The Stock Market Rally Should Continue In The Short Term

| About: SPDR S&P (SPY)


The market’s downtrend ended when a 3-day rally bounced the SPY 6.0% from 181 to 193. That was followed by another 5.6% gain to 204 during the next 22 days.

The SPY is 4.4% below its high of 213. But there is substantial resistance up to 213 on its price chart. The charts for QQQ and IWM are much weaker.

The Fed still uses ineffective monetary policies. The do-nothing Congress is still obstructive. And the electorate wants changes made in the way the game of politics is played.

Resolution of these troublesome situations could have profound affects upon the performance of the economy and the stock market for many years to come.

The “Sobon Oscillator” continues to track the performance of stocks as it provides feedback for guesstimating what the SPY will do during the near-term future.

Introductory Considerations:

All of the statistical data used in this article was processed in my workbook. And all of the price and trading volume data fed into the workbook was downloaded from Yahoo Finance. I make extensive use of index numbers in the analysis that I do. So wherever you see multiple price lines on a chart or bars where trading volume data is shown, the performance of one line or bar is fully comparable to any other such item relating to stocks or ETFs.

"The way to make money in the stock market is to buy a stock. Then, when it goes up, sell it. If it's not going to go up, don't buy it!" - Will Rogers

Regarding the Economy, the Fed and Politics

In the first of seven articles I wrote during the last three months, I included the paragraph which follows. It is long and because of the important issues it addresses, if the reader reads it and nothing else that follows, this article will have served a purpose because he might get an idea of the magnitude of the potential downside risks in the market. At the present time, Mr. Market appears to be oblivious to such risks:

"With the free-market economic processes being "corrupted" by the Fed's wishful-thinking policies, there was little need for corporations to launch capital expansion programs despite low interest rates because prospective demand growth was tepid, due to the fracture of secular growth trends caused by the 2007-08 financial fiasco. Besides, corporate leaders could easily boost stock prices by using profits (and/or borrowing money at low interest rates) to finance share buyback programs which (not surprisingly) increased the value of their stock options. And when financial assets are diverted from investment in capital assets, the role that the "accelerator" has as a determinant of economic growth is diminished. There was (and continues to be) high underemployment and little growth (if any) in per capita discretionary income (which is the main driver of the economic "multiplier," as such relates to consumer spending). The Fed was (and continues to be) more concerned about fighting deflation than inflation or the imbalances in the economy which it helped to create. To Wall-Street types "bad news was often considered to be good news" so they took advantage of the so-called "Fed put" and pushed stock prices higher from time to time simply because the flow of lackluster economic news gave the Fed excuses for not increasing interest rates. Things endure according to the amount of virtue they contain. And there wasn't much that was virtuous about the performance of the Fed, the do-nothing Congress or corporate America before and after the fiasco of 2007-2008. Can there be any doubt about the reasons why economic growth has been anemic?... That explains why the underpinnings of the economy were (and still are) weak and dependent upon the Fed for the life support... And on the basis of what is currently being talked about by Fed officials regarding their interest rate policies (with a quarter-point hike in the discount rate in December 2015 and another such "data-dependent" boost in each of the four quarters of 2016), it may be that they are finally acknowledging the fact that their policies since the end of Q1 (which did bailout the economy) were counterproductive. If the aforementioned rate increases occur, the Fed's policies might be less counterproductive than they had been, but counterproductive nevertheless because QE does not get to the root of the problem." (Emphasis added.)

Right now, the mood on Wall Street is bullish because the Fed did not increase the key interest rate at last week's meeting although salient economic conditions met its stated goals for doing so. Janet Yellen did a hocus-pocus job trying to explain the Fed's inaction because she feared, among other things, that a possible rise in the dollar could have an adverse effect on exports. Goldman Sacks opined that the interest rate decision was the most dovish statement made by a Fed official during this century. Christine Lagarde said that Mario Draghi's decision to cut rates was appropriate because it made things better than they would have been. What she failed to say is that no enduring benefit will result from his action and additional imbalances in economic and stocks market structures could (and probably will) get worse.

The Fed's recent opinion was extremely naïve. And it shows that Yellen and the others have painted themselves into a corner and don't know how to get out of it. Add to that the fact that (1) the do-nothing Congress is in a state of political gridlock that has been exacerbated by the vacancy created on the Supreme Court which the Republicans do not want to see filled because it could change the conservative balance among the justices. (2) A contentious political campaign is underway and the Republican Party is in disarray and it is having trouble choosing an electable leader. (3) Political and monetary problems exist in many foreign countries. And (4) it appears that we may already have an international house of cards and the central bankers (along with the politicians) don't know how to cope with it. Nevertheless, the performance of the stock market is still dependent upon the investment (speculative?) decisions made within the investment community. So let's consider that which follows to see what the recent sweep of such decisions were up to the present time and what that may indicate for the market during the near- to longer-term future.

