The Die Is Cast: A Substantial Market Downtrend Could Begin Within 10 Days

| About: SPDR S&P (SPY)

Summary

A contentious political campaign is underway…. The do-nothing Congress is hobbled by the Republican Party which is in disarray…. The outcomes of elections could have profound effects on the market.

By now, every investor this side of the planet Jupiter should know the U. S. economy (and the stock market) continues to be on life support provided by the Fed.

In my 4-25-16 article, I concluded the SPY (at 209) would have to overcome significant resistance to get through its 150-day high of 211. It is now at 206.

Thus far, the bulls haven’t fared very well: the SPY, QQQ and IWM are down 2.3%, 8.1% and -8.0%, respectively, from those highs. Furthermore, the market’s technical condition also weakened.

In this article, I will use the “confirmed trends” component of the “Sobon Oscillator” to show that a significant downward trend in stock prices could begin within 10 days.

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 statistically comparable to any other such item relating to stocks or ETFs.

Forecasting the market is a guessing game and one needs to make educated guesses based upon known historical performance.

There are five component parts (and some 34 variables) in my oscillator. These relate to (1) price trends for major market indexes and (2) the volume of trading in such. (3) Highs and lows for some 450 stocks in my data base and (4) strength or weakness on the moving average trend lines for such. And (5) "confirmed trends" for the 450 stocks. I get to choose which of the component parts I wish to emphasize when drawing my conclusion. For this article I chose (5) the confirmed trends component of the oscillator. The other four will not be charted in this article and neither will they be discussed.

General Overview of the Recent Rally

For perspective, let's look at the chart below to see what happened in the stock market during the last 150 trading days (that's about seven months) that got it to where it is now.

Click to enlarge

The chart shows the performance of seven well-known ETFs during the 150 days (about seven months). Also shown are (1) my index of 450 stocks (the dark blue line) and referred to in the legend as S450; and (2) my index of 43 technology stocks (the light blue line) and referred to as Tech43. The S450 index is unweighted (as is the Tech43) and it correlates well with the Guggenheim S&P Equal Weight RSP (NYSEARC: RSP), the black line on the chart. The other equal-weighted index, the Nasdaq 100 (NASDAQ: QQEW), is the light green line on the chart.

All of the other indexes shown are capitalization weighted; and, they are identified by colors of their lines in the legend of the chart. They include the S&P Industrial Index (NYSEARCA: SPY), the Nasdaq 100 (NASDAQ: QQQ), the Russel 2000 (NYSEARCA: IWM), the S&P 400 large-caps (NYSEARCA: ^OEX), and the S&P 400 mid-caps (NYSEARCA: MDY).

Because the SPY is widely considered to be the most important of all market barometers, I consider it to be the benchmark indicator for the general market.

All of these market indexes bounced off the bottoms of their price charts in February, beginning 64 trading days ago. However, some did so more dramatically than the 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 so-called "investment-grade" companies) outperformed the large-cap stocks.

The chart shows that most of the indexes performed well during the bounce: but (1) the SPY was outperformed by the RSP because (2) the mid-cap stocks such as those in the MDY outperformed the large-cap stocks like those in the ^OEX. The market showed weakness during the last 11 trading days but these four SPY related indexes did significantly better than the others being discussed here.

(3) The QQQ and the QQEW were laggards during the bounce when compared to the SPY. The QQQ is lopsidedly weighted with large cap stocks (the top six stocks in the index account for 36% of its value). Weakness in Apple (OTC:APPL) and a few other stocks took their toll and caused pronounced weakness in the QQQ. It and QQEW are now underperforming all of the other indexes being discussed.

(4) The IWM also bounced but it lagged the performance of the SPY.

(5) My Tech43 index matched the strong and bullish performance of the RSP up until 11 trading days ago. Following the lead of technology stocks like Apple (NASDAQ:AAPL), this index showed "pronounced weakness" as some of its component companies reported poor operating results. This augurs ill for the near-term future of the Tech43. It had outperformed all of the other indexes referred to above for the last two years.

And (6) my S450 had been keeping pace with the four SPY related indexes up until the time that the technology stocks started to act poorly. Nevertheless, it still outperformed the QQQ and the IWM by large margins.

When I write an article like this I consider all of the feedback that I get from the oscillator when drawing conclusions about the outlook for the stock market. And I get to choose which subsets of breadth indicators I emphasize when finalizing a conclusion: (1) if I see that trend-changing developments are occurring in any of four component parts of the oscillator, I could use that feedback to make my final decision about the market's indicated trend. Or (2) I could refer to a fifth component dealing with the computer generated "confirmed trends" breadth indicators as shown in the bottom panel of the next chart.

