As stock market fiddles negatively, bullish cause burns

Market Snapshot:

Over a period of about six months, the stock market, as measured by the major indexes, traced out what appears to be a classic Head and Shoulders Top with a defined Left Shoulder, a Head, a Right Shoulder, and a Neckline. Trading volume diminished throughout the pattern’s formation. Prices broke to the downside and sunk through the bottom of the Neckline. Downside measured move objectives were reached and the market put in place a low which was subsequently tested. A rally ensued, but after prices retraced earlier losses back to the Neckline, bids sank again. The latest decline leaves index prices, as measured by the S&P 500, 7.8% above the measured move low at a point equal to index pricing thirteen months earlier. At the same time, the S&P was last just over 15% below the Head of the price pattern.

Admittedly, the “pullback” from the short-term rally into Neckline resistance has retraced what could be a “normal” 40% to 60% correction of the up move off of the lows. And prices have also achieved deeply “Oversold” levels on the Minor Cycle at levels equal to short-term lows created over the past several years. And prices have achieved those “Oversold” levels in the vicinity of the lower edge of defined Intermediate Cycle Price Channels (1154.28—S&P 500). Put another way, the stock market could be ripe for a rebound on the near-term.

Market Overview – What We Know:

• S&P 500 has corrected just over 60% of the advance begun after the October 4 intraday low (1074.77). Such action can be “normal” in an otherwise positive advance where next larger Intermediate Cycle remains positive.
• To suggest trouble for S&P 500, index would have to decline below lower edge of 10-Week Price Channel (1154.28 -- through December 2). Such weakness would then suggest possible “test” of that October 4 low.
• Short-term trend is as “Oversold” as at any time over past several years. “Oversold” conditions can persist, however.
• To reassert Intermediate Cycle uptrend begun after October low (1074.77—S&P 500), S&P would have to better October 27 intraday high at 1292.66.
• Weekly Most Actives Advance/Decline Line (MAAD) declined to new intermediate-term low last week and was last within 25 issues of breaking low put in place week ending March 13, 2009. Daily MAAD Ratio has moved back into “Oversold” territory.
• MAAD on Major Cycle has continued to underperform broad market, a suggestion Smart Money remains skeptical of longer-term stock market prospects.
• Call/Put Dollar Value Flow Line (CPFL) remains remarkably weaker than market and could sink to new lows with little additional effort.

But keeping in mind the bull / bear battle, which has one side believing new market highs will follow while the other thinks a new bear market is underway, the bears are winning and it remains possible that price action over the past several months could prove to be distribution selling into a major cycle top that followed a 2 ½-year rally from the March 2009 lows. Underscoring that notion, and despite the possibility for another market pop to the upside, it is obvious after a year of trying the bullish camp has simply not had the power to overcome bearish resistance even though they have tried repeatedly to accomplish that task.

Then there’s Cumulative Volume (CV). CV in the S&P 500 entered into a freefall in late August. CV in the bellwether S&P 500 sank to a level equal to CV levels reached in late March 2009. In other words, that negativity eliminated virtually all of the gain accrued since the March 2009 lows. At the same time, CV in the S&P 500 Emini futures contract has been a disaster. In the early weeks of the decline in August and after the completion of the Head and Shoulders Top, Emini CV eclipsed the March 2009 plot low and sank to a new all-time historic low on August 8, a point from which it has yet to recover. In fact, whereas the S&P Emini has given back about 60% of its price gains since the October lows, Emini CV has faded nearly 75%.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

And last, there is Momentum. Short-term Momentum is locked decidedly in “Oversold” territory. On the Intermediate Cycle Momentum is right a neutral with a slightly negative tinge. Historically, “Neutral” readings in the early stages of a bear trend have equated to “Overbought” levels in a bull trend. And then we have Major Cycle Momentum that continues to hover within range of “Neutral” also. The longer-term indicator was a bit negative into the October lows and then reversed to a bit positive into the recent short-term highs. The point is, it wouldn’t take much selling to flip Major Cycle Momentum back into negative territory. And considering the tentative nature of our indicators on the smaller Intermediate Cycle, such action would not be a really good thing for the hopes and dreams of already challenged bulls.

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.

In sum, we could see a short-term rally within the next several days. But there is certainly no promise of such action given the fact that “Oversold” on any cycle can stay that way after brief rallies. Put another way, there were no less than 10 short-term “Oversold” conditions evident from October 2007 until the March 2009 price lows and five on the next larger Intermediate Cycle.

Price boundaries remain well defined. If the S&P 500 sinks below its October low (1074.77) with confirmation from our key indicators, we will be inclined to believe the market top put in place last May was for “real.” If, however, the bullish camp is able to muster enough buying power to not only overcome the late October high (1292.66—S&P) and then the May 2011 high (1370.58), so much the better for the bulls. In the meatime, the market “fiddles.”

McCurtain Most Actives Advance/Decline Line (MAAD)

Weekly MAAD declined last week below the plot low it made the week ending September 30. With only another 25 negative issues the indicator could fracture the March 2009 low while putting Weekly MAAD at a level not seen since April 1995. The weekly series is only moderately, not deeply, “Oversold.”

Daily MAAD, on the other hand, did not sink below its October low while last holding 46 issues above that level. The Daily series is nonetheless “Oversold” on the near term.

It is the status of the larger weekly trend that is the issue. Not only did Smart Money fail to fully participate in the rally which began after the March 2009 lows, let alone since the March 2003 lows, but it has been evident that each time the market has declined anew, they have eagerly sold. The October 2007-March 2009 decline is evidence of that enthusiasm. On the other hand when the market has been in a rally mode, the Smart Money folks have given a proverbial yawn. That tone cannot continue indefinitely.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL continues to show no upside enthusiasm. After peaking back on February 25, 2011 on the Daily Cycle, CPFL has tended to work lower when the market has been weak while showing little impetus on the upside when the market has been stronger.

Admittedly, CPFL has not demonstrated a substantial decline since those highs earlier this year, but the fact it could make new lows with relative ease is the important point since we have never seen an instance in the history of the indicator when index prices indefinitely defied the negative bias of CPFL.

Click charts to enlarge

Conclusion

The stock market, as measured by the S&P 500 has dipped into “Oversold” territory on the Minor Cycle after nearly a month on on-balance selling and since October 27 (1292.66—S&P). While “Oversold” conditions can persist on any cycle from Minor to Major, the fact that index pricing has moved into the vicinity of the lower edge of the 10-Week Price Channel (1154.28—S&P 500) and statistical support in conjunction with those short-term “Oversold” levels, could mean the stock market is on the verge of a near-term rebound.

The extent to which such a rally might develop, however, would not only determine the staying power of the still positive Intermediate Cycle, it could also help to determine the longevity of the larger Major Cycle that has been flirting with fractionally positive and negative readings for the better part of the past two months.

Underscoring all cyclical possibilities, selling below the October lows would almost certainly accelerate downside activity on the Major Cycle. On the other hand, nothing but new highs (above 1370-58—S&P 500) would re-affirm the bull cycle initiated in March 2009.

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.