Oversold stock market ripe for rebound, caveats abound

Problem is, what if selling evolves into something that is not “normal”? And why would it do that?

Market Overview – What We Think:

• With major indexes within range of 200-Day moving averages and with short-term “Oversold” levels at downside extremes, we suspect broad market could be net higher by end of week.
• While “Oversold” readings will take inevitably take hold and a near-term bottom will be put in place, attempting to “bottom fish” a declining market is difficult at least. 
• Once any Minor Cycle retracement begins, we suspect it will prove to be short-lived and will do little more than erase “Oversold” readings prior to resetting market for another down leg within context of intermediate negative.
• Best guess on how far this intermediate negative will carry would be toward 1283-1213 if “normal” 40% to 60% pullback develops.
• Until proven otherwise, we must regard Intermediate Cycle selling as no more than corrective action within framework of Major Cycle positive.
• Since majority of our key indicators did not confirm market strength into recent highs, we cannot rule out possibility more weakness might occur. Such selling could bring market pricing into line with negative indicator divergences.

First, stock market price action since March 2009, let alone since last October, has been positive to the extent it presented a buying opportunity that resulted in a 113% gain in the S&P 500 from March 2009 (666.79) to the April 2 high (1422.38). Recent selling, has shaved that gain to 94%. But no matter, that’s still nearly a triple since March 2009 if an investor bought at the bottom and sold a month ago. Fat chance….

Second, the problem many investors may now be facing is that they may have done some buying as the rally began and now with prices fading back toward purchase levels, do they hold or do they exit? Put another way, is this pullback that has been developing since the S&P hit its peak on April 2 merely a corrective phase worth holding within the framework of a primary bull trend that began in March 2009, or is selling the resumption of a bear market begun in October 2007?

Daily S & P 500 Index with Cumulative Volume

Weekly S & P 500 Index with Cumulative Volume 

Third, the answer may ultimately rest with our intrepid indicators that have continued to perk along these many months. It is they who have and will continue to vote on the internal strength of this market. In that acknowledgement is the problem. With the lone exception of our Daily Most Actives Advance/Decline Line (MAAD) that bettered its 2011 plot high in early February with subsequent follow through into the April S&P high, not one of our other key indicators confirmed price strength to new highs for the move begun in April 2009. Historically such negative divergences have preceded a change in the long-term trend to negative. In fact, Momentum on the Major Cycle in the S&P 500 peaked the month ending March 31, 2010 and has not re-approached that level since then. We find it interesting that Major Cycle Momentum is now suggesting, as it hovers only slightly positive, that only a bit more selling will flip long-term Momentum negative to signal an end to the uptrend initiated in March 2009.

Daily S & P 500 Emini Futures contract with Cumulative Volume

Weekly S & P 500 Emini Futures contract with Cumulative Volume

Last, underscoring negative possibilities in Major Cycle Momentum, we continue to note the failures in Cumulative Volume (CV) in the S&P 500, S&P Emini futures contract, Dow 30, and the NASDAQ Composite. CV in none has performed as well as index pricing. Options sentiment as reflected in our Call/Put Dollar Value Flow Line (CPFL) peaked the week ending February 25, 2011 after rallying with the market for nearly two years off of the 2009 lows. And our Weekly Most Actives Advance/Decline Line (MAAD) has also been a notable failure since by not only failing to better its spring 2011 peak, but by remaining ominously poised (see Weekly MAAD) chart not far above the March 2009 Weekly MAAD low.

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, while we’re willing to allow that selling over the past several weeks could prove to be no more than a “normal” correction within the context of a still positive bull market, given current levels in pricing, it wouldn’t take much more net selling to substantially change the complexion of this market to the extent index prices begin to seriously move in the direction of our indicators that have remained unimpressed by market strength for far too long.

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD declined to new short-term lows last week and to lowest levels since late last December when S&P 500 was quoted near 1260. Weekly MAAD is in synch with the daily series and was also back to levels hit near the end of 2011.

While the Daily MAAD Ratio is deeply and historically “Oversold,” the fact that the larger intermediate trend is now driving prices is an indication the smaller cycle could prove to be unreliable as to “when” an upward bounce could develop. That ambiguity simply underscores the truth that just because the near-term trend is “Oversold” readings don’t mean the market is necessarily a “Buy.” Put another way, when Daily MAAD comes off the “Oversold” dime and begins to move higher it will probably be doing so because the market is, in fact, rebounding.

The current status of both Daily and Weekly MAAD highlights the ongoing fact that Smart Money has not liked this market for months and that following each rally, many of which MAAD tentatively participated in, Smart Money has shown little reluctance to hit the sell button.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Last week CPFL suffered its worst week since late last summer. After peaking just over a month ago on April 9, CPFL has been steadily fading. In fact, the indicator has given back nearly one half of its gains since the December 19 lows. In the preceding rally CPFL also came nowhere near its February 25, 2011 plot highs. That failure and variance as compared to the progress made by the major indexes since the October lows is further evidence that options players have only been buying just a few more calls than puts over the past several months. The fragility of CPFL could quickly reverse to the downside.

Options player hesitancy in spite of defined higher bids in the major indexes underscores their apparent skepticism about the longer-term prospects for this market.

Click charts to enlarge

Conclusion

Further losses in major indexes and broad spectrum of stocks last week advanced a negative theme on the Intermediate Cycle after the previous intermediate trend peaked after the late March and early April price highs. Since the short-term trend is now suggesting some rebounding action could develop, given somewhat unreliable current “Oversold” conditions, we could see some prices rally this week. Such action, however, would probably unfold within the context of a lingering negative on the Intermediate Cycle and could precede either movement back to what would be the recent lows or selling below those levels to re-assert negativity on the intermediate trend.

While we must regard this evolving pullback as merely a retracement in the still positive Major Cycle bull trend until proven otherwise, the fact that the majority of our key indicators have not liked this market for months is an ongoing concern. As we have suggested before, index pricing could ultimately adjust and get in synch with the indicators before this move is over. If such a scenario occurs, it’s important to remember that there isn’t a lot of room left on the downside before index pricing and indicators would fracture key support levels to signal long-term negativity.

*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.