consider. Index prices have returned toward the upper limit of 10-Week price channels that can now act as resistance (see Table below) at levels that are also coincident with those February highs. In other words, not only have prices traced out what could be very nice Head and Shoulders tops in all of the key indexes, but resistance and deteriorating volume suggest the pattern could be near completion.
So what scenarios do we see as possibilities?
- The Short-term rally tops out within the next few sessions in the vicinity of the upper boundary of 10-Week Price Channels that are coincident with the February highs, or the Left Shoulders of potential Head and Shoulders tops in the major indexes. Ongoing volume deterioration confirms the pattern. Prices then sell lower, decline below the June lows and potential Necklines, and the Intermediate Cycle downtrend resumes.
- Despite weak market internals, index prices continue upward and new highs above the May levels are reached. Our key indicators would probably remain unconvinced and would likely not confirm market strength, just as they did not underscore strength by the major indexes to new highs in May.
- Prices remain range bound as they have on a relative basis for the better part of the past six months.
S & P 500 Index with Cumulative Volume
In sum, as price action develops over the next week or so, that movement will define the short-term trend. It will also determine the staying power of the larger Intermediate Cycle which continues to remain under the influence of negative Momentum and Volume, with both of our proprietary Trading Oscillators also holding negative. The bulls must pull the market back from the brink or the bears are going to win this battle. It still remains to be seen who is going to win the long-term Major Cycle war which continues to remain positive, albeit challenged.
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