Oversold stock market ripe for rebound, caveats abound

Stock index, chart, technical analysis

Market Snapshot:

In last Friday morning’s Market Snapshot we suggested that “attempting to bottom fish a declining market is a lot like trying to catch a falling knife.” In Friday’s trading that knife cut a bit deeper and may have had something to do with the poor showing in Facebook’s IPO that only eked out a 23 cent gain on the day, despite all the hoopla at the front of the offering.

FB aside, in just six weeks the major averages have erased nearly one half of the gains accrued during the previous seven months. That weakness highlights the old market adage that “Oversold” readings early in a new Intermediate Cycle negative aren’t necessarily “Oversold.” In fact, they are merely accurate to the extent the new trend is negative and more market weakness could follow. Thus the relentless “falling knife."

But it is a virtual certainty this bout of selling will come to an end and that some retracement action could follow. And soon….With the S&P 500 in the vicinity of 200-day moving averages, depending on whether they are calculated using a simple, exponential, or weighted average, some longer-term support could contain downside selling pressures. In fact, we wouldn’t be surprised to see some rebounding develop this week.

Market Overview – What We Know:

• Friday’s selling was sixth session in row major indexes lost ground. Indexes also lost sharply on week.
• In just over six weeks since S&P 500 hit short to intermediate-term high on April 2 (1422.38) major indexes have lost nearly one half of gains accumulated in same indexes over past seven months.
• Short-term trend, as measured by MAAD Daily Ratio, remains in historically “Oversold” territory (.37) on Minor Cycle.
• Intermediate Cycle remains negative and Major Cycle is “Neutral.”
• Intermediate Cycle, as measured by Weekly MAAD Ratio, was last moderately “Oversold” (.62).
• Weekly Trading volume on NYSE was rose nearly 12% and Average Price per share declined $1.58 to $55.12. Highest recent average price occurred on March 15 at $61.48.
• Daily MAAD sank to another short-term low last Friday and was last at level equal to late December S&P 500 price of 1260.
• CPFL was negative Friday by 2.03 to 1 as compared to Thursday’s level when ratio was negative by 4.24 to 1. Variance suggests rate of put buying is diminishing as some options players are also looking for bargains via call options.
• Cumulative Volume (CV) in S&P 500 cash index and S&P 500 Emini futures contract declined to new short-term lows Friday.

Thing is, while the short-term trend could begin to show some improvement that would allow deeply “Oversold” near-term stats to head back toward “Neutral” or somewhat better, the larger Intermediate Cycle and how it will eventually relates to the Major Cycle could become an issue. Since the uptrend since October is now over, the challenge will be to determine where index pricing might make a stand at stability on the Minor and then the Intermediate Cycles. If the S&P 500 simply stages a classic 40% to 60% pullback, we would look for S&P pricing to put in place a short to intermediate-term low in the 1283 to 1213 range.

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.