Following May to October stock decline -- blue sky or Sisyphus?

Market Snapshot:

The stock market never gives all players what they want. Price action over the past several months is an example of that truism. Longs, as measured by the S&P 500, who entered the market anytime after February are still waiting to break even and remain under water. Shorts that entered the market anytime after the first week in August are waiting to break even and remain under water.

What remains to be seen now is which side will come out ahead in the weeks to come. Will the bulls be vindicated by further gains? Or will Sisyphus prevail? One colleague we speak with regularly believes without a doubt that the stock market is headed for new highs. Or will an upside failure ultimately bail out nervous shorts? Another colleague we know believes that any strength will prove to be merely a bear market rally.

We are a fence sitter right now. We know that the “bluer” the stock chip, the better the issue has performed recently and since the August lows. Both the S&P and the Dow Jones Industrial Average have done better than the NASDAQ Composite or the Value Line Index which has placed a poor fourth. Could strength recently be just a blue chip rally?

Market Overview – What We Know:

• S&P 500 and Dow Jones Industrial Average rally to short-term highs Friday and on week as NASDAQ Composite and Value Line Index lag.
• Cumulative Volume in S&P 500 and S&P Emini on daily and weekly cycles has yet to break above resistance highs made in August, despite strength in pricing above August resistance.
• S&P 500, Dow 30, and NASDAQ have rallied above upper edge of defined 10-Week Price Channels to underscore positive tone on Intermediate Cycle. Only the Value Index has failed in that respect and remains nearly 34 points below this week’s Price Channel point at 2675.64.
• Short-term cycle remains “Overbought” in Momentum, our two proprietary Trading Oscillators, and Daily MAAD Ratio. Intermediate Cycle indicators remain moderately “Oversold” to “Neutral.”
• CPFL was positive Friday by 3.10 to 1 and on week by 2.78 to 1. Indicator remains in downtrend stretching back to early March and has failed to confirm any of recent strength in broad market.
• MAAD was positive again Friday and has moved within range of defined downtrend line stretching back to March 3. Break above downtrend line would still leave indicator well below March highs and level required to make new high.
• Major Cycle Momentum was last fractionally positive in Dow 30 and NASDAQ while holding fractionally negative in S&P 500 and Value Line Index.

We also know that Minor Cycle stats that were deeply “Oversold” into the October 4 short-term lows are now very “Overbought” even though “Overbought” readings in a new uptrend can remain that way for extended periods of time. Underscoring upside potential is the fact that the next larger and more powerful Intermediate Cycle remains moderately “Oversold,” but not deeply “Oversold” as was the case two weeks ago. That nuanced change in the intermediate trend means that the next stop on the intermediate ratio scale is “Neutral” and neutral readings in a bear trend can equate with “Overbought” in a bull. Think May 2001 and May 2008, both hesitations with neutral readings occurring in primary bear markets.

But the biggest concern we have is all that overhead resistance created since early February, through the May high, and through late July and just before the downside break following the structuring of a classic Head and Shoulders top. The downside targets from the H&S formation were reached via the August and October lows and were coincident with “Oversold” conditions on the Intermediate Cycle, so that move is over, but now we are attempting to determine the context -- intermediate decline in a bull, or a bear?

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

Was the May/October decline the worst of it? There have been other periods in stock market history such as September/November 2004, February/July 1980, October 1971/February 1972, January /July 1968, and February/May 1948 when the market presented many of the signs of a new bear, but Intermediate Cycle weakness simply prove to be a lull in a primary bull.

One of the argument made by our colleague who suspects the market will rally to new highs, is that trillions of dollars are waiting on the sidelines and equities are the only place to be. Bonds are a bad bet and the gold market is such a tiny window of opportunity relative to equities, so it doesn’t count. All of these things are, in fact, true. But to achieve new highs, the market, as measured by the S&P 500, must rally another 133 points, or just under11% from current levels on increasing volume via CV through major resistance just to get back into blue sky territory. And that action must also be confirmed by MAAD and CPFL. In the meantime, the market would have to absorb the selling of longs eager to break even with a few diehard shorts covering losses with new longs required to push the market upward. Is that a recipe for new highs?

Note: Stop levels, a function of the extant trend, are based on the trailing moving average price channels for the Highs or the Lows of an index. Whether or not a specific index is suggesting a "Buy" or Sell" is determined by whether or not index prices are above or below the current channel Stop levels. Stop levels should only be used as an entry or exit guide and in conjunction with other market entry and exit strategies.

Underlining all of the question marks is the fact that most of our Major Cycle indicators have yet to cast decisive votes. Some readings remain fractionally within range of even and others are hanging in the air somewhere between moderately "Overbought" and "Overbought." A shift in those trillions from the sidelines, one way or another, could win the day for the bulls on the Major Cycle – or not.

Major Index Price Objectives at top of 10-Month Price Channels

In a nutshell, all we can reasonably say at this juncture is that the Minor Cycle is positive and could rally higher. The intermediate cycle remains in a zone of opportunity and could also move higher. And the Major Cycle remains iffy. Will new highs follow? Maybe, but even at the risk of being flat out wrong we’re not yet ready to bet the farm on such a move. If new highs do follow we would much rather be long when the May highs are acting as support rather than as resistance, as is currently the case. If there are "opportunity costs" incurred in the meantime so that a bear trap can be avoided, so be it.

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD appears to have been in favor of recent stock market strength. Not only has the indicator been moving steadily higher since making a short-term low on October 3, but this key indicator is now seriously within range of fracturing a defined downtrend line stretching back to the March 3 indicator high. Weekly MAAD has simply been corroborating Daily action.

But the MAAD Daily Ratio has moved back into moderately "Overbought" territory from deeply "Oversold" conditions in evidence just three weeks ago while the weekly series has moved up from deeply "Oversold" conditions that persisted for four months to "Neutral." Such readings in a bear trend can equate with "Overbought" levels in a bull phase and can precede a resumption of selling.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Despite stock market strength over the past three weeks, CPFL has shown little inclination to move decisively higher. The indicator made a new Intermediate Cycle low on October 17 and has improved slightly since then, but has shown nowhere near the improvement as have market indexes.

That upside failure, given the history of CPFL, suggests that options players remain skeptical of recently positive stock market action. While they could come on board at some point, the fact they have not so far should give bulls cause for concern since we have never seen an instance when CPFL exhibited a negative divergence and the market ignored that negative tone indefinitely.

Click charts to enlarge

Conclusion

Short-term gains continued last week with both the S&P 500 and the Dow Jones Industrials posting new Minor Cycle highs with breaks above minor resistance and the upper edges of defined 10-Week Price Channels. But given the fact the NASDAQ Composite and the Value Line Index have yet to fully join the party, we wonder if strength could prove to be more blue chips than all chips with perhaps a few indicator cow chips thrown in.

There is also the fact that the short-term cycle has moved rapidly back into "Overbought" territory while previously deeply "Oversold" Intermediate Cycle stats have moved to "Neutral."

While some are suggesting the market is on the verge of a powerful rally within the context of the Major Cycle uptrend begun in March 2009, we continue to ponder major resistance stretching up to the May highs (1370.58—S&P) with the current lack of confirming volume as noted in our Cumulative Volume series. Although its true rallies can persist longer than many suspect and that higher bids can come on less than stellar trading volume, it is the staying power of such rallies without volume and indicator underpinnings that can ultimately be the deciding factor in the staying power of a rally. In other words, is the market confronting a Sisyphean task?

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, private investor and financial markets consultant 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 link will take you to the MAAD article.