Stock market rallies, approaches near-term overbought condition

Bull shadow, stock chart

Has a short-term low been hit? When the S&P 500 reached 1343.35 on November 16 via an intraday low, the short-term bottom was probably made. Since then the bellwether has rallied just under 5%. Has an intermediate-term low also been reached? Probably not. What about the Major Cycle advance that has been underway since March 2009? That trend remains intact, but selling since the middle of September has put stress the 3 ½-year-old bull.

That’s about the sum of it at the end of a low volume holiday week during which all of the major indexes rallied more than 3% while recovering a large chunk of recent losses. But there is an array of caveats. First, strength was powered by diminishing volume on Monday, Tuesday, and Wednesday. There was no trading on Thursday. And on Friday the market closed early. Given lingering short-term “Oversold” conditions that have persisted for several weeks, the market was simply ripe for a countertrend rally.

Market Overview – What We Know:

• Major indexes posted strong gains last week with none advancing less than 3%. But strength was accompanied by low holiday volume during a truncated trading week.
• While short-term trend has reversed back to positive, to suggest more positive flavor on larger Intermediate Cycle, S&P 500 would need to rally above upper edge of 10-Week Price Channel (1456.37 through November 30).
• To re-assert Major Cycle uptrend, S&P must rally above September 14 intraday high at 1474.51.
• Following slightly lower low on November 14 below June 4 bottom, Daily MAAD has rebounded over past several sessions, but Daily MAAD Ratio has already spiked upward and back into “Overbought” territory (last at 1.71).
• While Weekly MAAD Ratio remains “Oversold” (last at .68), fact Daily MAAD Ratio has already moved into zone of vulnerability is cause for concern.
• CPFL was positive by 3.99 to 1 last week with Weekly CPFL Ratio last plotted at .50 in “Oversold” territory.
• On longer-term basis Cumulative Volume (CV) in both S&P 500 and S&P Emini has continued to under perform relative to S&P 500 pricing.

And, lacking other evidence, that’s the way we are going to treat strength since that November 16 low – as a “return action” rally within the context of a still negative larger Intermediate Cycle. While some of the more conventional measurements like stochastics and short-term Momentum have merely rallied back to “Neutral,” our Most Actives Advance/Decline Ratio has skyrocketed back into extremely “Overbought” territory (last at 1.71). While that MAAD reading is not necessarily a reason to rush for the exits, it is an indication that those “Oversold” conditions that persisted for weeks could be eliminated with just a few sessions of concerted buying. Such action is often a reflection of countertrend market movement in the early stages of a larger cycle decline. It is also true that our Daily Call/Put Dollar Value Ratio remains “Oversold” (last at .69) while both Weekly Ratios in MAAD and CPFL are toward “Oversold” territory. Hovering over all of the smaller cycle stats are long-term market measurements that remain “Overbought.”

So we’re back at another one of those points that have developed since index price highs made an Intermediate Cycle high back in the spring of 2011 – after defined Intermediate Cycle pullbacks into the lows of October 2011 and then again in June of 2012, prices rallied to new highs and their best levels since March 2009, but NONE of our key indicators confirmed pricing to those new highs.

Market Overview – What We Think:

• Short-term upward pop in market indexes over past several sessions has eliminated much of near-term “Oversold” conditions while replacing them with “Neutral” to moderately “Overbought” readings. Updraft in Daily MAAD Ratio is yet another indication strength since November 16 could prove to be nothing but reflex rally.
• Ultimately, extent to which September/October highs (1474.51—S&P 500) are seriously challenged will determine whether or not strength is merely a brief upside feint in Intermediate Cycle negative, or if it will turn into full-fledged intermediate reversal to positive.
• How price movement plays out will determine status of Major Cycle uptrend in effect since March 2009.
• In face of ongoing indicator deterioration, such as in our Daily MAAD series that has erased all of its gain since June lows, we can only wonder how this market can shake off so much internal negativity to make new highs for the move begun in March 2009. If it does, yet another negative divergence would likely develop.

Which brings us to this most recent pullback. After the September/October highs in the major indexes, short-term selling morphed into an Intermediate Cycle negative. Uptrend lines since the October 2011 lows were fractured marginally. Cumulative Volume trend line breaks confirmed that action. Daily MAAD that had underscored none of the market’s advance after it peaked back on March 20 began moving decidedly lower after the September highs and made a fractionally lower low on November 14 before recovering somewhat over the past several sessions. Weekly MAAD remains weak relative to the longer-term trends with two noticeable upside failures since May 2011. And CPFL has remained lackluster since peaking way back on February 25,2011.

Daily S & P 500 with Cumulative Volume (CV)

Weekly S & P 500 with Cumulative Volume (CV)

If we are correct in our assumption that near-term buying since November 16 will prove to be nothing but a bounce in a larger Intermediate Cycle negative, then we would expect index pricing to begin to weaken anywhere from here on. Such strength would allow prices to recover 40% to 60% of losses since those September highs. Accompanying pricing, ratios would be reflecting readings in the “Neutral”-plus to “Overbought” range, a characteristic of ratios in a new bear trend. We would also look for prices to stay below the upper edges of 10-Week Price Channels (1456.37—S&P 500 through November 30).

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

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

For a resumption of intermediate-term weakness, we would then need to see selling back to and below those November 16 lows (1343.35—S&P 500). If there is weakness back to, but not below, those points, then a case for an Intermediate Cycle low could be made. Such market movement would become problematic, however, because the Major Cycle trend would have been left intact. In fact, the S&P could sell down to 1275 without suggesting an end to the long-term advance begun in March 2009, recent trend line breaks notwithstanding.

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, how the near-term rebound now under way develops will determine the staying power of the next larger Intermediate Cycle that will determine whether or not the bull market remains in effect. Damage over the past two months has been noticeable, but it has not been serious enough to reverse the advance underway for the past 3-½ years. Given indicator deterioration and the fact the market has made little net headway over the past 18 months, however, we wonder how much longer negative divergences will be able to persist.

Conclusion

Short-term gains since the November 16 intraday lows (1343.35—S&P 500) will ultimately determine the staying power of the larger Intermediate Cycle that is currently negative. If it turns out strength over the past several days is merely a countertrend bounce in an otherwise negative larger trend, then we would expect prices to begin failing on the upside within the next several sessions. Renewed selling could then develop and a possible test of the recent lows could follow.

If, however, the market has a greater store of resilience on the Major Cycle that has been in an uptrend since the lows of March 2009, short-term buying would continue, 10-Week Prices Channels would be exceeded on the upside as Intermediate Cycle “Oversold” conditions would take on greater importance, and the September 14 intermediate high at 1474.51 in the S&P 500 would be exceeded. In that latter instance, nothing but strength to new highs would re-affirm the 3 1/2 year-old bull trend.

*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.