The Performance of the SPY and Related Indexes

The white box on the chart frames the performance of the market during the last 25 trading days. During the first three of those days all of the indexes shown bounced and then trended higher for the next 22 days. Later on (in the section of this article dealing with the "Sobon Oscillator") I will focus on those last 22 days and guesstimate what such indicates for the near-to longer-term future.

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The chart above shows the performance of six well known ETFs during the last six months. And, my index of 450 stocks (the blue line) and referred to in the legend as S450. The S450 index correlates well with the Guggenheim S&P Equal Weight ETF (NYSEARC:RSP), the black line on the chart. All of the other indexes shown are capitalization weighted and they are identified by their line colors in the legend on the chart. They include the S&P Industrial Index (NYSEARCA: SPY), the Nasdaq 100 (NASDAQ:QQQ) and the Russel 2000 (NYSEARCA:IWM), the S&P 400 large-caps (NYSEARCA: ^OEX), and the S&P 400 mid-caps (NYSEARCA: MDY). Since the SPY is widely considered to be most important of all market indexes, I will refer to it as the primary indicator for the market.

All of these market barometers bounced off the bottoms of their price charts about 25 trading days ago. However, some did so more dramatically than others and therein lays the key to understanding the rally's performance: the small- and mid-cap stocks (which are usually considered to be more "speculative" than the larger "investment-grade" companies) outperformed the large-cap stocks: (1) the equal-weighted RSP (black line) outperformed the capitalization-weighted SPY (red line). (2) The MDY mid-caps (orange line) outperformed the ^OEX large-caps (purple line). (3) The IWM (brown line) is loaded with small-cap stocks. It had been the long-term laggard among the indexes shown but it outperformed all of them during the first 20 days of the rally. (4) The QQQ (green line) is much more heavily weighted with large caps than any of the other indexes and it outperformed all of the other indexes by wide margins during recent months. But it underperformed all of them during the 25-day rally. And (5) whereas the SPY is 4.4% below its all-time high, the QQQ and the IWM are 7.5% and 16.3% below their respective highs.

The three horizontal lines on the chart relate to the 150-day trading range for the SPY. The red hashed line indicates the bottom of the trading range for the SPY at 181. The dotted black line relates to the SPY's current price of 204. And the blue hashed line defines the top of SPY's trading range at 213. In order for the SPY to break above the blue line and make new highs, it would have to get through much technical resistance on its price chart. (But it would be much more difficult for the QQQ or the IWM to do that and make new highs because they show much more technical weakness on their price charts than the SPY.) To address the possibility of that happening, I will accede to the analysis presented below when I write about the "Sobon Oscillator".

The heavily weighted stocks have much influence upon the weighted market averages. The top 25 stocks in the SPY 500 stock index account to about 36% of its value. The chart below shows that their performance was fairly balanced during the past 25 days (framed by the white box) when compared to the SPY (the bold red line) or the RSP (the yellow line).

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The next chart shows the performance of the top 15 stocks in the QQQ, with the focus being on the 25 days framed by the white box. The 15 stocks in this 100-stock index account for a lopsided 37% of its value. None of them managed to make new highs. And several heavily weighted stocks were mediocre performers among them.

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The next chart shows the performance of my 24 industry groups, with the white box framing the price action during the last 25 days. The groups are identified in the legend along with the number of stocks in each group.

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All 24 of these groups participated in the rally with gold stocks (the yellow line) showing the biggest gains from very depressed levels while industrial metals (the white line) doing very well also. The MLPs (the dark red line) bounced from all-time low levels but they are still laggards in the market.

The next chart shows the performance of foreign stock markets, with (you guessed it) the white box framing price action for the last 25 days.

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The chart shows that the recent rally in stock prices was a world-wide phenomenon as investors in foreign countries found reasons for bidding up stock prices.

