Expect This Volatility to Stick Around

 |  Includes: QQQ, SPY, SSO, XBI, XHB, XME
by: Bruce Zaro

Last week, markets had their best week in 4 years as the recovery from the January 22nd morning meltdown continued. Yesterday gave us an overdue down day, but here's why I believe the action we've seen recently will lead to more than just a rally. I see this timeframe as one akin to the important market low of March 12th 2003 or, worst case, the October 10th 2002 bottom. I believe there's an increasing chance we will add January 21st 2008 to the list, a month from now.

Here's the key evidence I'm looking at:

Selling is dry up

The number of new lows on the New York Stock Exchange reached the 1100 range in the January 21st sell-off. Such an extreme reading is rare indeed and has typically marked important bottoms. Since that day, the list of new lows has shrunk dramatically and the new high list is expanding apace. The same is true for the NASDAQ universe, albeit in a more muted trend.

Buyers are emerging

Those high/low readings are reversing up in tandem with the percentage of stocks above their 50 Day Moving Average. Usually I have more faith in a move if both of these reverse up in tandem, as they are doing now.

Multiple sectors showing strength

Twenty-eight of the forty sectors I cover are now showing an increase in the number of buy signals in their groups; this reading is up from just two such sectors at the market low. Most importantly, the bullish percent, which I have referred to recently, also reversed up from levels a tad below those seen in the aftermath of the 1987 Crash! This indicator continues to suggest that demand is taking charge.

We're still closer to oversold

While a majority of sectors have begun to exhibit strength, all the indicators mentioned above remain in, or near, deeply oversold territory and should have plenty of room to move higher from here. Even that all-important gauge, the bullish percent has only increased from that low in the mid-teens to the 32% level; keep in mind, the 30% level is typically considered very oversold, and is a level that's rarely reached on the way down.

In other words, don't let yesterday's sell-off shake your faith; all the market has done over the last two weeks is move from a dramatically oversold condition to a routinely oversold one. Given the ongoing fundamental fears about the health of our economy, I expect heightened volatility to remain for quite awhile, but I do not expect today's sell-off to lead to something worse than we've already lived through.

Keep your wits about you; we remain in a low-risk environment for buying equities, a result of the tough sell-off which likely concluded on January 21st.

Investors looking to participate via ETFs can be acquiring broad market issues like QQQQ or SPY. More aggressive buyers can even be looking at leveraged long ETFs such as SSO, which provides 200% exposure to the S&P 500.

Leading sector ETFs which can be considered include XME (metals and mining), XBI (biotech) and XHB (homebuilders).

Disclosure: The author is long QQQQ, SSO, XME, XHB, XBI