Stock market negative, but oversold on minor, intermediate cycles

Second, and despite all the negative variances we have highlighted in previous weeks between price and our key indicators, the power of the uptrend since the October lows must be honored. There is no denying the fact the S&P 500 rallied just over 32% since the cash index made an intraday low last October 4. That being said, however, power up does not necessarily mean that there will necessarily be proportionate power down to correct the excesses of the previous move. That is to say, the Intermediate Cycle excesses that have accrued since last fall must be eliminated before the market will exhibit some signs of statistical health preparatory to a new advance.

Market Overview – What We Think:

• More weakness on short-term trend and developing negativity on larger Intermediate Cycle last week seem to have ended uptrend in effect since last October.
• We say “seem to” because “Oversold” conditions have developed relatively quickly on Minor Cycle and are already modestly “Oversold” in our Most Active Weekly Ratio. Admittedly “Oversold” conditions can be deceiving in early stages of a decline, so price must be the arbiter with upper edges of trailing Price Channels acting as good “failsafe” points for upside reversals (see accompanying table).
• Question is how far weakness will carry if pullback proves to be more than “normal,” given lingering indicator weakness, and what will be the implications for larger Major Cycle that has been hovering near “Neutral” for months? Preliminary best guess is that weakness on order of 40% to 60% of gain in S&P 500 since October (1283-1213) could develop.
• But given “reluctance” of the majority of our key indicators to confirm market strength into recent highs, next presumption could be that selling could carry on downside further than many market practitioners expect. 
• Three indicators, MAAD, CPFL, and CV that measure Smart Money bias, sentiment, and the power of buying continue to indicate market underpinnings remain problematic and that price action could adjust accordingly.

The big question now is “where will that Intermediate Cycle low develop, and when?”

Presuming that the S&P 500 remains a valid representation of the broad market and that a “normal” correction of the previous advance would call for a 40% to 60% pullback from the recent high at 1422.38—S&P 500, weakness toward 1283.33 to 1213.81 could be possible. Coincidentally, a long-term uptrend line stretching back to the March 2009 price low in the S&P 500 (666.79) comes into view over the next several weeks in the 1200 to 1225 area at the outside limit toward 60%. Simply put, the index could sink to the lower zone of the price projection while still keeping the bull trend initiated in March 2009 intact.

Daily S & P 500 Index with Cumulative Volume

Weekly S & P 500 Index with Cumulative Volume

If, however, that uptrend is fractured via more concerted selling and if Momentum on the Major Cycle dips into negative territory while an Intermediate Cycle “Oversold” condition occurs, the odds would not favor strength to new highs during the next Intermediate Cycle advance. That could mean the high put in place a month ago at 1422.38—S&P 500 cold prove to be the top of the bull move initiated in March 2009.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

Why is that latter possibility still possible in spite of the rally the market has experienced over the past several months? Because of the ongoing laggard status of most of our key indicators. With the exception of our Daily Most Actives Advance/Decline Line (MAAD) that marginally exceeded its 2011 highs in February highs, none of our other indicators confirmed price strength by any of the major indexes. Weekly MAAD failed as did our Daily and Weekly Call/Put Dollar Value Flow Line (CPFL), Daily and Weekly Momentum, and Daily and Weekly Cumulative Volume (CV). If the current price pullback proves to be shallow and indicator weakness is also minimal, current weakness might be viewed in retrospect as merely a hesitation within the context of the longer-term advance initiated just over three years ago.

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.

There is another possibility. Shortly after the rally began in October we suggested we could see prices rally to new highs, which they did, but that we were skeptical that there would be indicator corroboration. That is the scenario that has played out. Some might suggest that the indicators are simply wrong this time around. That would be a first. Undoubtedly the market will resolve this issue in the not too distant future. But in the meantime, we believe it’s important to keep in mind that none of our longer-term indicators have confirmed price strength in any of the key indexes to their recent highs. That, in addition to current weakness, is a cause for caution at least at worry at worst.

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD declined to a new short-term low last Friday and was last plotted at a level equivalent to an S&P 500 price of 1295. Weekly MAAD also moved lower last week and was last at a level not seen since the end of January when the S&P was near 1300. What we find interesting about the coincidence of the two indicators using two sets of data is that while Daily MAAD perked to a marginally higher high above its 2011 highs in early February with a final high on March 20, Weekly MAAD did not. Yet both indicators have gotten back in synch via recent market weakness and were both at levels equivalent to an S&P 500 price of about 1300.

There is another similarity developing between Daily and Weekly MAAD that bears watching. Both have quickly moved back into “Oversold” territory. The Daily MAAD Ratio first dipped to deeply “Oversold” back on March 10 when the S&P was at 1358. Clearly that level was premature. Now it’s back toward the same levels. Weekly MAAD, however, has been moving steadily lower and was last plotted at .78. If the larger cycle follows the lead of the smaller, should we presume the Weekly MAAD Ratio is not really “Oversold,” or that the current reading is prematurely optimistic?

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Call/Put data based on Dollar Value remains noncommittal. Daily CPFL made a short to intermediate-term low on December 19 with a short-term peak on April 9. The Daily indicator was last stuck in a range between the two points while still holding well below its 2011 highs. Put another way, options players have only been a bit more bullish since December than bearish while failing to show any real market enthusiasm on the longer-term cycle.

This divergence will be tossed into the historical dustbin just as all others have been. We should note, however, that over the 30 years of this indicator’s history, other notable instance where CPFL failed to confirm new highs in the broad market include the 2000 and 2007 bull market highs.

Click charts to enlarge

Conclusion

More selling last week in the major indexes re-asserted short-term negativity while suggesting a reversal of the uptrend in effect since last October. We think the odds of a correction of the 32% advance in the S&P since the fall of last year is under way even though price and indicator ratios have rapidly corrected back toward “Oversold” levels and even though “Oversold” conditions can persist early in a reversal. In other words, while “Oversold” readings may develop, they can be deceptive and may not be giving an accurate reflection of market action except to the extent they remain negative.

*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.