Market Bounce Not Unexpected

While I think the S&P 500 has more room to the downside, the bounce Thursday wasn’t unexpected. If you listen to the mainstream media, the explanation is the the positive GDP numbers, which at 3.4% blew away expectations.

While it will take a few days for the whole report to be dissected, it is more likely that it was an excused used to run up prices, rather than the actual rationale. Especially since many have pointed out reasons at the beginning of the third quarter why the recession may be over. I attribute the bounce today to the extremely oversold breadth - in the very short term.

One of the best measures for this is the percent of S&P 500 stocks above their short term (10 day) moving average. This metric sharply fell to just 6% yesterday. At the start of the week it was 20.4% and on Tuesday it was 14.4% and then it fell below the important 10% level which marks extremeshort term oversold levels. This is the level that was mentioned in the recent Lowry report: Turbulence Ahead.

The oversold level was clearly visible across many important sectors. Many of which had equal or worse breadth than the general market proxy. The transports were especially hard hit for example. As were the gold stocks, which as I’ve repeatedly mentioned, tend to follow the general market.

Another measure of short term breadth is the ratio of daily new highs to new lows on the Nasdaq:

As the chart shows, the last time new lows increased this much and new highs dissipated this much was back in early July, which launched the second leg of the spring rally. As Lowry’s report mentioned it is quite possible to experience ashort term set back within a primary uptrend. Things to watch for are how the market responds to this oversold condition. If the market weakens significantly in spite of poor breadth, then it will need to trade lower to find a strong bid. If on the other hand, the S&P 500 can rally immediately off such ashort term extreme, then we know that the uptrend is intact.

An important part of this is the medium term outlook. The percent of S&P 500 stocks above their 50 day moving average has managed to put in higher lows each time as the chart below shows:

Since October 2008, medium term breadth for the S&P 500 index has been stair stepping higher. It needs to remain above 30% to maintain the uptrend, which it seems to have done already.

And the very long term breadth measure - the percentage of S&P 500 components above their 200 day moving average - remains at peak levels. With today’s strong showing, it moved once again above 90% where it has been since August 2009. This is reminiscent of the rally we saw in late 2003. I’ve detailed this here: Comparing Market Breadth To 2003’s Bull Market.

Comments

[Fibozachi:]

Solid technical analysis Babak; thank you for sharing your thoughts. Just like any other issue, index or metric there are various technical methodologies that DO in fact help individual traders make informed decisions about market internal readings.

For an extensive read into volatility that includes comprehensive technical analysis of the $ADD, $TICK, $VIX and $VOLD alongside clearly detailed charts: fibozachi.com/technici...

".... on a fourth consecutive down day, Wednesday’s TICK plotted an enormous amount of negative readings while registering a stunt low of -1422; marking only the seventh time that a tick reading below -1400 has registered since the beginning of Primary wave 2 (circle) began with a single daily High Wave candlestick on March 6th. While 12 separate occasions of TICK readings that exceeded -1000 plotted over the course of today’s impulsive price action, VOLD also spiraled towards its lowest value since approximately 10/01/09 and 9/01/09; finding exact support at the trendline that connects the two ....
.... fast-forward back to Wednesday’s impulsive price action across the board, which registered as a “90/90 day” according to a metric popularized over the past few years by Lowry’s Research, which occurs when NYSE stocks exhibit both cumulative breadth and cumulative volume ratios that are each greater than 90% of their total. Wednesday’s powerful downside breadth clocked in at over 9 stocks down for each 1 up and exhibited similarly impressive volume with 91.6% to the downside in the single strongest negative thrust for market breadth in at least six months. Moreover, as wave v of (iii) appears to have ended at Wednesday’s close at 1038.5 (ESZ09), in yet another sharp ending diagonal pattern, traders were abuzz about an extraordinary McClellan Oscillator reading of -381.49 at the close; which “normally” would all but ensure a relief rally from such unabated selling pressure even if only temporarily ....

