Stocks walk fine line between correction and bear market

Stock index, chart, technical analysis

Over the past several weeks and since the mid-September to early October short to intermediate-term highs, the average losses of the four major indexes we follow on a high to low and close to close average basis ranged from 8.2% for the Dow Jones Industrial Average, 8.3% for the S&P 500, 9.0% for the Value Line index, and 11.4% for the NASDAQ Composite.

Those with a more bullish bias on the market suggest those losses are within the tolerances of a “normal” correction within the context of the Major Cycle uptrend begun in March 2009. Those who are more bearish say, “No, the losses in the NASDAQ alone indicate a new bear market has begun.”

Market Overview – What We Know:

• Major indexes were in loss column again last week, but momentum of selling wasn’t as intense and some rebounding came at end of week.
• Through last Friday and since recent highs, NASDAQ lost 11.4% (average of high to low and close to close losses), Value Line index was down 9.0%, S&P 500 8.3%, and Dow Jones 30 8.2%.
• To suggest more positive flavor on Intermediate Cycle, S&P 500 would need to rally above upper edge of 10-Week Price Channel (1459.02).
• To re-assert Major Cycle uptrend, S&P must rally above September 14 intraday high at 1474.51.
• MAAD on both Daily and Weekly cycles continues to underscore negative divergences. Daily MAAD eked out new short to intermediate-term low last Wednesday by sinking slightly below its June 4 support low. Indicator has effectively erased all of gain since June. Daily MAAD Ratio was “Oversold” at .81 while Weekly MAAD Ratio was “Oversold” at .67.
• CPFL was negative last week by 3.18 to 1. Daily CPFL Ratio was last “Oversold” at .44 with Weekly CPFL Ratio “Oversold” at .60.
• Daily Cumulative Volume in S&P 500 has kept in synch with index, but Daily CV in S&P 500 Emini remains noticeably negative while reflecting S&P price equivalent of about 1300.

We have always had difficulty subjectively determining what is “normal” in the stock market. To suggest that the adjective can describe most stock market behavior would fly in the face of historical evidence that relies on abnormalities to determine true buying or selling opportunities. One of the historical norms indicates that a pullback of 10% in a bull trend is “Normal.” If there is a decline of merely 8%, as is the case with the S&P 500 currently, does that mean more selling is inevitable? What if the market declines 15%? Is that the signal for a new bear trend? And so on…. All of this reminds us of the story about the small boy who wanted to know, when looking at two mountains with his father, if he “would die more falling off of the big mountain than falling off of the smaller one?” Such is the role of fathers and perhaps of analysts, too.

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

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

Of the two possibilities, a pullback in a bull or the start of a new bear, we have found it increasingly difficult to accept the notion that a market with such weak underpinnings will go on definitely. That has been the case since the highs made in the spring of 2011. To underscore that skepticism, we refer again to our Most Actives Advance/Decline Line (MAAD) and especially the Daily series that made a slightly lower low last week below its June 4 plot bottom. What is significant about that action is that the indicator has been moving net lower for the past eight months. It peaked on March 20 and nearly two weeks before the broad market. It then declined until June 4 and made a low with most major indexes. But thereafter synchronicity failed. The S&P 500 rallied to a new high for the move on September 14 (1474.51), but Daily MAAD was nowhere in sight. In fact, the indicator rallied back less than 50% from its June lows relative to its March highs. Then came the September highs in the indexes, MAAD sank and made a new 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.

What MAAD on both the Daily and Weekly series is suggesting is that Smart Money has been increasingly viewing market strength with skepticism. Weekly MAAD has also been failing on the upside. After peaking in late April 2011 that larger time series failed on two additional rallies to confirm S&P strength. Because we don’t want to hang our hat on just one indicator, it’s important to note that similar failures have been evident in our Call/Put Dollar Value Flow Line (CPFL), in Cumulative Volume (CV), and Momentum.

In sum, how the market develops over the next several weeks will largely determine whether market weakness during the past two months is merely a “normal” pullback within the context of a primary bull market that has not runs its upside course, or perhaps the beginning of a “new normal” with a bear’s tail tacked on it.

McCurtain Most Actives Advance/Decline Line (MAAD)

Daily MAAD sank to a new low last Wednesday to totally eliminate all of its gain since the June 4 lows. What that means is that MAAD and what we refer to as the Smart Money” crowd have underscored virtually none of the rally in the S&P 500 from its June 4 low (1266.74) until the high on September 14 (1474.51).

Could it be that MAAD is simply setting up for yet another negative divergence in front of another rally that will carry the S&P and the major indexes back above those September/October lows? Yes, it’s possible, but like it or not, MAAD losses over the past several weeks have been troubling. “Oversold” conditions aside, the Intermediate Cycle is now negative. The lower edges of 10-Month Price Channels (1277.32—S&P 500) that continue to define the downside “failsafe” points on the long-term trend are within view and In another several days those sell points will notch higher at the beginning of the new month (1293.26—S&P 500). Simply put, the market must rally or negative MAAD divergences will prove to be prescient.

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL was negative again last week. On a Dollar Value basis there were 3.17 times as many Puts as Calls. After peaking with the market back in September, Daily CPFL has been moving steadily lower. The only positive mitigating factor with the indicator is the fact it is now deeply “Oversold” on the Daily Cycle at it has returned to a defined uptrend line stretching back to lows made nearly a year ago. If that trend line is broken that would be bearish. If it is not, then the September high must be overcome for the indicator to re-assert its longer term uptrend. Of the two possibilities, we suspect the indicator will be unable to make new highs.

Conclusion

Earlier in our summary we noted the absolute losses in the major indexes over the past several weeks. But what we did not highlight was the fact that the S&P 500 has simply eliminated all of the price gains it accrued since the May 2011 highs. That selling effectively erased the 7.5% gain for those who bought above 1370.58 or the 15.6% gain for those who theoretically bought into the S&P lows (666.79) in early March 2009. In other words, an investor who sold in May 2011 would now be slightly better off than the investor who held equities from May 2011 to date.

As we have been suggesting for some time, when key indicators such as MAAD, CPFL, Momentum, and CV continue to negatively diverge from the market, the odds of return on investment begin to diminish. The decline over the past two months has once again highlighted that point.

*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.