Just last week the S&P-500 SPY made a new 52-week high above 2100 and sat just 2% shy of all time highs. The recent 3 day losing streak has shaved 2% off the market and brought it to 2079, yet the bears would have you believe we're below 2000 on the SPX. Not only are they parading around on social media claiming victory, but they're also declaring once again that this is the "top". Personally I think their reason for claiming victory is they haven't lost money for the first time in several weeks, which is a win in their books. After seeing the market soar over 300 points the past 3 months, any red is going to be a relief for the stubborn bears remaining short.
The strange thing is one of the main arguments amongst bears is the market simply can't go higher after going up 300 points in a row and it's overbought. This argument is akin to betting on red at a roulette table because the past 30 outcomes were black and it can't be black forever. While it's true it will eventually be red, you may have no money left to bet by the time a red outcome shows up, and the same holds true for the market. Those short the market currently are shorting a resilient up-trend that is above all of its key moving averages. Even the 200-day moving average has finally begun to point higher, which is the barometer for bull and bear markets. The time to be short the S&P-500 was while we traded under a declining 200-day moving average, not when we're trading above it as its slope turns positive. I see absolutely zero reason to be bearish until we break the 2000 level on the SPX and believe we will continue to rally throughout the summer months.
Past 2 days: VIX up 40%, S&P-500 down 1.7%
The past 2 days the volatility index VXX has exploded higher, while the market has recorded a measly 1.7% drop. This is the weakest 2 day sell off ever for the SPY for a 40% jump in VXX. To put this in perspective, while yesterday was the 8th best day for VXX in the past 25 years, it was the 1085th worst for the S&P-500 or basically a non-event. The SPY lost 0.81% yesterday, yet looking at the VXX up 20% you'd think the market had fallen off a cliff. Of 70 occasions since 1990 when the VXX gained 20% or more in one day, the average drop for the SPY was 2.95%. I attribute this to many investors being at their wit's end with Brexit fears and interest rate chatter wherever you look. In the past several years there are several times we've had pervasive fear due to the debt ceiling, Greece defaults and Ebola scares, and like all of these other panic scenarios this too shall pass. The below chart from Jordan Thurow shows how large of a standard deviation from the norm this VXX move is given the move in SPY yesterday.
So what does this all mean? You're likely wondering what happens next when the VXX records massive gains exaggerating the drop of the overall market. Interestingly enough, there have only been 8 other times when the VXX jumped 40% in 3 days while the market fell by 3% or less. In 7 of these 8 occurrences a month later the market was up 1.9%, with a median return of 2.7%. So while many bears will use this statistic and tell you the VXX is foreshadowing on what lies ahead, they're completely wrong as the odds lie in the longs favor in more than 80% of these instances.
NYSE Mclellan Oscillator approaching oversold levels
The NYSE Mclellan Oscillator (NYMO) is a useful tool in helping to see where the market is on an overbought and oversold basis. The most useful application of this indicator is buying oversold readings when the market is in up-trends, and shorting overbought readings when the market is in downtrends. As you can see from the chart above, the overbought reading on March 7th (+ 180 NYMO) occurred at 1990 on the SPX and the signal was basically a non event. The reason the signal was a non event for the most part was because as stated above the NYMO indicator is most useful trading in the direction of the dominant trend. Markets move based on momentum and oversold can easily become more oversold so the only time I use the NYMO indicator is when a clear up-trend is in place. Looking at the past 2 oversold readings in April and May of this year, an oversold NYMO translated into a 4% rally on the market within 2 weeks or less. In the below chart I have shown more instances of the application of oversold NYMO readings in up-trends. On all of these 3 occasions when the NYMO flashed an oversold signal the market rallied 4% or more within the next 2 weeks. While some may look at the 2nd signal and say the market only went up for 2 days and then continued to drop, the signal was still valid as there was a drawdown of 0.5% on the long entry before the market reversed back higher. I would call this a winning trade as any time you have a drawdown of 0.5% or less from a signal and are up 4% over the next month, that is a good risk/reward trade. By no means is the NYMO a holy grail but I find it very useful to see where we are in terms of an overbought and oversold basis at any given time period. While there is a possibility we could see a further 1-2% decline here before a bounce, I would be covering shorts here as a bear as opposed to riding them out. The S&P-500 is currently sitting very close to readings which have preceded bottoms in the past and I believe longs have the odds in their favor here, not the bears.
