Unsuspecting traders could be shocked by market surprise

But what if? (We often ponder that question late at night here in Manhattan when we see that taxi traffic consists mostly of “Off Duty” cabs heading home). What if that short-term pullback from October 27 (1292.66—S&P 500) to November 25 (1158.66—S&P) was merely the “B” leg of an A-B-C rally that began after the October 4 low (1074.77—S&P). If so, the next leg up could be the “C” leg of the move that should equal the “A” leg. If the “C” leg and the “A” leg are the same length, measuring from the bottom of the “B” leg up puts the S&P at 1376.55. Surprise! Surprise! That target just happens to be 5.97 points above the May 2, 2011 S&P 500 high at 1370.58 and the best level since March 2009. Think that new high would attract any new buyers? When answering, please keep in mind our movie theme.

Market Overview – What We Think:

• Until S&P 500 can decisively break above downtrend line (1250-1255—S&P 500) stretching back to October 27 intraday and short-term high at 1292.66, staying power of short-term uptrend remains in doubt.
• If it turns out pullback from October 27 to November 25 was a “B” leg correction in an A-B-C rally begun after October 4 low, then upside measured move to 1376.55 comes into view. Level would create a new high for move since March 2009 and would better May 2011 peak by several points.
• But with all of our key indicators (MAAD, CPFL, CV, and Momentum) lagging pricing, move could prove to be massive trap for “late to the party” longs.
• Another possibility is that market simply fails to overcome major resistance up to the 1370.58 level and Intermediate Cycle top is created somewhere this side of there. That scenario would feed into possibility all price strength since October lows has been bear market retracement.
• Critical to staying power of current Intermediate Cycle uptrend and larger Major Cycle will be market’s ability to overcome massive resistance stretching up to May high at 1370.58.

Also, what if NONE of our key indicators including MAAD, CPFL, CV, and Momentum confirmed the move? What would the odds be for the market’s staying power in the face of such a massive divergence? In our book the chances would be somewhere near slim, zip, and nada. In other words, such an apparently bullish market move could prove to be “The Perfect Hook.” It’s happened before. Think 1973, 2000, 2007.

But here we are now. The larger Intermediate Cycle remains positive to the extent prices have not moved below the lower edge of 10-Week Price Channels (see table) that were threatened last week. In fact, prices in the S&P 500 came within five points (4.39) of breaching that level last week before powering higher by over 100 points to that defined short-term downtrend line stretching back to late October.

Daily S & P 500 Index with Cumulative Volume

Weekly S & P 500 Index with Cumulative Volume

Which brings us back to the short-term trend line and market action playing out over the past six weeks. Clearly there are sellers waiting just above current market levels hoping to sell as they break even or those wanting to put on new shorts. It remains to be seen how that seller’s mentality will work out, but given the fact the market remains at the lower edge of a larger band of resistance stretching up to the May high (1255-1370.58--S&P 500), making a bet that buyers will not be able to overcome that resistance isn’t bad strategy since prices have already failed before toward that level. That’s unless there’s enough power beneath current quotes to first push prices above the downtrend line (1250-1255--S&P 500), then the October 27 high (1292.66), and then major resistance.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

Obviously, if prices remain unable to overcome the selling bias that has persisted for months and which has left prices almost exactly where they were back on August 2 (1254.03) when the S&P 500 broke below the Neckline of the completed Head and Shoulder Top formation, the bearish case will prevail. That would not surprise us since such action would be classic.

But back at “What If,” assume this market needs to stage one more rally to suck in as many lemmings as possible. That’s what happened in October 2007 when the S&P bettered the highs of the previous several months and none of our key indicators confirmed that market action. On a smaller scale the same sort of thing developed into the May 2011 highs when our key indicators did not confirm index strength.

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, with market possibilities clearly written to the extent the S&P 500 either rallies to new highs or it does not, it is a certainty ongoing failure to do so will not accrue to the benefit of bulls. What is going to be a huge deciding factor in this upcoming battle will be the status of our key indicators such as MAAD, CPFL, CV, and Momentum. If the market does finish off a “C” leg rally from current levels and if that rally results in new highs, those indicators must confirm such strength by also moving to new highs. We suspect they will not be able to do that. Such action would no doubt set up a scenario for a replay of “The Perfect Hook.”

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD Daily Ratio remains moderately “Oversold” while still offering the potential for higher prices on the short-term cycle. And while the indicator tended to mimic index price action off of the October index lows, since reaching a short-term high back on November 11, MAAD has been somewhat weaker than index prices.

There is also the fact that while the S&P has recovered about 50% of the losses it suffered between the May high (1370.58) and the October low (1074.77), MAAD on the smaller cycle has only come back about one third. That lagging action also does not take into account the fact that Daily MAAD must rally back above its March 3 plot high to re-assert the Major Cycle advance in the indicator begun in March 2009.

Which brings us to Weekly MAAD statistics that sank to new short-term lows the week ending November 25 even though the more sensitive Daily series did not. Weekly MAAD nonetheless continues to underscore long-term weakness in the indicator by moving downward toward that major low created the week ending March 6, 2009. Put another way, Smart Money apparently remains skeptical of this market and could force MAAD on the larger cycle to a new low with relative ease.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL has remained in a downtrend since peaking on the Intermediate Cycle back on February 25. Not only has the indicator continued to erode lower for the better part of the past year, but CPFL has shown no upside enthusiasm whatsoever since the October lows. That unfavorable bias is simply another indicator suggestion that another group of market players, options buyers, has seen no reason to become enthusiastic about higher stock market prices.

Nothing but strength back above those late February indicator highs would result in an overtly bullish stance from CPFL. Everything this side of there would simply be a return move within the context of larger cycle negativity.

Click charts to enlarge

Conclusion

The stock market is currently confronted with two choices. On one side it must rally to new highs (above 1370.58—S&P 500) to re-assert the bull trend begun after the March 2009 price lows. Or it does not.

If the first scenario develops via new highs, for the move to be “confirmed,” all of our key indicators would also have to make new highs (CPFL, MAAD, CV, and Momentum). Is that possible? Anything’s possible. But is it likely? No.

Or the market fails to make new highs and our indicators continue to look weak. The October lows are fractured via a new round of selling as the larger Intermediate Cycle turns negative following weakness below 10-Week Price Channels. That’s when the more important Major Cycle would roll over to the downside with negative readings from Momentum. At that point the bear would resurface in earnest.

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.