Intermediate stock cycle is ripe for pullback

Market Snapshot:

Back on February 29 we thought the S&P 500 and the Dow Jones Industrials might have traced out Key Reversal Day formations. And for a little more than a week that possibility had some credence. But then the major indexes spiked to new short term highs to re-assert the larger intermediate trend. What is now true is that we are looking for a top and a reversal on the larger Intermediate Cycle that has been underway since the October 4 lows. It will come. That is a certainty.

Last week’s net failures after new short-term highs on Monday put the Minor Cycle trend in jeopardy. If the lower edges of defined 10-Day Price Channels (1384.06—S&P 500 / Monday) are fractured on further selling, then the larger Intermediate Cycle would become an issue. Currently, however, there is a relatively wide margin (nearly 6%) between current pricing and the lower edge of the 10-Week Price Channel at 1313.50 in the S&P 500 (until March 30). With a new bout of volatility, considering the fact VIX is currently not far from historical low volatility extremes, that margin of safety could be quickly erased.

Market Overview – What We Know:

• Losses last week in major indexes put a damper on Minor Cycle strength that has developed over past several sessions and, if it continues, could put in jeopardy Intermediate Cycle uptrend begun last October 4.
• With both Minor and Intermediate Cycles still vulnerable because of “Overbought” statistics, “Overbought” Sword of Damocles continues to hang over market.
• Intermediate Cycle at lower edge of 10-Week Price Channel would be threatened with price weakness below 1313.50 in S&P 500.
• Trading volume on NYSE shrank 2.5% Friday while price of average share on NYSE rose 10 cents to $58.36. Highest recent average share price was March 15 at $61.48. On week NYSE volume declined 25%.
• Short-term Momentum has confirmed none of recent strength in any of major indexes to recent best bids for move. Nor has Intermediate Cycle Momentum.
• Daily Most Actives (MAAD) was slightly positive Friday with 10 issues up and 9 down. Weekly MAAD was negative by 8 to 12. Daily MAAD Ratio remains marginally overheated with Weekly MAAD “Overbought.”
• Daily CPFL was positive Friday by 1.15 to 1 while Weekly CPFL was positive by 1.40 to 1. Both Daily and Weekly series remain substantially below February 2011 highs, despite index strength above similar levels.

With both the Minor and Intermediate Cycles resting in “overbought” territory with a degree of market complacency also evident, there is a general market tone that could develop into a pullback. While it’s true “Overbought” readings can persist and do not in and of themselves mean the market is in danger of an imminent decline, when the “Overbought” oscillators do turn lower, that action almost invariably coincides with price weakness. The same is true of an “Oversold” condition – when the oscillators turn higher from persistent “Oversold” readings, so does pricing.

So, while we cannot say that a decline is “Red Zone” imminent, we can say it is inevitable. Fine distinction, but true. Short and intermediate term Momentum is also backing up the notion the market has lost upside steam. Minor Cycle Momentum has yet to better its early January levels while Intermediate Cycle Momentum has failed to surpass the peaks it made in mid-February to suggest that recent new highs for the move are suspect. At the same time, Major Cycle Momentum has been ensconced near neutral for months.

Market Overview – What We Think:

• Intermediate Cycle that has been underway since last October 4 is certainly due for some corrective action. Question remains as to which short-term top will prove to be peak of advance mature intermediate uptrend.
• Failure of Momentum on both Minor and Intermediate Cycles to confirm any of strength to new highs for move over past two weeks could be early sign market is becoming increasingly vulnerable.
• But if pricing corrects “Overbought” excesses on near-term without significant price weakness, possibility exists market could be performing “setup” for further gains. Such action preceded most recent near-term rally following abortive Key Reversal Day on February 29.
• Fact that Cumulative Volume (CV) remains weak in S&P 500, Dow 30, and NASDAQ Composite underscores fact participation in market over past several months, let alone last decade with historically low trading volume, is abnormal and probably unsustainable, at least as it relates to higher index prices on long-term.

