Market recovers from losses, but resistance remains

Market Snapshot:

"Slow down there, sport. One big losing day does not a new bear market make!"

"I know that, but last Wednesday’s loss of nearly 390 points in Mama Dow and almost 47 in the S&P took serious chunks out of the market and set the stage for possible downside follow through."

"Yah, but… yah, but…. Thing is, sport, the shorts gave it all back Thursday and Friday plus some on Sunday night and then a few positive ticks on the week. So what you’ve gotta decide is whether that one day downside wonder was the end of the short-term rally, a draw play, or something else."

Such was part of the internal dialogue we’ve been having over the past several days. And underscoring those cogitations is the knowledge that while the Minor Cycle in the stock market had been exhibiting moderately "Overbought" conditions, most of those readings had been neutralized into last Wednesday’s downdraft. Short-term Momentum was toward "Neutral" while our two proprietary Trading Oscillators also hit "Neutral" in conjunction with the selling. In addition, our Most Actives Advance/Decline Line (MAAD) Daily Ratio led the parade by slipping back to "Neutral" nearly two weeks before Wednesday’s selling.

Market Overview – What We Know:

• S&P 500 recovered nearly all of its losses suffered last Wednesday via strength on Thursday and Friday. Index was actually up a fraction on the week.
• S&P 500 was last within range of October 27 intraday high (1292.66), and minor resistance put in place October 27. That level must be surpassed on upside to re-assert Intermediate Cycle positive
• Despite strength, however, index prices remain stalled in vicinity of ‘Necklines” of defined Head and Shoulders Top formations that were given definition prior to and into the early August and early October lows. Those “Necklines” define initial resistance and can act to impede price strength.
• Daily Most Actives Advance/Decline Line (MAAD) rallied to new short-term high last Friday as indicator remains in synch with index pricing. Daily MAAD Ratio was last near “Neutral.”
• Intermediate Cycle remains positive, albeit moderately “Overbought” while Major Cycle remains near “Neutral.”
• Cumulative Volume in both S&P 500 and S&P Emini has been in synch with S&P, but on relative basis has not recovered as much of decline from May high as has S&P index. While S&P 500 has recovered about 65% of price losses since May high, CV in S&P 500 and S&P Emini has only recovered about 50%.
• Call/Put Dollar Value Flow Line (CPFL) continues to underperform broad market.

What we’re getting at here is that neutrality in what appears to be a positive trend, and by that we mean the next larger Intermediate Cycle, can be good enough for a resumption of the larger cycle advance. In other words, attempting to profit from a short-term pullback in a larger cycle positive is a lot like trying to push a balloon under water. Each time the short-term cycle pulls back, there are buyers waiting to get in.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

But the bulls must still prove their point. Even though the Minor Cycle has come back nicely from the October lows, more strength must follow. And even though the Intermediate and Major Cycles could provide the favorable backdrop for additional upside activity, the elephant in the room, the resistance up to 1370.58—S&P, must be overcome. Can that resistance be absorbed? Yes, it’s possible. But, in fact, nothing but new highs will re-assert the long-term bull initiated after the March 2009 lows.

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.

Short of certainty that major resistance has been eliminated with a "look back" in a few months, there is also the classic nature of price action since May and since the construction and resolution of that Head and Shoulders Top we have referred to often. While it’s true the pattern’s objectives have been met, we continue to wonder if this market is merely staging a return-action rally within the context of a longer-term top put in place last May. Intermediate Cycle statistics remain positive, but they have moved rapidly higher over the past several weeks from deeply "Oversold" conditions to moderately "Overbought." Its true prices on the Intermediate Cycle could mimic recent short-term action by moving laterally for a time to eliminate "Overbought" readings, but there is still the major resistance problem.

Index Price Objectives / Resistance at top of 10-Month Price Channels

In sum, an investor playing the larger Intermediate trend should remain optimistic providing prices do not sink below the lower edge of defined 10-Week Price Channel lows (see table). If an investor has been looking for a short-term pullback, then strength above the October 27 intraday high (1292.66) would indicate a resumption of the larger Intermediate Cycle positive within the context of a major trend which remains tentatively positive.

No matter how the short-term trend resolves itself, however, until that peak at the May 2011 high (1370-58—S&P 500) is overcome, all price movement short of that level must be viewed as "return action" within the context of a longer-term top. Simply put, either the market makes new highs to re-affirm the major trend, or it does not.

McCurtain Most Actives Advance/Decline Line (MAAD)

The Daily MAAD Ratio reached an "Overbought" extreme of October 18. Since then the indicator has moved steadily back to "Neutral" territory and was last holding toward that level. Historically, "Neutral" readings in an otherwise positive larger cycle, intermediate in this case, can precede a resumption of the larger trend. In other words, that corrective action in MAAD on the Minor Cycle may have been enough of a statistical pullback necessary for a resumption of the dominant Intermediate Cycle.

There is also the fact that following sharp selling last Wednesday, MAAD did not demonstrate the same negativity as the broad market and then recovered very quickly on Thursday with strong follow through on Friday. The indicator then rallied to a new short-term high on Friday.

In a nutshell, MAAD has begun to exhibit a slightly more positive tone than the broad market to suggest that Smart Money may have begun to view index pricing in a somewhat more favorable light. But like the broad market, MAAD still has good distance to travel before the indicator would be positioned to overcome the highs it made March 3 nearly two months before the broad market peaked.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Unlike MAAD which has begun to assume a more positive tone relative to the broad market, CPFL, which measures the activities of options players, has demonstrated little net improvement since the August/October lows. Options buyers, in a word, have remained skeptical of stock market strength and have continued to hedge their bets on a net Dollar Volume basis by purchasing nearly as many puts as calls.

While it’s possible the options crowd could be carried along by a new round of stock market euphoria, history suggests that so long as this indicator remains mired in skepticism, the longer-term prospects of the broad market should also be viewed with caution.

Click charts to enlarge

Conclusion

The sharp recovery in the major indexes last Thursday and Friday on the heels of Wednesday’s losses could prove to be "short-covering" rally, or it might be the resumption of the larger Intermediate Cycle positive following a little over two weeks of lateral corrective action on the Minor Cycle. While we had anticipated a lengthier short-term pullback, there is no denying that buyers have pushed prices to within range of the October 27 intraday high (1292.66), the point which must be exceeded to re-assert the larger Intermediate Cycle positive. That coupled with the fact that our Most Actives Advance/Decline Line (MAAD) hit a new short-term high last Friday is a hint more market improvement is possible.

But it remains to be seen if strength since the October lows will prove to be a resumption of the Major Cycle advance begun in March 2009, or not. Until Major resistance at 1370.58 is exceeded, the coin is still flipping.

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.