Bears warn of divergences, yet breadth indicators at new highs
There is no end to the list of negative divergences the bears have pointed out as we rallied 300 points the past 4 months. From relative strength divergence to MACD divergence, the bears have tried tirelessly to slow up the SPY with their gloomy indicators but so far to no avail. Not surprisingly, I haven't seen any bears pointing out all of the positive divergences this market has shown us, especially concerning market breadth. Last Tuesday the NYSE made 395 new 52-week highs, the most in over 2.5 years and the furthest thing from a bearish indicator. The last time the NYSE had a reading of similar magnitude was in October of 2013 when it recorded 460 new 52-week highs. This was an extremely bullish development for the market as it marked the lows for the 12 months and returns going forward were exceptional. Going forward 6 months from the signal the return was 10.2% and 12 months from the signal the S&P-500 was up 15.8%. If we saw a similar move in the current market that would put us at 2407 on the SPX by next June.
In addition to purely NYSE 52-week highs on a daily basis, the advance/decline line is not showing any signs of a cyclical top. In every top of the past 50 years the NYSE advance/decline line (NYAD) has diverged and trended down while the market went higher. This is not the case at all with the current market as breadth makes new highs while the market consolidates just below all time highs. Zooming into a more current chart of the NYSE advance/decline line, you can see that during this pullback the NYAD has made a very routine pullback and the up-trend remains very clearly in place.
Technical Outlook & Summary
I believe that bears would be much better served to practice reactive investing rather than predictive investing as they continually attempt to call tops on the market. The NYAD chart shown above will tell you when a cyclical top is in place if you have the patience to wait for it, yet bears consistently attempt to predict the top while the signs are not in place. In addition to this the 20-month moving average has been successful in predicting the past 2 major corrections, yet the bears ignore that indicator as well. Click to enlarge
The S&P-500 has always traded below the 20-month moving average before a real correction occurred. In 2 of the 3 instances in the past 16 years the market fell below the 20-month moving average and found resistance trying to regain it, which spelled serious trouble for bulls. In 2011 SPY fell below the 20-month moving average but quickly regained it and it ignited a massive 100% rally over the past 5 years. This was a failed bearish signal for the bears and is worth paying attention to, as the market has currently done the exact same thing. The only difference in this signal and the signal in 2011 is the market has lost and regained the 20-month moving average on two occasions, trapping even more stubborn bears this time around. Zooming in on the chart you can see the 20-month moving average is at 2046 and until we close below this level on a monthly basis, I don't believe the bulls have anything to be concerned about.
Looking at a daily chart of the S&P-500 there is absolutely nothing bearish about the current scenario. The 200-day moving average has finally started to turn positive while the 50-day moving averages is trending higher. SPY is sitting on its up-trend line with an oversold NYMO reading and also right above its 50-day moving average, an area it often finds support near. From a trend following perspective, the market just made new 55-day highs and is simply experiencing a brief pullback to shake out some "late to the party" bulls.
Looking at the QQQ, the chart is very similar to that of the SPY. While the QQQ has lost its 50-day moving average it is still above its 200-day moving average and is trending higher after having just made a new 55-day high. 55-day highs are significant as they represent Turtle trading long entries and any trend followers using the Turtle Trading System as I do would be going long the market using this signal, if they were not already long previously. The QQQ is also sitting right above up-trend support and is still in a very clear up-trend and bull market as long as it holds above the 107 level. Click to enlarge
Anything is possible in the market and Brexit may finally be the catalyst to take the market down. My point with this article is that there is no reason to be predictive but instead being reactive we can still get short but do so when all of the indicators align. Currently the outlook for the market is still bullish and I believe this is a routine pullback to shake aggressive longs out of the market. My opinion on the market's bullishness would change if I see a daily close below 2010 on the S&P-500 which would violate the 200-day moving average and inflict some damage to the current up-trend. I believe bears are currently attempting to front-run a crash or decline in the market and I don't believe it is wise to do so. Crystal balls have never been a successful way of investing in the market and with the market near oversold levels and breadth at all time highs, this is not the time to be short.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPY over 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.
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