Then there is Trading Volume and Cumulative Volume. Activity on the NYSE remains at the lowest levels in nearly a decade. When price is added into the equation, and despite the fact index pricing has bettered 2011 highs, Cumulative Volume (CV) has not. Even CV in the NASDAQ Composite Index has failed to underscore strong price gains in the underlying NASDAQ index.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

The overall deterioration in market activity has been reflected in our Most Actives Advance/Decline Line (MAAD). While MAAD using Daily data recently bettered its 2011 highs, the Weekly series has not. Since the latter is a better reflection of long-term investor sentiment than the former that is shorter term and more volatile, there is the ongoing suggestion that the so-called Smart Money crowd, despite index gains since March 2009, has not participated in this market as it did during previous and more inclusive uptrends. That statement may sound like a contradiction of our earlier assertion that professional investors have been driving index prices higher. Not really, because what we are looking at is the “degree” of participation. In other words, higher prices on deteriorating market volume mean that, absent sellers, prices can still rise on diminished participation. They have. In that lack is also the danger.

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.

Reflecting another deficiency is the failure of our Call/Put Dollar Value Flow Line (CPFL) to demonstrate any appreciable gains since the October lows. CPFL rallied nicely off of the March 2009 bottom and kept pace with index price gains until February 2011. Since the indicator high on February 25, 2011, CPFL hit an intermediate-term low on December 19 nearly two-and-one-half months after the October 4 intermediate price lows. And since December 19 the indicator has moved feebly higher on both the Daily and Weekly Cycles, only advancing above the downtrend line stretching back to February 2011 within the past several days. Bottom line on CPFL? Options players have simply not participated in the rally since last October to the same degree they were present for previous rallies. In fact, they have only been buying a few more calls on a Dollar Value basis since mid-December. That failure is not a vote of confidence for the long-term prospects of the stock market.

In sum, price action over the past week saw the short-term trend demonstrate weakness – yet again and albeit somewhat higher. Whether that selling develops into a concerted pullback on the larger Intermediate Cycle remains to be seen. But with ongoing indicator failures on the upside, a possibility we suggested several months ago if the rally continued and index prices bettered 2011 price highs, one of two things will happen -- either index pricing in the major indexes gets in synch with our indicators or the indicators get in step with index pricing. Wanna bet on which option unfolds first?

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD rallied to its best level since last October last Tuesday. Once indicator peak was made, however, the MAAD faded over the balance of the week, a negative bias that was reflected in larger Weekly MAAD statistics that were also negative on the week with eight issues advancing and 12 declining. On that note, Weekly MAAD remains the poor sister of the two cycles in that the Weekly series has yet to break above its 2011 highs while Daily MAAD did so back on February 3.

It is the tone of the larger Weekly MAAD data that remains important. While Weekly MAAD moved marginally above a secondary downtrend line stretching back to October 2007 two weeks ago, a more formidable resistance line extending back to the 2000 indicator highs has yet to be overcome. With index pricing still more aggressive than MAAD on both the Daily and Weekly trends, the indicator continues to highlight the fact that the rally since March 2009 has begun taking on different characteristics than at any point previously in that rally, at least as far as Smart Money is concerned.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL was higher on both the Daily and Weekly cycles last week, but on a net basis since CPFL reached its indicator highs back on February 25, 2011, performance has been decidedly lackluster.

While CPFL was finally able to rise above a downtrend line stretching back to those 2011 highs last week, on a net basis it is nowhere near overcoming the actual 2011 indicator high. That variance from February 2011 to current is the first such disparity in CPFL since the March 2009 lows. Just after that low, CPFL rose steadily with the market until February 2011. Thereafter, despite the creation of an Intermediate Cycle low in October 2011 that was followed by higher index pricing, CPFL has failed to participate to any degree on the upside.

While the reasons for the lack of trading by options investors many eventually become clearer, suffice to say the options crowd has continued to buy only marginally more Calls on a Dollar Value basis, than puts, for months. That noticeable lack has not only created the wide disparity in CPFL plots, it has also underscored prevailing negativity in an indicator that has historically validated strong uptrends.

Click charts to enlarge

Conclusion

With the exception of the NASDAQ Composite index that gained .41% last week to its best level (3090.08) last Wednesday since last October’s lows, none of the major indexes followed suit in terms of net gains on the week. In fact, the Dow Jones 30 was last on the verge of breaking below the lower edge of its 10-Day Price Channel (13079.79 / Monday) after registering the biggest index loss last week at minus 1.14%.

Whether or not current short-term selling, net, turns out to be the beginning of the end for the Intermediate Cycle advance that began last October 4 remains to be seen. But suffice to say, the conditions for a meaningful pullback continue to unfold. With only one exception, Daily MAAD, none of our key indicators has confirmed any of the strength by the major indexes to new highs and their best levels since October 2011. Although this rally could prove to be an historical exception in terms of our indicators failing to underscore index pricing, we seriously doubt it.

*Note: Unchanged issues are not counted.

**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.