Stock market drama may be close to resolution point

Market Overview – What We Think:

• While short-term “Oversold” conditions have been surfacing as result of three weeks of net market negativity, it’s important to remember “Oversold” in early stages of new decline on larger cycles may be merely reflection of new “negativity” and not of buying opportunity.
• Nonetheless, until index pricing breaks below defined uptrends (1422—S&P 500) in effect since June lows and lower edges of 10-Week Price Channels (1392.40—S&P 500), we cannot preclude yet another near-term bounce within context of still positive Intermediate Cycle positive.
• To confirm resumption of Intermediate Cycle uptrend, S&P 500 would have to rise above September 14 intraday high (1474.51) and stay there.
• What would likely be lacking, however, as has been the case since spring 2011 highs would be indicator confirmation that we continue to suspect has been revealing a lot about market strength for months. And the likely eventual direction of market price action….
• Indicators such as MAAD continue to suggest Smart Money has only been buying a bit more than it has been selling since June lows, even though index pricing has made new highs for move initiated in March 2009. That tone is not bullish.
• In background it’s important to keep in mind fact market is entering time of year that has proven to be historically vulnerable -- think 1929, 1987, and 2007.

In addition, none of our key indicators has been able to overcome the resistance highs made in early to mid-2011, and even though index pricing went on to its best levels since the bull move began in March 2009. At least until September 14 when the S&P 500 peaked (1474.51).

From the high in May 2011 (1370.58) until that September 14 peak, the S&P 500 rallied nearly 7.6%. Over the past three weeks that 17 month gain has been shaved to 4.2%, not including any commissions or fees incurred by an investor. Put another way, an investor buying the S&P in May 2011 has barely made ¼ of a percentage point per month over the past 17 months. And that was after our key indicators reached their turning point, or “climax,” in a drama preceded by a 106% gain in the S&P 500 from March 2009 over two years until May 2011. Since then, our indicators have continued to signal increasing risk for longs.

Daily S & P 500 with Cumulative Volume (CV)

Weekly S & P 500 with Cumulative Volume (CV)

So now the issue is where the “climax” in pricing develops, given a profound lack of indicator confirmation on the Intermediate and Major Cycles for the past 1 ½ years. Evidence over the past three weeks is suggesting such final resolution may be developing. As index prices rallied to their best levels in September and since March 2009 with no indicator confirmation, the turn to the downside after a brief short-term upside feint was abrupt. Since September 14 the NASDAQ Composite has lost 5% of its value and faded back toward a rising uptrend line (3020) in effect since June 4 while coming within range of the lower edge of its 10-Week Price Channel (3009.09 through March 19). And even with that initiation of “falling action,” the Intermediate Cycle in the NASDAQ Composite, as is the case with the other major indexes, is still “Overbought.”

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

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

While some might point out that NYSE Trading Volume has been shrinking for the past three weeks and that that movement could mean selling is drying up as the short-term trend has become “Oversold,” we could suggest that in the early stages of any larger cycle decline, “Oversold” is not necessarily “Oversold.” It can merely be a reflection of new negativity creeping into the market.

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.

As in the denouement of a Greek tragedy, we suspect that in retrospect the justifications for the lingering negative divergences in our key indicators since the 2011 highs will become clear. The advantage of these indicators is that we are able to look forward to future possibilities for the stock market. As the current drama plays out, we suspect the outcome could be unfortunate for those investors who do not see the final acts coming. The unfavorable divergences that have been unfolding could prove to be not only historically prescient but also, like our play, dramatic in terms of the price damage they may be predicting. In other words, the stock market may be about to enter acts four and five – falling action and denouement. And whether or not the viewer achieves catharsis and/or pleasure while viewing this drama will depend on whether or not he’s long or short.

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD fractured by inches a rising uptrend line stretching back to the June low last week to suggest that weak index pricing since September 14 could prove to be something more than merely a near-term pullback within the context of a lingering Intermediate Cycle positive. To prove the point we would need to see renewed weakness in the major indexes with coincident downside follow-through in Daily and Weekly MAAD.

What is disturbing about the performance of Daily MAAD over the past few weeks, let alone since the March 20 indicator plot high, is that Daily MAAD is resting in the lower 25% of its respective range even though the S&P 500 and the other major indexes remain relatively close to their 2012 highs. Put another way, renewed selling in the broad market could result in further weakness in MAAD below those June support lows to suggest Smart Money continues to view this market with extreme skepticism. The question would then become how much longer index pricing could resist selling pressures that could get it in line with MAAD, a potentially troubling development.

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL has been a relative non-performer for months. While the indicator demonstrated some improvement following the June lows and into late September as the market put in place what were at least short-term highs, it is the longer-term stance of the indicator that remains relevant. After peaking the week ending February 25, 2011 and several weeks before index prices made their Intermediate Cycle highs, CPFL has consistently failed to get back in synch with pricing.

That negative divergence between the major indexes and CPFL is yet another sign that the quality of the market participation for the better part of the past two years is of a lesser nature than that which propelled prices higher, even after the March 2009 lows. Clearly, options players using Dollar Value measurements have not liked this market for quite awhile and have not been willing to make major commitments to it as was the case during other broad, bullish phases.

Conclusion

Index pricing declined last week and NYSE trading volume shrank. The market looks a little “Oversold” on the Minor Cycle and index pricing is holding at or near uptrend lines stretching back to the June lows. From that action one might presume yet another short-term pullback may be reaching a termination point and that renewed buying could soon propel index pricing to new intermediate term highs.

Perhaps.

Or market deterioration could be a sign that the rally since June continues to lose steam as has the uptrend that began in March 2009. From an historical perspective, we continue to suspect the negative divergences in our key indicators since the spring of 2011 will prove to be prescient and that index price strength since the October 2011 lows will prove to be an endgame in a bull trend many will view at some point as nothing but a poorly fueled “bounce” in the wake of the 2007-2008 bear market.        

*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.