Revisiting 'The Market Correction Is Underway'

| About: SPDR S&P (SPY)

Summary

This follow-up to my recent article confirms my bearish opinion about the stock market for the near- to longer-term future.

Because of the feedback from my up-darted oscillator, I am more bearish now than I was before.

The market is now testing the August lows and I believe it will drop another 10% or more from current price levels.

Introduction

This article is a follow-up to my bearish article on the market posted by Seeking Alpha on January 6, 2016. Stocks in many sectors of the market showed significant price declines since then. And that begs the question, "How low will the stock market go? " Let's see if I can provide some perspective on the market's decline and what it signals, if anything, for the near- to longer-term future.

Since I provided extensive commentary about the economy, the Fed, the do-nothing Congress, and the political campaigns underway in the recent article, I will not do any of that in this article. And except for one significant digression, I will limit my comments to matters that relate directly to the stock market. If a new reader wants to know what I had to write about the other topics referred to, he can read what I wrote in the previous article because nothing of significance has changed regarding them. That article was 14 pages long and drew flak from some readers because of its length. This article will be much shorter and, its scope will be limited to the market's performance during recent days and its prospects for the near- to longer-term future.

Regarding the performance of the market

The first chart (there will only be two) shows the performance of eight well known ETFs during the last six months, and also my index of 450 stocks, which I call the S450 (the blue line on the chart). It is an equal weighted index that correlates well with S&P's equal weighted index (NYSEARCA:RSP) which is the black line on the chart. The other indexes shown are capitalization weighed and they include the S&P 500 index (NYSEARCA:SPY), as well as the S&P 100 (^OEX) and 400 (NYSEARCA:MDY), and also the S&P growth (NYSEARCA:IVW) and value (NYSEARCA:IVE), the Nasdaq 100 (NASDAQ:QQQ) and the Russel 2000 (NYSEARCA:IWM).

Look how "bubbly" the QQQ was (the green line) in comparison to the other indexes during the last 36 trading days. It is a capitalization weighted index and three stocks making new highs during those days account (according to data available on StockTrader.com) for 10.7% of QQQ's index. Those stocks were Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), and Alphabet (NASDAQ:GOOG). Based upon the consensus estimates of 38 analysts, at 607 AMZN is priced at 322 times 2015's earnings ($1.88 per share) and it doesn't pay a cash dividend. GOOG reports a lot of earnings (based upon the estimates of 45 analysts, earnings were $27.16 per share for 2015) but it doesn't pay a cash dividend. Priced at 714, the p-e ratio is 26. Facebook is priced at 97 and it sports a p-e ratio of 45 (based upon the estimate of $2.16 per share by 48 analysts) and it doesn't pay a cash dividend. These are examples of stocks I would avoid in the current investment environment. Besides being fully priced (in my opinion), they are stocks favored by algorithmic traders who may have been responsible for the bubbly price action in the QQQ referred to on the chart shown above. An individual investor is always subject to the whims of such traders and the kind of investment environment indicated for the near- to longer-term future could not be the kind that would work in his favor. But I digressed. The primary purpose of this article relates to the general stock market and not individual stocks.

In my January 6 article, I stated that the market "would go down to at least test the August lows." On the left side of the chart shown above you can see where those lows were. And on the right side of the chart you can see that some of the indexes, notably the Russel 2000 and the S&P mid-caps , have already broken below their August lows while all of the others look like they will do so very shortly. The blue box on the chart frames the price action that occurred during the last 22 trading days. What follows relates directly to those days.

Documentation by the "Sobon Oscillator"

The chart below shows what my oscillator recorded for the 22 days. So let's see what can be gleaned from what is shown in the next chart, with emphasis placed on the price action for the five days beginning with January 2 (the blue box). The oscillator's construction and purpose were fully explained in the January 6 article so little explanation about such will be repeated here. Every day is a new day in the life of a market technician so he gets a chance to justify or change his previously stated opinion as warranted (if the Fed can be data dependent, so can I).

Here is brief review of what the oscillator shows in the four panels on the chart:

(1) The first (top) panel shows the daily price change from the previous day for the SPY, QQQ, IWM, RSP and my S450 index. It also includes price-change data for the S&P 100 index (^OEX) which I added for the express purpose of presentation in this article because of its special importance at this time. I use bars to show the percentage change from the previous day for each of the indexes, with the yellow bar being that for the ^OEX.

(2) The second panel shows the volume of trading in the SPY, QQQ, and IWM ETFs as well as the S450 index. The higher the volumes, the greater are the convictions about what investors (speculators?) think they are doing in the market.

(3) The third panel shows breadth indicators for stocks making "highs-and-lows" in the S450 index, (which I use as a proxy for the RSP with which it correlates highly) and also the SPY (with a lower correlation due entirely to SPY's capitalization weightings). The time spans for the eight series of highs and lows range from about one week to six months, as the shorter ones (referred to as S1, S2, S3 and S4) are lead indicators for the longer ones (the L1, L2, L3, and L4). So they help lead the market to where it will evolve over the longer term as it makes "higher highs and higher lows" (with that being bullish) or, perhaps, "lower highs and lower lows (and that being bearish)."