The bottom line conclusion to be drawn from this chart presentation is that speculative interest in stock markets was pervasive on a world-wide basis. When that happens, stock prices can only go in one direction, with that being up. Whether such was rational or irrational is debatable. Others can engage about such matters if they so choose. When it comes to the stock market I rely upon feedback that I get from my oscillator to indicate what has been happening in the stock market and indicate what will likely occur during the near- to longer-term future. And that part of this article follows:

Documentation by the "Sobon Oscillator"

The oscillator is an original creation of mine. It is based upon empirical knowledge gleaned from the harsh lessons taught in the School of Hard Knocks, to which I paid my dues. My workbook requires some 1.3 million computations to update daily. Most of that is required by the oscillator. Since I use a high speed computer, processing of the input data (all of which relates to stock prices and trading volume) is not a problem. The source of all such data is Yahoo Finance. There are many moving parts and I upgrade them when needed. I recently added two new indicators (they are really refinements of another indicator) and if additional indicators are needed, they will be added. It is easy to develop a useful indicator providing a problem can be defined. So if I miss badly on a guesstimate that means there is a problem and it is up to me and not the tooth fairy to solve it. Since last August when the oscillator was activated, all of my guesstimates about the near-term performance were ballpark correct.

By using the feedback that I get from the oscillator, I will (1) explain the salient features of the stock market's performance as documented in the next chart. And (2) guesstimate what such signals for the near- to longer-term future as the market trends toward its "always" ill-defined long-term goal.

To facilitate understanding of what the oscillator does, let's quickly review what the 34 variables shown in the four panels on the chart are all about:

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(1) The first (top) panel shows the daily price change from the previous day for the SPY, RSP, and the S&P 100 index (^OEX). For perspective, it also shows such data for the Nasdaq 100 index, the Russell 2000, my index of 450 stocks (which I call the S450), and my index of 45 technology stocks (which I call the Teck45).

(2) The second panel shows the volume of trading in the SPY, QQQ, and IWM ETFs as well as the S450 and Teck45 indexes. The higher are 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 or lows" in the S450 index. The time spans for eight series of highs or lows range from about one week to seven months, as the shorter ones (referred to as S1, S2, S3 and S4) are lead indicators for the longer ones (the L5, L6, L7, and L8). 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)." Also, I am always ready and willing to improve the effectiveness of the oscillator. So I recently added the"RE1" and "RE#2" breadth indicator to the eight shown in the third panel. They are the"accelerator" and"sustainer" among the "momentum" indicators. These terms will lack meaning to readers but they have important and well defined meanings to me. I will have more to write about them shortly.

And (4) the fourth (bottom) panel shows breadth indicators for the"moving averages" for the 450 stocks. The time spans for the eight moving averages range from about one week to seven months. The shorter-term breadth indicators (referred to as S1, S2 and S3) are lead indicators for the longer ones (the L4, L5, L6, L7and L8) 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 two short-run time periods framed by the colored boxes on the chart. The section on the right side of the chart (the pink box) shows data relating to this week's market activity. That will bring us to the cutting edge of the future.

What happened to the breadth indicators during the 22 days shown on the chart can be summarized as follows:(1) the price-change data for the various indexes averaged below their usual gains (top panel on the chart) even though(2) the volume of trading was at average levels (second panel).(3) The moving averages (the bottom panel) improved steadily from very depressed levels and they are all in positive territory at this time, with the leaders (S1, S2, and S3) indicating that further improvement for the followers (L4 through L8) is probable for nearby days. And(4) the high and low breadth indicators lost much of their momentum during the first eight trading days from their burst to the upside during the three-day period preceding the data shown on this chart. However, during the last 14 days the newly minted RE#2 indicator (the orange bar with the black border) was usually strong because repetitive gains made by the small- and mid-cap stocks on consecutive days. The large-cap stocks were not the primary drivers for the stock market gains. In fact, it you were to look closely at the yellow column with the black border on the top panel of the chart, you would see that the ^OEX showed smaller gains than all of the others. That and knowledge gleaned from other charts shown above led me to the conclusion that what we have been seeing in the market was largely a short-covering rally.

Until such time that the bullish sentiment currently present in the market is reversed, the market should trend higher. There is substantial resistance on SPY's price chart and much more of such resistance on the price charts for the QQQ and the IWM. Although I am bearish on the long-term trend of the stock market because of the monetary policies of the central bankers and the political problems referred to above, I must make allowance for the actions of Mr. Market and conclude that the market will go higher during the near-term future. There is a time to buy and hold stocks, there is a time to sell them, and sometimes one has to be cautious and trade them when suitable trading opportunities present themselves.

The next and last chart shows the performance of the VXX, with the dotted trend lines and hashed lines to show its trading ranges. If and when the current rally in the stock market ends (as it will someday), the VXX should be of interest to those traders who are willing to bet that the downside potential for the market is substantial.

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If it wasn't for the nonsensical policies of the Fed, and the contentious positions taken by the national political figures, what would we investors do for aggravation?

When writing an article like this, I never tell readers what they should do in the market. I write the story according to the way I understand it. I may tell readers what I am doing when I buy or sell stocks. It is up to them to make their own personal investment decisions.

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.