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by Chris Puplava

The markets plunged early this week on a disappointing ISM reading with a retest of Monday's lows on Wednesday before rallying the rest of the week with the S&P 500 up 0.70% on the week. In last week's report I stated we should expect a bounce this week as all of my intermediate timing indicators had reached oversold territory but I still wanted to see two more developments occur before declaring a bottom was in, which is removal of excessive bullish sentiment heading into the pullback and a surge in buying. So far I would say sentiment is two thirds of the way towards healthy levels and it is still too soon to determine if we've had strong enough buying. My guess is we cool off a bit early next week and then we'll have to see how the market behaves to get a better sense of whether this is a sustainable rally or merely a dead cat bounce.

Follow the Money - Weekly ETF Flows

When looking at inflows and outflows into major exchange traded funds (ETFs), we can see the last week was clearly risk-off with a total of $17.8B in outflows from large and midcap ETFs (SPY, IVV, and IJH). Also, the Emerging Market ETF (EEM) and iShares Russell 2000 ETF (IWM) saw large outflows of $2.0B and $1.6B respectively. On the opposite side, there was a massive inflow into bond funds with $8.9B moving into the iShares UST bond ETFs (SHY, IEI, TLT, IEF) and the iShares corporate bond ETF (LQD). Most of the money moving from stocks to bonds occurred on Monday and may have spelled capitulation as highlighted on Thursday (see post) along with Michael Harnett, chief investment strategist at Bank of America Merrill Lynch: Stock market correction is over, flows show capitulation: B. of A.'s Hartnett.

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Source: Bloomberg

S&P 1500 Member Trend Strength

As shown below, the long-term outlook for the S&P 1500 is clearly bullish as 72.8% of the 1500 stocks in the index have bullish long-term trends. The market's intermediate-term outlook slipped to bearish at 37.5% this week from last week's 49.8% reading. The market's short-term trend remains in bearish territory at a 25.2% reading. What we have is a short-term and intermediate-term oversold condition in the context of a bullish long-term trend.


* Note: Numbers reflect the percentage of members with rising moving averages: 200-day moving average (or 200d MA) is used for long-term outlook, 50d MA is used for intermediate outlook, and 20d MA is used for short-term outlook.

The most important section of the table below is the 200d SMA column, which sheds light on the market's long-term health. As seen in the far right columns, you have 72.8% of stocks in the S&P 1500 with rising 200d SMAs and 63.4% of stocks above their 200d SMA. Also, eight out of ten sectors are in long-term bullish territory with more than 60% of their members having rising 200d SMAs, with the utility and telecom sectors the only ones with a reading below 60% at 34.4% and 53.3% respectively. Downside leadership in traditionally defensive sectors is not a cause for alarm.

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Source: Bloomberg

S&P 500 Market Momentum

The Moving Average Convergence/Divergence (MACD) technical indicator is used to gauge the S&P 1500's momentum on a daily, weekly, and monthly basis. The daily and weekly MACD for the S&P 1500 are still on sell signals with a weekly sell signal given two weeks ago as short-term momentum loss has turned into medium-term momentum loss. However, the monthly buy signal given in early 2012 remains in force as the market's long-term momentum remains solid.


Source: Bloomberg

Digging into the details for the 1500 stocks within the S&P 1500 we can see that the daily momentum for the market has deteriorated sharply from a reading of 71% a few weeks ago to the currently bombed out reading of 18%. Readings below 20% are associated with short-term bottoms and why there is a strong chance we rally into next week.

The intermediate momentum of the market worsened as well as it fell from 56% three weeks ago to 36% this week, putting it into bearish territory and which also led to a weekly sell signal on the S&P 1500. Currently, the weekly numbers are at levels we've seen with intermediate-term bottoms in the past.

The market's long-term momentum remains solid at a strong 72% this week, putting it well into bullish territory as the market's long-term momentum remains steady. The best way to read the table below is that we are both short and intermediate-term oversold in a strong bullish trend. This is what you look for to "buy the dip" in a bull market.

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Source: Bloomberg

As highlighted in past reports, it was concerning to see the market heading higher while the percentage of members with weekly MACD buy signals fell, and why I felt weakness lay ahead. With the pullback, the weekly reading is where it was at the last three intermediate lows and supports the notion we've seen an intermediate low. What is concerning and will have to be watched ahead is the slow deterioration in the long-term monthly signals, which still remain in bullish territory (> 60%). Should we see a dip below 60% that will be a clear warning sign the market is on shaky ground.

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52-Week Highs and Lows Data

What continues to be encouraging about the market is that even in the midst of a decline we still saw more new highs than new lows this week and suggests the bulls retain hold of the market.

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Source: Bloomberg

As I've highlighted often in my writings, the best way to tell when a bull market is transitioning into a bear market is by looking at spikes in 52-week highs during rallies versus spikes in 52-week lows during declines. Whichever spike is greater shows who's in charge. This can be seen looking at the 2000 and 2007 tops where the spikes in new lows exceeded the prior spike in new highs on a preceding rally before the market peaked. Also, you can see in the middle of 2003 that the bulls took control when you saw a greater spike in new highs than in new lows.

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With that in mind, when looking at the S&P 1500 over the last two years we have seen spikes in 52-week highs continue to dominate, and the near muted response in 52-week lows despite the sell-off continues to suggest this is a healthy pullback in an ongoing bull market.

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Source: Bloomberg

Market Indicator Summary

Below is a multi-indicator chart of breadth and momentum in the S&P 500, which shows we reached an oversold condition late last week and that a snapback rally was highly likely. I want to see a surge in MACD buy signals north of 10% (very bottom panel) to declare the current rally anything more than a dead cat bounce.


Source: Bloomberg

What is encouraging is that the market's pullback has gone a long way in removing the excessive bullish sentiment that occurred as we entered the year and there is now a healthier mix of optimism and pessimism between investors.

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Source: Bloomberg

Summary

The most important take away from this report is that the long-term trend and momentum of the market remain deep in bullish territory so talk of a bear market is highly premature, particularly given that spikes in new 52-week highs have been dominating spikes in new lows during declines. We reached intermediate-term oversold levels this week and saw major capitulation out of the stock market and into the bond market that often is a hallmark of major lows. However, what we need to see now is significant buying and strengthening momentum to declare the current rally anything more than a dead cat bounce. We will likely have some backing and filling going on next week, and hopefully-- as the dust settles-- we will get a better sense of the market's next direction. Overall, do not lose sight of the market's long-term trend, which still remains firmly bullish.

Source: Market's Bill Of Health - Capitulation Monday Set The Stage For Market Rally