The chart below is a copy of the previous chart with a few things added.(1) The panel on the bottom is the "confirmed trends" component of my oscillator as referred to above. And(2) the pink box frames the performance of the market as it went down to make its trough while the white box frames what happened since the market went up to make its high some 12 days ago.

Click to enlarge

According to the oscillations shown in the panel, the current "long-term cycle" started when the market went down to make a trough in August 2015 and then it went up to make a peak near the end of April 2016. That entire time span lasted about 120 trading days (that's six months). And now I expect the stock market to go down to make another trough, beginning within 10 days. Why? Consider that which follows:

The long-term trend indicator (OTC:LTTI) is the black line on the panel and it is much less volatile than the short-, medium- and longer-term crossovers (the green, red, and blue lines, respectively). The shorter cycle indicators lead the longer ones to where they are going (such is true although that may not always appear to be the case as shown in the panel because there is a trick to interpreting the oscillations which I will not explain here).

The short, medium and long cross breadth indicators (the bottom panel) are identified by the green, red and blue lines, respectively. As crossovers, they are lead indicators for the "Long-Term Trend Indicator" (OTC:LTTI) as each of them oscillates the way that it does. As can be seen (1) they weakened and then led the LTTI down from its near-maximum high of 86% (with 100% being the maximum) as shown in the left side of the panel. At times when they showed strength, such was not sustainable long enough to arrest the downtrend in the LTTI.

(2) When the LTTI reached its bottom during August 2015, it showed a reading of minus 93% (which was near to its possible minimum of minus 100%). When that happened, the short, medium and long crossovers were already showing substantial strength because the LTTI had already gotten to the lowest level that it would go. So they had nowhere to go but up.

(3) The brief rally in the stock market indexes fizzled and they went down to test their recent lows. Such tests were successful. But following the lead provided by the short, medium and long crossovers, the LTTI continued to rise and then trended upward to reach a high of plus 94% about 12 trading days ago.

(4) Since then all three of these breadth indicators trended lower but the LTTI (although trending downward) is still in positive territory, with a reading of plus 18%.

(5) In order for the LTTI to be positioned for a pronounced drop in stock prices, it would have to drop below the zero line. Until that happens, a significant market correction will not likely occur.

(6) To understand why such is so, consider the following: on the left side of the pink box you can see when the LTTI went from a positive (bullish) value to a negative (bearish) value. And on the right side of the pink box you can see when the exact opposite occurred. Between those two points, the stock market trough began and ended…. Using the same logic, the white box shows when the stock market rally began and it will likely show when it ends (which I am guessing will happen within 10 days).

And in conclusion (7) if and when the LTTI drops into negative territory, the market's technical weakness could make it vulnerable to a waterfall drop in stock prices (such as that which happened in August 2015). I am not going to put a number on how low the SPY could go. When you start making estimates like that, it is easy to let the wish father the thought and that is when you can get whipsawed by Mr. Market. I much prefer to follow his lead and that is why I constructed my oscillator the way that I did.

I am bearish on the long-term trend of the stock market because of (1) the inadequacies of the monetary policies being used by the central bankers that benefit the business establishment at the expense of just about everybody else and (2) the political problems extant here in the United States and also abroad. I wrote extensively about such matters in previous articles so I will not repeat that which I already wrote.

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 the market when suitable trading opportunities present themselves. At the present time I do not own any stocks. But, I have been doing some short-term trading in a leveraged inverse ETFs.

The chart below shows the performance of three popular 3x leveraged ETFs related to the SPY, QQQ and the IWM, for the last 150 trading days (in addition to the price lines for the market indexes and oscillator previously shown). It also shows the performance of the VXX. These speculative investment vehicles should only be used by speculators (gamblers?) who understand and can accept the risks involved.

Click to enlarge

They are volatile and, surprisingly, they only performed well when the market decline was at its worst as shown in the pink box. During the recovery phase of the long cycle they were generally in a declining trend. At the present time, only the SQQQ is making some upward progress and that is because the QQQ is doing so badly. If the opportunity presents itself, I expect to be a buyer of some of these speculative vehicles in the not too distant future.

If readers are interested in trading inverse ETFs, I suggest that they learn whatever they can about them now.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.