And (4) the fourth (bottom) panel shows breadth indicators for the "moving averages" for the 450 stocks. The time spans for the seven moving averages range from about one week to six months. The shorter-term breadth indicators (referred to as S1, S2 and S3) are lead indicators for the longer ones (the L1, L2, L3 and L4) since they, too, must help to lead the market to wherever it is trending (be it up, down or sideways).

Since the longer-run trend of the stock market must be a "sum-of-the-parts" that reflect what happened during sequential short-run intervals, let's consider what happened during the three short-run time periods framed by the different colored boxes.

For perspective, let's begin by reviewing what happened in the market beginning on Monday, December 13 (the pink box) with the Fed's two-day meeting scheduled to start on Tuesday, and an announcement about hiking interest rates scheduled for Wednesday. It is no secret that the investment community knew that the rate would probably be hiked by 25 basis points and the establishment would (as it so often does) put a positive spin on whichever way the decision would go to show that "good news was being discounted" or that "bad news had already been discounted". The market was up slightly on Monday and much more strongly on Tuesday and Wednesday on heavy volume. But then after the fact, in whipsaw fashion, the market gave back more than all of those gains on very heavy volume during Thursday and Friday.

That brings us to Monday Dec. 21 (the white box) and two consecutive four-day trading weeks leading up to Christmas Day and then New Year's Day and, of course, the tax-loss selling season. What there was of the "Santa Claus" rally didn't't amount to much and may have been trumped by tax-loss selling considerations. The oscillator ended the year with weakness in all of the short-term breadth indicators but that might have been caused by yearend tax-loss selling pressure. So I waited a few days to see what the investment community did as trading resumed in January before trying to determine the significance of that weakness.

That brings us to the beginning of trading in 2016 (the blue box). On Monday (Jan. 4) the market declined so it was probable that selling pressure in the market during the final trading days in December was not due entirely to year-end tax-loss selling. And with all of the breadth indicators declining like they did on heavy volume, further weakness was signaled by the oscillator for the market during the near-term future. Why? Consider that which follows:

(1) The price changes for each and all of the indexes shown in the first (top) panel declined by more than 1.0%. And the volume of trading in each of them was twice the daily norm as shown by the bars and dotted lines in second panel. The same thing can be said for the three days ending with Friday, January 8. So the selling being done was done with conviction.

(2) The breadth indicators for the moving averages were weak at the beginning of the week and they just kept getting weaker right up to and including Friday. When the S1 breadth indicator (it leads the others) showed a reading of -46% on Friday that meant 92% of its stocks were weak because of the way that these indicators had to be constructed. Since 100% is as low as the S1 could go, it was approaching maximum weakness. The S2 and the S3 indicators were following suit and showed that 84% of their stocks were weak. All of the longer-term breadth indicators were also following suit and showed readings of 72% weakness for the stocks in their respective moving averages.

(3) The breadth indicators for the highs and lows (the third panel) were also weak at the beginning of the week and they, too, got weaker (especially on Thursday and Friday) when the S1, S2, S3 and S4 breadth indicators gave negative readings ranging from -81% for the S1 to -74% for the S4. The longer-term breadth indicators for the highs and lows were following and ranged from -69% for the L1 to -30% for the L4.

The only conclusion that can be drawn from what was now shown by the oscillator is that the momentum in the market was decidedly bearish and, therefore, the market could go lower during the near-term future. How low? My guess is that it could drop another 10% from current price levels.

But, I would also like to qualify that bearish estimate by making some statements about the ^OEX: The big-cap stocks have much to do with the performance of all capitalization weighed indexes as shown by the statements about AMZN, FB, and GOOG made in my digression above. While the mid-caps and the small-caps had been showing weakness in all sectors of the market for many months, the big-caps outperformed them and made the performance of the capitalization weighed indexes look much stronger than they would otherwise be on unweighted bases. So don't be fooled by their relative strength on price charts because they are distorted by the weightings and, therefore, these indexes conceal as much as they reveal. In recent days the weakness in the ^OEX (as shown in the top panel of the blue box) shows the big-caps declined sharply along with the others. Although I didn't include it in this article, my workbook data for the ^OEX shows that it is now 7% below its record high made 44 days ago. And it shows pronounced weakness on the 10-, 21- and 43-day moving average trend lines that I use to define trend reversals. If and when the ^OEX starts to underperform the market on the downside , then it's "Katy-bar-the-door" for the market and it could drop much more than the 10% from current price levels.

Summary and Conclusion

In my previous article I stated that "the market would likely go down to at least test its lows made in August of 2015."

(1) At 192, the SPY is now 10% below its record high of 213 made seven months ago and it is about to test its August low. The RSP and my index (the S450) are at their August lows. And because of negative momentum on their price charts, all of the other ETFs referred to above could test their related lows very shortly.

And more importantly (2) I believe that the SPY could drop another 10% from current price levels before it finds a bottom. But if the ^OEX (representing, as it does, the big-cap stocks) starts to lead the market down, the general market will go much lower than 10% from current price levels.

Addendum

I received many compliments about the previous article and more than 150 new followers. I want to thank the readers for their kind words. I also want to thank the editors at Seeking Alpha for their assistance, especially Mike Taylor who rejected the first draft of the previous article that I submitted. His criticism was constructive so I deleted four paragraphs and revised two others before resubmitting.

Best wishes to all.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.