Stock market near highs without key indicator confirmation

Market Overview – What We Think:

• Tuesday’s price reversal may have signaled an end to rally in effect since June 4 lows. While Key Reversal Day was signaled in only Dow Jones Industrial Average, all major indexes were negative on week.
• Ongoing negative divergence by Daily MAAD in face of market strength since MAAD peaked July 3 reflects fact Smart Money has been exiting, if not simply avoiding, market. With disparities in place, odds will continue to suggest short to intermediate-term highs could be imminent, if they have not already been reached via last week’s highs.
• If market turns negative on Minor Cycle and then threatens reversal of Intermediate Cycle positive, long-term uptrend stretching back to March 2009 lows would almost immediately become an issue since trendline is now approximately coincident with those June lows (1266.74—S&P 500). In other words, if June lows are fractured on renewed selling, odds would be good major advance since March 2009 could be finished.
• If recent rally is legitimate and has more room to go on upside, we continue to wonder about indicator corroboration? We cannot remember instance where market powered higher on long term indefinitely without confirmation from key indicators. Tuesday’s reversal may have finally resolved that problem.

A few weeks ago we summarized the status of one of our key indicators, the Most Actives Advance/Decline Line (MAAD). In fact, in the August and September issues of Futures, we provide an in depth analysis of MAAD on the Monthly Cycle stretching back to 1961 with a trading algorithm comparing MAAD to the more traditional, and in our opinion highly flawed NYSE A-D Line.

Following a super cycle bull trend in the stock market that began in the late 1970s, equity prices made a significant top in 2000 that has yet to be surpassed statistically over a wide range of indicators, and specifically MAAD. Although the indicator moved with equity prices off of the 2002 and 2009 lows, it has never regained the tactical luster it experienced prior to 2000. A series of lower highs and lower lows have predominated, action that suggests that the Smart Money crowd, that group which MAAD reflects, has not been buying equities to the same extent they bought prior to that 2000 high.

Daily S & P 500 with Cumulative Volume (CV)

Weekly S & P 500 with Cumulative Volume (CV)

Also, over the past 13 years there have been Intermediate Cycle price highs that were preceded by prescient indicator negativity in MAAD. The most notable was the peak that preceded the October 2007 high by nearly three months. MAAD again broke down prior to the May 2011 highs. But the status of the indicator in this current environment is significantly re-approaching the deterioration in 2007. After peaking back on July 3 about one-half way through the current rally begun on June 4, Daily MAAD has confirmed NONE of the strength in the broad market. That negative divergence suggests that Smart Money has been tending more toward selling on strength for the better part of the past two months than they have been inclined to buy on strength.

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

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

While it could be asserted MAAD is simply early as it was in 2000 by several months, and that the market still has room on the upside before a final high is made, the point is that MAAD is demonstrating ongoing signs of deterioration not just on the very Major Cycle since 2000, but also on the Intermediate Cycle, and most recently on the Minor Cycle. All of that deterioration, regardless of cycle, indicates that the overall tone of the stock market switched in 2000 from a state of accumulation that had prevailed for the previous 25 years to one of net distribution. Some will disagree with that assessment, but that is our view as based on our interpretation of nearly 50 years of MAAD data.

                       8/27      8/28       8/29       8/30       8/31       8/31        8/31

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.

Even in such a market environment, however, there can be powerful rallies and money can be made. The uptrend since March 2009 is an instance of such a move. But statistically, the “quality” of the rally over the past 3 ½ years is inferior. Not only has there been a marked deterioration in overall market activity as reflected in actual market volume and then sentiment indicators like MAAD, but there has been a prevailing unease that is not characteristic of a powerful and dynamic bull trend. Imagine a sustained bear market reflex rally vs. the market uptrend that lasted from late 1994 until early 2000.

While we fully realize that continuing to call for a final market high while using divergence tools that continue to weaken, even as prices continue higher, is a form of calling “wolf,” to deny the status of these indicators would be a lot like denying the validity of storm clouds on the horizon as the temperature is dropping precipitously in coincidence with falling barometric readings.

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD Daily high put in place July 3 remains intact. Peak was made about one-half way through S&P 500 price advance begun June 4. Fact that Daily MAAD made more important top back on March 20, and has been moving net lower with only a slight reflex bounce following June 4 low, is significant and could be an indication Smart Money has continued to avoid this market despite apparent recent strength.

The last time we witnessed such MAAD deterioration prior to a market high was in the period just before the May 2011 highs and prior to that into the October 2007 highs when MAAD peaked in early July 2007. Underscoring short-term MAAD deterioration is the failure of Weekly MAAD relative to the April 2012 high and the May 2011 high.

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL was net lower last week and continues holding below a resistance high made back on April 9. While the indicator has been demonstrating some strength since early July in the wake of the early June lows, CPFL is still weak on the long term cycle and is nowhere near significant highs made in February 2011 prior to the May 2001 highs.

The fact that CPFL, like MAAD, has confirmed little of the price moves since the broad market made lows in October 2011 is a classic long-term divergence that could be preliminary to the creation of a significant Major Cycle high on the order of the one created in October 2007.

Conclusion

Net losses prevailed in the stock market last week, but the short and intermediate-term trends have yet to be decided. True that the Dow Jones Industrial Average signaled a Key Reversal day via negative price action last Tuesday, but that movement was indecisive since none of the other major indexes confirmed it.

What remains as a significant issue in this market environment is the status of our key market indicators relative to price action. MAAD, CPFL, Momentum, and Cumulative Volume (CV) continue to lag index pricing, as they have continued to do for weeks and, on the larger cycles, for months.

In the face of these negative indicator divergences relative to price action that has been seemingly reluctant to give meaningful ground on the downside is to say that we have never seen an instance where our indicators continued to deteriorate and the market did not follow suit. The question now is when the synchronicity will occur.

MAAD Daily data for past 30 days*           CPFL data for past 30 Days

*Note: Unchanged issues are not counted.

MAAD Weekly data for past 30 Weeks**     CPFL data for past 30 Weeks

**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.