Oct 30 06:23 AM

[enigmaman:]

Very informative piece supported by reliable technicals all of which have a basis tied to investors greed and fear responses. For lack of my technical knowledge I will only say there is more reason for this market to maintain itself at these levels through the remaining days of this year because those helping to steer it have a vested interest in doing so at least until 1/1/2010 This is not about fundamentals, technicals or economic recovery its all about hanging on long enough to close the books on 09 with profits intact, thats it!

Oct 30 07:29 AM

[401KMAN:]

It looks good that the market jumped so much yesterday, but it still seems to be wallowing between 9,500 and 10,000.

I don't view this jump (yesterday) to be a significant sign.

Oct 30 08:52 AM

[Fibozachi:]

A good point about monitoring calendar dates enigmaman, but you may be looking at the wrong calendar; investment banks and mutual funds close their year-end books by the end of October MINUS T + 3, so that would have been on Tuesday of this week and could be cited as a fundamental factor that may have very well have contributed to selling pressures on Wednesday, when only a few institutions such as FIDO and large scale prop trading desks such as GSCO would still be active in the trenches, providing a supportive bid underneath key issues of institutional sponsorship. On a related note, pension funds tend to finalize changes to their large-scale tactical allocationary weightings by either the end of May or the second week of June, in the explicit anticipation of semi-annual board meeting reviews that take place during central driving period of June / July for strategic shifts. You may recall how pension funds and strategic fund-of-funds insanely re-weighted toward extremely one-directional inflationary tactics during this exact period last year, which coincided with ending fifth waves driven by pure fear in commodities across the CRB. For whatever it is worth, simply hope that this helps further drive creative thought about the topic.


On Oct 30 07:29 AM enigmaman wrote:

> Very informative piece supported by reliable technicals all of which
> have a basis tied to investors greed and fear responses. For lack
> of my technical knowledge I will only say there is more reason for
> this market to maintain itself at these levels through the remaining
> days of this year because those helping to steer it have a vested
> interest in doing so at least until 1/1/2010 This is not about fundamentals,
> technicals or economic recovery its all about hanging on long enough
> to close the books on 09 with profits intact, thats it!

Oct 30 09:17 AM

[enigmaman:]

Thanks for the info on end of year as per each segment of the industry or market, my mistake was not to specifically address the driving force behind the success of this rally, OPM, 401k, mutual funds etc these are the people who will get their year end statements and then judge performance based on these, every MM cares what their customers think of them at year end, because they dont want them to change teams, you know its all about the packaging.

On Oct 30 09:17 AM Fibozachi wrote:

> A good point about monitoring calendar dates enigmaman, but you may
> be looking at the wrong calendar; investment banks and mutual funds
> close their year-end books by the end of October MINUS T-3, so that
> would have been on Tuesday of this week and could be cited as a fundamental
> factor that may have very well have contributed to selling pressures
> on Wednesday, when only few institutions like FIDO or GSCO would
> still be in the trenches, actively providing a supportive bid underneath
> key issues of institutional sponsorship. On a related note, pension
> funds tend to finalize changes to their large-scale tactical allocationary
> weightings by either the end of May or the second week of June, in
> the explicit anticipation of semi-annual board meeting reviews that
> take place during central driving period of June / July for strategic
> shifts. Hope that helps.

Oct 30 09:31 AM

[Old Trader:]

I wasn't as surprised by yesterday's bounce, as I was by the fact the S&P retraced all of the previous day's loss, and a tad more, strengthening into the close. Still, I think today's action will be more meaningful than yesterday's was.

Oct 30 12:26 PM

[JAMES CARLINI:]

Today's market pull back shows that it is what I call a Donkey Market - neither Bull or Bear.

With different forces pulling it in several directions everyday, it is a stubborn market that does not seem to be breaking past 10,000 or down under 9500.

See instablog - seekingalpha.com/user/... where I commented on an earlier article a couple of weeks ago.

401KMAN has a point.

Oct 30 12:27 PM

[Carl Spackler:]

Question for the author: Have you analyzed and back tested what happens when the rising support line of stocks above their 50 day MA gets broken? It might be interesting.

Oct 30 05:20 PM