Stock market gains, but strength still looks like reflex rally

Market Overview – What We Think:

• While short-term trend following June 4 lows (1266.74—S&P 500) has resulted in just under a 50% recovery of losses sustained following April 2 S&P 500 high (1422.38), rapid change in market stats from “Oversold” to “Overbought” on Minor Cycle suggests this rally could prove to have limited staying power.
• We could see short-term peak anywhere this side of upper edge of 10-Week Price Channel (1392.33 through June 22), a high that could be followed by a resumption of selling on Intermediate Cycle.
• While some measurements of intermediate trend are currently registering “Oversold,” it’s important to remember that Overbought/Oversold measurements are a rough indication of market “temperature” and can persist in one direction or another for extended periods of time. In fact, current Intermediate Cycle “Oversold” measurement may simply be indication of market’s larger cycle negative bias.
• Nonetheless, any near-term price improvement should be viewed with skepticism. We do not think March/April highs (1422.38—S&P 500) will be exceeded via rebounding. Short-term strength should merely serve to eliminate recent deep statistical negatives.
• In event larger Intermediate Cycle resumes downward course, there could be weakness in S&P 500 toward 1283-1213 if “normal” 40% to 60% pullback develops as calculated from April S&P 500 high at 1422.38.

On the indicator front, MAAD has rallied with market pricing, but on a bearish note has not rallied as much as has the S&P 500 since June 4. While the bellwether price index has recovered just under 50%, MAAD has only come back about 25%. That variance suggests that while the Smart Money crowd has bought marginally and may have additionally covered some shorts, it has not been as enthusiastic as has index pricing. In fact, if the market experiences another downdraft like the one recently ended, Weekly MAAD could break below its March 2009 plot lows even though the S&P 500 remains well above similar levels. That relationship of MAAD to its 2009 low is especially worrisome, because another round of selling like the one the market experienced after the April high would almost certainly force MAAD back below the March 2009 low.

Daily S & P 500 with Cumulative Volume (CV)

Weekly S & P 500 with Cumulative Volume (CV)

“So what,” you say. “Prices in the major indexes remain substantially above those 2009 highs and would need to drop dramatically to catch up with MAAD if the indicator made a new Major Cycle low.” In that variance is the problem. MAAD has been underperforming the broad market since the 2000 highs to suggest that while Smart Money has participated in rallies, it has hit the “sell button” with enthusiasm since then when given the opportunity, especially during the 2007/2008 bear market. Back in early 2000, the high was followed by a concerted downward move in MAAD. The rally after the 2002 lows only retraced about 50% of the previous decline. Then came the 2007 peaks and the catastrophic bear market in 2008. During that decline, MAAD made new lows. The ensuing rally in MAAD only came back about 50% even though index pricing recovered more than 80% of the 2007/2008 decline into the April highs of this year. Unfortunately, MAAD did not confirm that high in the wake of the March 2009 lows and did not better its 2011 high. That divergence is significant and underscores the lack of upside enthusiasm by Smart Money via MAAD.

There is also the long-term negative divergence in our Call/Put Dollar Value Flow Line (CPFL) that has continued to remain anemic since the indicator peaked at the end of February 2011. CPFL also failed to make a new high with index pricing into the recent highs to underscore the fact that options players, while participating to some extent in the rally since March 2009 and again since last October, have remained unimpressed with this market’s longer-term prospects.

Daily S & P 500 Emini Futures contract with Cumulative Volume (CV)

Weekly S & P 500 Emini Futures contract with Cumulative Volume (CV)

Last, there is the ongoing failure of Cumulative Volume (CV) in the major indexes and the S&P 500 Emini futures contract to better 2011 plot highs, despite recent strength in the major indexes to new highs for the move since March 2009. While it could be argued that all of these indicator failures, MAAD, CPFL, and CV, are a function of diminishing volume over the past decade, they are all, in fact, calculated on different data sets. We think a more likely answer is that on a relative basis, the underpinnings of the stock market are weaker than external prices are indicating. Those divergences are a long-term bearish sign. 

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.

So, what’s to be done in this environment? First, we could see some further index improvement on the near-term within the context of what still looks like an Intermediate Cycle negative. So long as the S&P 500 continues to hold below the lower edge of its 10-Week Price Channel (1392.33 through June 22) and given the fact the short-term cycle is already trending toward “Overbought” levels, we suspect a near-term top could soon be put in place, perhaps even this week. If we are wrong, nothing but strength back above the April 2 high at 1422.38—S&P 500 would suggest a resumption of the longer-term uptrend begun after March 2009.

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD continued to recover following June 4 S&P 500 low (1266.74) last week, but whereas the index has regained nearly 50% of the losses following the April 2 high (1422.38), Daily MAAD has only come back about 25%. That divergence suggests Smart Money has been buying the recent rally, but not to the same extent as prices have rallied. In other words, their enthusiasm has been tempered. That reluctance underscores our suspicion recent strength could ultimately prove to be no more than a failed rally within the context of a larger intermediate-term negative.

Of greater concern is the fact that Weekly MAAD, after failing to confirm a new high into the April peak in the S&P 500, was last within range of not only the lows made last October, but also the March 2009 lows. A break below the first level would be bearish, but a decline below the 2009 lows would suggest a statistical catastrophe and possibly a devastating longer-term decline while hinting that all strength over the past three-plus years has been nothing more than a weakly fueled rally spurred by weak hands.

Click chart to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL gained last week and was positive on a ratio basis of 2.83 to 1. On a relative basis, the indicator remains locked between its December 19 intermediate low and the April 9 high. More importantly, CPFL remains in a downtrend stretching back to the late February 2011 highs.

The fact CPFL has failed to confirm index pricing into the recent highs and mimicked what it did back in 2007 with another upside failure is reason for long-term concern. When options buyers are unable to muster enough enthusiasm in rallies to cause the number of Call purchases on a Dollar Value basis to substantially exceed the number of Puts purchased on a similar Dollar Value basis, there is a lingering hint, considering all forces involved, that the underpinnings of the market are weak. The failure of CPFL over the past several months, let alone since February 2011, is an indication the net bias of purchases has been on the Put Dollar Value side of the market on the long-term.

Click chart to enlarge

Conclusion

Prices in the major indexes gained last week, but we continue to suspect the currently positive near-term rally will stall out sometime within the next several sessions. At this juncture, we do not think prices, as measured by the S&P 500 cash index, will be able to better the upper edge of 10-Day Price Channels (1392.33—S&P 500), let alone the March/April Intermediate-term price highs (1422.38—S&P 500).

If we are wrong, nothing but strength above the March/April highs (1422.38—S&P 500) would indicate a resumption of longer-term positive trends. On the flip side, the attainment of new short-term lows below June 4 levels (1266.74—S&P 500) could be ominous considering the longer-term negative tone of some of our key indicators such as Weekly MAAD.

*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.